Canaan gets doubly squeezed in latest crypto downturn

The cryptocurrency mining machine maker’s revenue plunged and its net loss ballooned in the second quarter as its product sales and mining income both tumbled

Key Takeaways:

• Canaan’s revenue from product sales dropped more than 80% in the second quarter, while its mining income dropped 37%
• The company continued to accumulate cryptocurrency, but at lower values, as it used its machines for its own mining business to clear out unsold inventory

By Warren Yang

Wild swings in cryptocurrency values mean companies in the space often find their business either booming or busting. The market’s latest hair-raising crash dating back to last fall has left mining equipment maker Canaan Inc. (CAN.US) stuck in a rut, helplessly waiting for the next upswing.

When cryptocurrency prices began dropping nearly a year ago, many players scrambled for the emergency exits. Canaan, however, is charting the exact opposite course.

The company diversified beyond its original mining machine business by starting its own mining operation in 2021, and had amassed 1,915.5 bitcoins by the end of June, up about 29% from a year earlier, according to its second-quarter results released last week. It also held 3,951.7 ethers, though that was roughly the same as a year earlier. Yet its revenue from minting those digital assets, recognized at market values at the time they were awarded, dropped 37% year-on-year to $17.7 million as cryptocurrency values slumped.

Warehousing virtual tokens at times like these creates a conundrum for Canaan. During a crypto downturn, its inventory of unsold Avalon mining machines swells. At the same time, the value of its bitcoin and ether holdings falls, triggering unrealized losses that erode its bottom line. And of course, its mining revenue takes a hit since the same bitcoins and ether it mines now are worth a fraction of what they would have fetched a year ago.

Canaan’s revenue from product sales plunged more than 80% year-on-year to $13.6 million in the second quarter, as many miners fled the field due to mining costs that were higher than actual cryptocurrency values. Combined with its mining income, the company’s total revenue for the three months dropped by more than two-thirds to $31.9 million. To put this in perspective, product sales traditionally comprised the majority of Canaan’s revenue during crypto bull runs. But in the second quarter, this segment accounted for less than half of its total revenue.

On top of the sharp top-line contraction, Canaan also took a big charge for inventory write-downs and fair-value losses on its crypto holdings. The result? A second-quarter net loss of nearly $100 million, a massive increase from $11 million a year earlier.

The company operates on pretty thin liquidity, with its cash totaling less than $70 million at the end of June. It doesn’t help that Canaan is in the middle of a share buyback program, committed to spending $30 million repurchasing its stock through the end of this year. That’s a significant amount for a company struggling to generate cash from operations. To bridge that gap, Canaan sold some of its crypto assets last month.

Inventory conundrum

Crypto miners struggle these days as they face high costs that easily exceed their revenue. When the economics of mining become unfavorable that way, hardware manufacturers face massive impairment charges for inventory they can’t sell. For Canaan, this means that the fair market value for one of its Avalon 16-series machine plunges as it sits in a warehouse unsold, forcing the company to make direct write-downs on its balance-sheet.

Inventory costs are a fact of life for manufacturers like Canaan. But they can be managed. Canaan is looking to keep its inventory in check by deploying some unsold products into its own mining operations. This way, the company can convert idle machines into operational computing power, instead of writing them down or selling them at deep discounts. This allows Canaan to keep generating revenue, with the potential to book financial gains if its crypto assets appreciate in value.

But during a crypto downturn like the latest one, Canaan has no way of stopping its revenue from sliding. Cryptocurrencies are staging a strong late-summer comeback, driven by a convergence of improvements in macroeconomic conditions and renewed institutional demand. Yet the outlook for Canaan remains rather dark. Management said it expects the company’s third-quarter revenue to total just $11 million to $15 million, with much of that likely coming from its mining operation, as an industry-wide inventory glut undermines its machine sales.

“Looking ahead to the third quarter, although bitcoin price recovered somewhat at the end of August, miner procurement remains cautious, and the industry inventory still needs to be digested,” CEO Zhang Nangeng said on the company’s earnings call. “Some competitors have adopted a more aggressive pricing strategy to speed up cash collections. We expect miner sales and the average selling prices to remain under pressure in the third quarter.”

On the mining side, while higher digital asset prices increase the value of each coin mined, that lift alone can’t boost Canaan’s revenue from this business. That’s because when market prices rise, other miners turn on more machines across the globe, shrinking the number of coins Canaan actually mines each day due to the fixed supply of new coins. This means that the output of Canaan’s mined coins can decrease, offsetting benefits of rising crypto prices.

Predictably, Canaan shares tanked following the release of its second-quarter results, losing some 14% of their value in three days. They now trade at a price-to-sales (P/S) ratio of just 0.3, well below 1.94 for smaller rival Ebang International (EBON.US), which also runs its own crypto mining operations, in addition to its core business of making hardware.

For now, Canaan can keep buying its own unsold machines and running them to produce its own virtual currencies as long as demand from external customers stays weak. But that type of self-dealing isn’t really a practical long-term business model, leaving the company caught between a rock and a hard place until the next crypto boom takes hold.

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