Covid Bites Canaan in First Quarter, But Advance Orders Bode Well for Second

Leading crypto mining machine maker aims to ride the recent bitcoin slump by allocating more resources to its own mining

Key Takeaways

• Canaan’s first-quarter sales more than tripled, but Covid-related disruptions prevented it from meeting its own previous guidance
• Despite allocating more resources to crypto mining, Canaan’s crypto assets remain a fraction of its sales

By Rajiv Sekhri

Canaan Inc. (CAN.US), one of the world’s largest bitcoin mining machine makers, looked impressive last week when it reported its first-quarter revenue rose 237% year-on-year. The huge jump seemed quite positive, especially when one considers the price of bitcoin remained flat during the quarter. Things have been less rosy in the current quarter, with bitcoin’s price down nearly 40% since the start of April. But we’ll come to that shortly.

Canaan’s shares surged as much as 21.3% after it released its latest quarterly earnings report last Thursday, and ultimately closed 7.6% higher on the day. The fading momentum in intraday trade may owe partly to investors’ expectation for an even bigger first-quarter sales increase of up to 300% as previously guided by the company. In early March, Canaan had said it expected first-quarter revenue of 1.5 billion yuan ($225 million) to 1.6 billion yuan, up 275% to 300%. Oops.

CEO Zhang Nangeng blamed an “increasingly unpredictable environment due to macroeconomic uncertainties and logistics disruptions” caused by Covid-19 for the revenue shortfall. On the investor call to discuss the results, he added that the first quarter is traditionally “low season” for the company because of tight energy supply in the northern hemisphere in winter and a larger number of holidays. Zhang also warned that “spot sales” – typically smaller orders for immediate delivery of machines – would account for a “smaller proportion” of the overall total in the current quarter, most likely due to weak demand from bitcoin miners licking their wounds after recent big price declines.

If bitcoin prices remain under pressure, Zhang said, Canaan may allocate more of the computing power in manufactures to doing its own mining. Earlier this year, Canaan signed agreements with multiple companies in Kazakhstan to jointly mine bitcoin. At of the end of 2021, Hangzhou-based Canaan was operating about 10,000 machines in the Central Asian country, where it set up its first mining operations in June.

Crypto mining machine makers get stuck with unsold inventory when bitcoin prices tumble, leading some to hunt for their own cryptocurrency using machines that sit idle in their warehouses. While it may seem like killing two birds with one stone, the strategy can be costly as the supercomputers required for crypto mining are electricity guzzlers, resulting in huge bills that can offset the value of any mined bitcoin – especially when bitcoin prices are low. At the end of the first quarter, Canaan’s cryptocurrency assets were just $7.1 million, a fraction of its revenue.

Canaan’s sales in the first quarter totaled 1.36 billion yuan, more than triple the 403 million in the year-ago period. Its non-GAAP adjusted net income rose by an even stronger 280% to 543.4 million yuan from 143.2 million yuan in the year-ago quarter. With cash and cash equivalents of $417 million at the end of the quarter, and operating costs of around $40 million each quarter, the company clearly has sufficient cash to weather any difficult periods.

Built for a lifetime

Zhang said he sees big potential in growing demand from North America, where the company is building local teams, developing partnerships and improving after sales services. “We have seen rapid development of clean energy in North America, which is attracting more and more miners,” he said on the call. Often criticized for their heavy electricity use, crypto miners have increasingly turned to setting up generation facilities to power their operations, often using renewable energy.

At a Bitcoin event in Miami last month, Canaan, which started in 2013, unveiled its Avalon 1266 model, a machine touted by company officials for its durability. “If you buy our machines, you can use them for a lifetime … You don’t have to change your machine or replace them every year,” Canaan Senior Vice President Edward Lu told media at the event.

In the meantime, however, with bitcoin prices now trading at lows not seen for nearly a year, Zhang said Canaan has “dynamically adjusted our mining machine prices to share the pressure created by downward bitcoin prices with our customers.” He did not offer specifics, but added that Canaan expects its second-quarter revenue to total between 1.6 billion yuan and 1.8 billion yuan. That still represents year-on-year growth of about 50%, though is far slower than the big first-quarter gains.

Advance customer orders reached 1.77 billion yuan at the end of March, excluding orders delayed due to Covid-19 disruptions, Zhang said, adding that such orders are “at a high level, setting a solid foundation for our second-quarter revenue.” He expected bitcoin volatility to continue in a macro economic environment characterized by interest rate hikes and growing inflation. But he added he remains “optimistic on the long-term prospects for bitcoin and its associated supercomputing technologies.”

The company’s shares have lost more than 65% of their value since November 2019, last closing at $2.98 on Tuesday. Its revenue sagged in 2019 and 2020, leading to net losses, as bitcoin prices slumped in 2019, followed by the Covid-19 pandemic in 2020. A China crackdown on energy-intensive bitcoin mining and trading in mid-2021 didn’t help, leading to regulatory uncertainty for Chinese companies like Canaan.

Like all U.S.-traded Chinese companies, Canaan is also under the eye of the U.S. securities regulator for its China roots. The company’s auditor – the China affiliate of KPMG – is barred by Chinese law from sharing its audit records with the U.S. Public Company Accounting Oversight Board (PCAOB), putting Canaan out of compliance with the U.S. Holding Foreign Companies Accountable Act. If Canaan and its many Chinese peers in similar situations fail to come into compliance, they risk being delisted from U.S. markets. Earlier in May Canaan said it “has been actively exploring possible solutions to protect the interest of its stakeholders … and strive to maintain its listing status on Nasdaq.”

Canaan’s shares were trading at a relatively high trailing price-to-sales (P/S) ratio of more than 11 as recently as last June. But that figure has plunged to just 0.73, as the stock lost about two-thirds of its value and sales have soared. The lowly P/S compares with a stronger 2.57 for Ebang International (EBON.US), a Chinese maker of crypto machines with ambitions to operate a local digital currency exchange in Australia, and 1.23 for China-based crypto miner The9 Ltd. (NCTY.US).

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