Summary Bit Digital is a crypto miner diversifying into Ethereum staking and AI computing to improve profitability. The company's bitcoin mining operations have strong gross margins but struggle to earn a profit due to high corporate costs. Bit Digital's new AI venture has the potential to generate significant revenues, but there are risks and uncertainties in the competitive market. To be upfront, I am a crypto sceptic that have written cautious articles on HIVE Digital Technologies ( HIVE:CA ). The concept of buying rapidly depreciating specialized computing equipment to mine bitcoins with ever increasing difficulty never made much sense to me. However, with the recent rally in bitcoin prices, I am revisiting the space to see if there are any trading opportunities within the crypto miners. This article reviews Bit Digital's ( BTBT ) operations and strategy. Historically, BTBT's bitcoin mining operations is exactly as I envisioned; running on the computing treadmill to mine an ever decreasing number of bitcoins as difficulty ratchets higher. However, the company is diversifying into Ethereum staking and AI computing, which could help diversify revenues and improve corporate profitability. Overall, I expect the BTBT to good financial results for the upcoming Jul-Sept quarter given the YoY increase in bitcoin prices and the already announced crypto production. However, much of the surprise could already be baked into BTBT's share price. I think the more interesting catalyst would be the upcoming revenues and margins for the AI business, which could materially improve corporate margins and swing BTBT into real profits. Company Overview Bit Digital Inc. is an institutional scale crypto miner with a fleet of more than 40,000 specialized computers with a combined hashrate of over 2.0 EH/s (Figure 1). Figure 1 - BTBT overview (BTBT investor presentation) The company has operations in the United States, Canada, and Iceland and 99% of its energy is carbon free. BTBT's business model is unique in that it mines bitcoins, which are then converted into Ethereum and staked to earn yield. The yield is then used to acquire more bitcoin miners, creating a 'Bit Digital Flywheel' (Figure 2). Figure 2 - BTBT's 'Digital Flywheel' strategy (BTBT investor presentation) More recently, the company announced a new AI venture to acquire and host AI workloads for customers. Strong Gross Margins But Not Enough To Earn A Profit The biggest issue I have with crypto miners like BTBT is that despite showing strong 'gross margins' from mining bitcoins, they often have bloated corporate cost structures that lead to poor corporate earnings. For example, for the 6 months ended June 30, 2023, BTBT recorded $17.3 million in revenues and direct mining costs of $10.8 million, or 37.6% 'gross margins' (Figure 3). Figure 3 - BTBT financials (BTBT 10Q report) However, BTBT also recorded $7.4 million in depreciation and amortization and $10.5 million in SG&A, so even if we exclude the gains and losses on digital assets, BTBT had operating earnings of -$11.4 million or -65.9% margin. Excluding depreciation and amortization, EBITDA was still -$4.0 million or -23.1%. Depreciation Is A Real Cost Furthermore, depreciation is a real cost in the crypto mining business, since mining equipment starts to become obsolete the moment they are installed. Miners have to constantly buy new mining equipment in order to stay up to date with the ever increasing difficulty of mining bitcoins (Figure 4). Figure 4 - Bitcoin difficulty is ever increasing (blockchain.com) Never-ending Share Dilution To Fund CapEx Treadmill Since BTBT does not generate positive cash flows, how does it finance its capital expenditures? The answer is a never-ending series of share dilution to fund capital expenditures and any cash flow shortfalls. In the six months to June 30, 2023, BTBT generated negative cash flow from operations ("CFO") of -$9.3 million and it bought $7.2 million worth of property & equipment. However, if we read the cash flow statement, we see that the cash shortfall was funded by issuing $6.7 million in private placements, and $5.1 million worth of equipment was actually paid for using shares (Figure 5). Figure 5 - BTBT cash flow statement (BTBT 10Q report) Since December 31, 2020, BTBT's shares outstanding have nearly doubled from 44 million to 85 million while shareholders have seen a -89% total return (Figure 6). Figure 6 - Share count has nearly doubled since BTBT went public (Seeking Alpha) New AI Business Looks Promising As mentioned at the beginning of this article, Bit Digital also recently announced it would be launching Bit