Hut 8 Mining: Starting To Get Answers

Hut 8 Mining (NASDAQ:HUT) is a Bitcoin (BTC-USD) mining company that I covered for Seeking Alpha earlier this year. At one point, HUT happened to be my largest BTC mining equity position. However, since the proposed merger with US Bitcoin Corp ("USBTC"), I've taken a much more cautious outlook for HUT shares as I've moved to the sidelines while we wait out merger finalization. If you're not familiar with what I wrote back in January and February, I'd encourage you to also read those notes as well:

• Hut 8 Mining: More Questions Than Answers, 1/11/23
• Hut 8: Even More Questions Now, 2/16/23

The purpose of this article will be to add context to my previous HUT coverage given the latest information.

New HPC Client

In early 2022, Hut 8 completed the purchase of its high-performance computing subsidiary TeraGo. Since then, growth in that category has been slow nominally even though the segment has become a larger portion of the company's total revenue by percentage:

Source: Hut 8, 000s of CAD

On June 14th, Hut 8 announced a new HPC services client in the healthcare sector. The agreement is for 5 years with a company called Interior Health and the services will go through Hut's Kelowna location. We don't yet know what the revenue from the agreement will look like but we do know the deal goes through 2028. If my interpretation of the press release is correct, Hut won't see realized revenue from this agreement until first quarter 2024.

Revised Merger Details

The company also recently revised the post-merger "New Hut" mining capacity projection higher to 7.5 exahash. This revision up in mining capacity is as a result of additional miner energization at US Bitcoin's mining sites.

In addition to the fresh capacity figures, we now also have more insight into what US Bitcoin Corp's balance sheet looked like at the end of 2022. My expectation in February was that USBTC's financial position would be in tough shape:

I think we can safely assume US Bitcoin Corp is bringing some financial baggage with that EH/s capacity and probably not a lot of BTC.

That has proven to be true per Hut 8's merger prospectus. As of December 31st 2022, USBTC had about $751k in bitcoin and just $6.7 million in cash against roughly $106 million in current liabilities. USBTC also showed $157 million in non-current liabilities. The unaudited pro-forma current assets are mainly coming from Hut 8:

Source: Hut 8 S-4, figures in 000s of USD

The $13.6 million reduction in cash for the combined entity is due to banking, legal and accounting fees from the merger transaction. The $32.2 million transaction adjustment in cryptocurrency is due to revaluation of the assets from the date of the purchase rather than December 31st. Though the current Hut 8 entity is providing most of the current assets in the deal, the majority of the non-current assets come from USBTC:

Source: Hut 8 S-4, figures in 000s of USD

As of December 31st, New Hut would have had $123 million in property and equipment as well as $41.5 million in miner deposits. One of the major assets USBTC is bringing to the table is the company's joint venture investment in King Mountain JV where it shares 50% of mine capacity.

As was previously noted, USBTC forfeited property to settle with a lender. We now know the value of that debt was over $97 million and settlement came primarily through relinquishing miner deposits, equipment, property, and prepaid expenses. At the end of 2022, the combined entity would have had $706.4 million in total assets, of which $182.5 million were current. Also somewhat telling is the $219 million adjustment to intangible assets and goodwill due to the transaction. I view that as a bit of a red flag.

Source: Hut 8 S-4, figures in 000s of USD

From a debt standpoint, USBTC is still saddled with quite a bit of obligations even after adjusting for the debt extinguishment. Current HUT had just $45 million in total liabilities as of year end. That figure rockets to just under $215 million in the post-merger company. And this is obviously before factoring in any new liabilities from Q1 or Q2 of this year. Which is certainly a possibility given the losses each of these companies experienced last year as individual companies:

Source: Hut 8 S-4, figures in 000s of USD

At $46 million, USBTC generated slightly more revenue than Hut 8 in the second half of 2022 and it did so while losing less money. Even when factoring in income tax provisions and adjustments from the acquisition transaction, New Hut still has a $209 million loss in the second half of last year alone. It's certainly possible the new company may be able to cut expenses and operate more efficiently as a combined entity, but this company needs much higher bitcoin prices to break even if the pro forma numbers are an indication of current operations.

Reasons for Optimism?

Even though USBTC's balance sheet is unsurprisingly in bad shape, I think it's a good sign that HUT hasn't been forced to liquidate much of the company's BTC holdings in treasury since the deal went public. Hut 8's merger was originally announced in early February. At that time, the company indicated that it would be selling both mined BTC and HODL'd BTC to pay for operations. As of January 31st, Hut 8 held 9,274 BTC in treasury.

As of May 31st, Hut 8 holds 9,233 BTC. This is actually up 100 BTC from the company's end of March balance. From a year to date standpoint, the company has still been able to grow holdings to a larger degree than many of large industry peers like Riot Platforms (RIOT), Marathon Digital (MARA), Bitfarms (BITF), CleanSpark (CLSK), and Cipher Mining (CIFR):

Source: Company filings, values in BTC

Only Riot Platforms and CleanSpark have been able to add more BTC to balance sheet holdings year to date.

Risks

One thing that I've maintained in almost all of my public miner coverage is my belief that most of these companies aren't great long term investments due to the declining BTC-denominated revenue from the block reward halving every four years. The recent surge in transaction fees as a percentage of the block reward can certainly challenge that viewpoint, but it remains to be seen if the Ordinals/BRC-20-driven spike in fees from May is more of a flash in the pan or if it's the beginning of a sustainable long term trend. But to be clear, that's an industry-wide risk.

More specifically to Hut 8, while we have much better insight into the balance sheet of USBTC than we did back in February, the pro forma data for the two companies is as of December 31st and a lot can change in six months. While I think it's encouraging that Hut may soon have a top 5 operating exahash figure in the public equity markets, I'm concerned that such a large portion of New Hut's projected total assets will come from goodwill and intangibles.

Summary

Hut 8 currently has one of the largest BTC treasury balances in the entire public equity market. To me, that's the only real reason to consider longing HUT shares at this point. We don't have all of our answers yet on Hut 8 Mining. But we're starting to get some of them. USBTC's balance sheet isn't terribly surprising. Going forward, I would like to see some clarity on how much revenue the company expects from the recently announced HPC deal.

If nothing else, New Hut should have a better diversified revenue segment breakout following the merger. The exahash growth and new revenue segments are coming with a price; namely quite a bit more debt. Since there are other miners that will have cleaner balance sheets and solid production capacity, I still think it's wise to wait on HUT for now.

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