Marathon Digital: Look Out Below

A Tough Scene

Bitcoin, and crypto in general, has had a difficult twelve months. Despite the crypto rally that kicked off 2023, many of the largest-name coins are still trading in the red on a trailing twelve month basis.

Bitcoin, Ethereum, and Dogecoin are all down double digits. Crypto exchanges are also facing, well, headwinds: from the blowup of FTX, to declining exchange volume (click here to read our article on the topic) and SEC troubles at Coinbase (COIN), overall trust and trading volume in the crypto universe has been dented considerably.

The past two years has also seen electricity prices rise considerably. Consider the following table from the Bureau of Labor Statistics:

Since 2021, average prices for electricity per kilowatt hour [KWH] have spiked dramatically. This is expected to fall somewhat this year, but the electricity markets are highly volatile and, of course, forecasts don't always go as planned.

Against this backdrop, miners of cryptocurrency (particularly Bitcoin) have had a difficult go. After all, it isn't easy to turn a profit when the asset you mine is falling in value and one of your biggest input costs is going through the roof.

In this article we will consider Marathon Digital Holdings (NASDAQ:MARA), a Bitcoin mining company which we think is poorly positioned to perform well in the coming months. Let's dive in.

Accounting Troubles

To say that 2022 was a bad year for Marathon would be an understatement. For one, the company announced in February 2023 that its prior financial statements from 2022 and 2021 could no longer be relied upon, and that it would be issuing a restatement of the affected quarters in its 2022 10K.

Unfortunately, the warning signs were present well before February 2023. In the company's 2021 10K, Marcum LLP issued an adverse opinion (page 51) on the company based on a material weakness in the company's internal controls over financial reporting. Marcum explained that "[a] material weakness is a control deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis."

This opinion was expressed, again, in 2021. In 2022, things do not appear to have gotten better. In the most recent 10K, in fact, Marcum changes its wording of 'weakness' from singular to plural, which is most troubling.

In addition to the previously noted weakness regarding internal financial controls, Marcum added this on page 106 of the 2022 10K:

The Company had a material weakness related to the application and interpretation of generally accepted accounting principles primarily in the areas of consolidation, impairment of digital assets, disposal of property and equipment, and principal versus agent considerations in revenue recognition.

In other words, Marcum did not eliminate their original material weakness--because Marathon apparently didn't correct it--and added a new one which appears to be the material weakness that led to the restatement of the company's 2021 and 2022 financials.

Adverse opinions are things investors want to see. To see one go uncorrected for a year and then have a new material weakness uncovered is... not good.

2022 Results

Against the backdrop of falling cryptocurrency prices and rising electricity costs, one would expect that the financial results from Marathon would be less than stellar in 2022, but we think that would be an understatement.

Total revenues fell 26% year over year, from $159 million to $117 million, while the cost of revenues (looking at the energy and hosting line, in particular), jumped a massive 165% from $27 million to $72 million.

In this regard, of course, the company cannot be blamed. It is a mining business, after all, and just like anyone who mines anything, the value of the asset being mined along with input costs can fluctuate wildly.

What is not so understandable are the company's enormous impairment of mining equipment and its advance to vendors ($332 million) or its full of deposits due to the vendor bankruptcy of Compute North ($24 million).

This sea of losses led to the company reporting a net loss of $686 million for 2022.

The company, presumably in an effort to generate fresh capital against these losses, has been a prolific seller of stock over the last three years.

From 2021 to 2023, Marathon has sold $229 million, 313 million, and $361 million worth of stock, respectively. This--in conjunction with stock based compensation--has helped to boost shares outstanding from under 10 million in 2020 to over 160 million today.

The Bottom Line

Details on these results would be nice to have, but the company appears to not have held a conference call for its 2022 earnings. While one can debate the future of Bitcoin, or Bitcoin mining generally, we believe that the above issues should give investors--at a minimum--a high level of concern about the state of Marathon.

From the existence of not one, but two identified material weaknesses by the company's auditor, to the large issuance of stock and enormous losses the company has posted, we believe investors should be extremely cautious if considering Marathon. As for us, we opt to avoid it altogether.