Digital AI with an anchor customer providing up to $257 million in revenues over the life of the contract. Specifically, BTBT will provide specialized infrastructure to support generative AI workflows for an anchor customer. Under the agreement, BTBT will provide the customer with rental services for a minimum of 1,024 GPUs and a maximum of 4,096 GPUs. To fulfill its role in the agreement, Bit Digital has agreed to purchase 132 FusionOne HPCs for $35 million, each configured with 8 NVDIA H100 GPUs for a total of 1,056 GPUs. Under the terms of the agreement, for the minimum 1,024 GPUs, Bit Digital expects to generate between $23 - 27 million in revenues in annual revenues, beginning in January 2024. If the customer scales up to the maximum 4,096 GPUs for the maximum 3 years, the total contract could be worth over $250 million. On the surface, this sounds like a great deal for Bit Digital, as the company will recoup 66%-77% of the initial $35 million investment within the first year. However, it does come with significant risks for Bit Digital. First, while revenues for the GPUs will be $23 - 27 million, the announcement did not go over the matter of costs. The biggest cost for operating GPU servers is electricity; assuming Bit Digital has an average electricity cost of $0.049 / kWh, and each H100 consumes a maximum power of 10.2 kW , electricity costs for the GPUs alone could reach over $4 million (Figure 7). Figure 7 - BTBT has average electricity cost of $0.049/kWh (BTBT investor presentation) In addition, there are a multitude of server infrastructure costs such as cooling and networking that is required to service thousands of GPUs, so the true margin of these workloads will be far smaller than $23-27 million. However, management did comment in its press release that "the contract is expected to contribute substantially higher margins than the Company’s existing business operations." So my expectation is for gross margin in the AI business to be higher than the 37.6% gross margin in the bitcoin mining segment. If the company can generate 50% gross margins on $25 million in revenues, then that implies a ~3 year payback on the $35 million initial investment, which sounds reasonable. However, another risk to Bit Digital is the actual length of the contract. From the press release, the customer signed an initial contract duration of 1 to 3 years. Therefore, if the customer is not successful with its own large language model ("LLM") AI business, they could conclude the contract after 1 year, and leave Bit Digital holding the bag. Furthermore, there is no guarantee the customer will stay with Bit Digital after one year, as providing AI workloads is fast becoming a commoditized business. Startup competitors like CoreWeave and Lambda are providing H100 workloads on demand at $1.89 to $2.23 / hr (Figure 8). Figure 8 - AI workloads is becoming a commoditized business (Author conducted search on Google) In a year's time, these costs could come down even more, and there could be even more competitors in the space of providing AI workloads. Risks To Being Cautious Balanced against being overly cautious on Bit Digital's business model is the risk that BTBT stock can experience strong rallies if bitcoin prices go up. For example, YTD, Bitcoin prices have doubled and BTBT's share price has rallied by over 250% (Figure 9). Figure 9 - BTBT's share price has strong leverage to bitcoin prices (Seeking Alpha) In the upcoming third quarter (July to September), we already know BTBT mined 403 bitcoins and that bitcoin averaged ~$28,000 in the quarter, so BTBT's financials should see a nice YoY boost. The question is how much is already built into BTBT's stock price. Conclusion In summary, I do not believe Bit Digital's bitcoin mining business has much fundamental value, as it perpetually operates at a negative EBITDA margin due to high corporate SG&A. Furthermore, the company must constantly upgrade to the latest hardware to compete. However, that does not mean BTBT's shares should go to zero, as BTBT's shares clearly have a lot of leverage to bitcoin prices. Looking forward, Bit Digital is diversifying into an interesting business segment of providing AI workloads using NVIDIA GPUs. Although still early days, the AI business could significantly boost BTBT's revenues and spread the corporate G&A over more revenues, improving overall profitability of the company. For now, I remain cautious on the AI opportunity, as the margins in that business is still uncertain. Furthermore, it would help ease my concerns if BTBT were able to sign more customers to the platform. I rate BTBT stock a hold .
