Summary IREN did not violate our previous thesis but new observations prompted us to update. Firstly, IREN's non-cash book value margin safety is only temporal due to the lack of Bitcoin holdings. Secondly, IREN is not expected to generate material shareholder distributable earnings even during the upcoming bull run. As a result, IREN's ambitious expansion plan could result in only more shareholder dilution without shareholder benefits. IREN's problem is not a valuation problem, but a fundamental one. Introduction In our previous coverage, we suggested that Iris Energy ( IREN ) is not a lost cause despite the loan default, is investible below $2.90 , and could enjoy a short-term 146% (based on 9.1 EH/s capacity) upside potential should Bitcoin ( BTC-USD ) reclaim its all-time high (ATH). This thesis was primarily founded on several observations: 1. IREN was trading below its book value or our adjusted net asset value 2. IREN can keep up with its expansion guidance. 3. IREN can maintain its mining efficiency Although these observations remain intact, we had to update our thesis based on several new observations. In short, the update is not optimistic for IREN. Lack of Investment Value Proposition Explained IREN is a rather peculiar Bitcoin mining company because it does not accumulate Bitcoins. The implication is 2-fold. Depreciable Book Value Positive Margin Safety Net IREN's non-cash book value is technically entirely depreciable. This means that the positive margin between IREN's book value and the share price could eventually be depreciated away. In other words, the safety net presented by this positive margin could be temporal. For instance, IREN's 2023Q2 (latest known) book value per share is $4.58 while our adjusted net asset value stands at $296mil (= $69mil cash + $11.4mil prepaid + $242.5mil PP&E - $26,7mil total liability). IREN's PP&E average depreciation cost is about 9% per quarter. At the current $289mil market cap or $4.32 per share, it'll only take 1 more quarter for IREN to lose its positive book value to share price margin safety net. Comparatively, other miners such as Riot Blockchain ( RIOT ) ( 7,362 BTC ) Marathon Digital Holdings ( MARA ) ( 12,852 BTC ), and CleanSpark ( CLSK ) ( 3,002 BTC ) all have Bitcoin on their balance sheet in addition to the cash on hand. This makes their book value more resistant to depreciation. Lack of Bitcoin Holdings to Counteract Depreciating Book Value Safety Net The other implication is that IREN's book value safety margin does not benefit from a bitcoin bull run. For example, MARA's book value will increase by $12.752mil for every $1,000 increase in Bitcoin price. If our $90k Bitcoin expectation is realized by April 2025, MARA's book value could increase by more than $600mil (assuming all future Bitcoin mined are retained) from just the Bitcoin holdings alone. Hence, this is another minus for IREN's upside potential. You might argue that, even if IREN couldn't benefit from Bitcoin holdings, couldn't IREN benefit from higher profit if our Bitcoin expectation is realized? No Shareholder Distributable Earnings Just Like In The Past No, because of the halving event. IREN's total all-in Bitcoin mining cost per BTC is about $33,640 per BTC (= $109.6mil per year / 3,259 BTC mined ), which is pretty good. But after the halving, IREN's total all-in mining cost would double to $67,280 as the expected Bitcoins mined is halved. We estimate the average Bitcoin price for the April 2024 - April 2025 period to be $66,000 (middle of $42,500 and $90,000 ). As a result, IREN's profit distributable to shareholders would be 0. This is not surprising considering IREN did not return any shareholder distributable profit except for 2 quarters since 2020. On the flip side, what if Bitcoin failed to meet our conservative expectations? The consequence would be even more devastating for IREN. Thus, IREN lacks the investment value proposition from both the book value safety aspect and profitability aspect. The absence of these 2 aspects negates any benefit of having an ambitious expansion plan. IREN does have a good track record of meeting guidance. IREN guided a 9.1 EH/s capacity by early 2024 and looks likely to overachieve. IREN's expansion from 5.56 EH/s to 10 EH/s is fully funded while expansion plans to 20 EH/s have not. Nevertheless, IREN's path to 20 EH/s has clarity thanks to the equipment purchase option at $14mil per 1 EH/s of equipment or a total of $140mil. IREN primarily funds its expansion through equity offerings shown by the correlation between capacity expansion and the number of common shares outstanding (Table 1), negative earnings for all quarters except 2 , and flat total liabilities (after the loan default). At the current market cap, IREN needs to increase its common shares outstanding by 50% (equivalent to a 34% shareholder dilution). Following the narrative presented, this 34% shareholder dilution does not produce any material profit distributable to shareholders. Table 1. Relationship Between Mining Capacity and Common Shares Outstanding FY Common Shares Outstanding (mil) Capacity (EH/s) 2023 66.7 5.56 2022 55 4 2021 19.8 1.15 Source: Author Verdict In short, we could not identify any investable proposition in IREN. We only found a depreciable margin between book value and price, a lack of Bitcoin holdings-driven value add, and a lack of shareholder distributable income, yet shareholder equity could dilute by 35%. We would like to clarify that, unlike CLSK , IREN's problem is not a valuation problem, this is a business fundamentals problem. Therefore, these findings suggest that investors should look elsewhere for "alpha" or even to trade Bitcoin's Beta. So far, we have covered CLSK and IREN and found that both are attractive even though CLSK is much more attractive than IREN. We maintain our stance on HODL-ing spot Bitcoin and consider a small portion of the "greedy" option strategy to drive more returns. We also suggest reading our Bitcoin outlook for 2024 as we continue to cover more miners in the company week. Stay safe.
