Marathon Digital Holdings (MARA 0.86%) stunned many investors last year when it transformed itself from a patent-holding company to a Bitcoin (BTC +3.15%) mining one. Instead of leveraging its patents to generate more revenue from licensing deals and litigation, Marathon placed a long-term order for more than 100,000 high-end Application-Specific Integrated Circuit (ASIC) miners from Bitmain. Essentially, by investing in ASICs the company narrowed its focus solely on Bitcoin mining.
Marathon held 126 Bitcoins at the end of 2020. This March, it bought another 4,813 Bitcoins at an average price of $31,168 each. It continued to expand its mining fleet to 31,000 active miners at the end of November, and its total Bitcoin holdings hit 7,649.1 for a market value of $437.4 million at the end of the month. Marathon expects to expand its fleet to 133,000 active miners by mid-2022.
Analysts expect Marathon's revenue to increase from just $4.4 million in 2020 to $186.2 million this year. Next year, they expect its revenue to soar 290% to $725.3 million.
Image source: Getty Images.
Investors might look at those estimates and think Marathon looks undervalued at less than five times next year's sales. They might also think it's a good alternative way to profit from Bitcoin's rising price without directly buying the cryptocurrency and holding it in a digital wallet. Those bullish points are valid, but investors should also consider these five red flags before pulling the trigger.
1. Bitcoin's declining price
Bitcoin's price has nearly doubled to about $47,000 over the past 12 months. But over the past month, it lost more than 20% of its value as inflation-related fears caused investors to shun more speculative investments like cryptocurrencies and high-growth tech stocks.
Bitcoin's decline contradicts the popular theory that it's an effective hedge against inflation. It might eventually protect investors from inflation in the future, but that probably won't happen until its volatile prices stabilize. So if inflation continues to climb next year, investors should expect Bitcoin's price to decline further and drag down Marathon's stock.
Moreover, shares of Bitcoin mining companies like Marathon and its main rival Riot Blockchain (RIOT +2.56%) have actually underperformed Bitcoin over the past month:
Source: YCharts
That gap indicates it might be smarter to simply buy Bitcoin instead of investing in Marathon or Riot.
2. Widening losses
Marathon generated $90.2 million in revenue in the first nine months of 2021, but it posted a net loss of $47.7 million -- even after booking a $58.8 million investment-related gain from Stone Ridge's Bitcoin-oriented NYDIG fund. Excluding that gain, Marathon's operating loss of $106.7 million indicates it spent over two dollars to generate each dollar of Bitcoin revenue.
By comparison, Riot Blockchain generated $122.4 million in revenue in the first nine months of 2021, with an operating loss of just $2 million. Marathon's steep losses -- which can be attributed to its ongoing purchases of miners, plant expansion expenses, and energy costs -- arguably make it a much riskier investment than Bitcoin itself.
3. Inflation and energy costs
To secure lower energy costs, Marathon started a joint venture with Beowulf Energy in Hardin, Montana. It issued six million shares of its restricted common stock to fund the deal, which granted Beowulf a stake in the joint venture in exchange for favorable energy rates. Beowulf's coal-fired energy plant enables Marathon's data center to run at a production cost of $0.028 per kilowatt-hour (kWh), which is comparable to Riot Blockchain's energy consumption rate.
However, energy prices have been soaring as inflation hit a 39-year-high in the U.S. last month. Those rising prices, coupled with the increasing energy requirements to mine a single Bitcoin, could force Beowulf to hike its rates or renegotiate its terms with Marathon. Higher energy costs would likely make it even tougher for Marathon to narrow its losses.
4. An SEC subpoena
Last month, Marathon revealed that it had received a subpoena from the Securities and Exchange Commission (SEC) in regards to its deal with Beowulf. The SEC is investigating Marathon's usage of restricted shares instead of cash to fund that deal -- and if it violated any security laws.
The investigation casts additional doubts on Marathon's ability to secure low energy costs as it expands its mining fleet next year. The SEC also started investigating Riot's transformation into a Bitcoin mining company in 2018, but that probe ended last January without any charges being filed. Riot's outcome could provide some hope for Marathon, but likely not enough to offset the growing doubt of investors.
5. The $650 million convertible debt offering
Lastly, Marathon announced a new $650 million convertible senior notes offering to fund its purchases of additional Bitcoin miners last month. That offering should increase Marathon's debt-to-equity ratio from about zero at the end of the third quarter to nearly 1.0. The convertible shares will also likely dilute its existing shares after they mature in Dec. 2026.
My opinion: just buy Bitcoin instead
Marathon might have an early-mover's advantage in the Bitcoin mining market, but its stock is still too speculative to recommend. For now, investors who are interested in buying Bitcoin should consider directly purchasing the cryptocurrency instead of investing in Marathon, Riot, and other miners.
