Starboard sees an opportunity to create value in Riot Platforms

Business: Riot platforms is a digital infrastructure and bitcoin mining company. It has bitcoin mining operations in central Texas and Kentucky, and electrical switchgear engineering and manufacturing operations in Denver. It operates a bitcoin-powered infrastructure platform. Its segments include Bitcoin Mining and Engineering. The Bitcoin Mining segment is dedicated to bitcoin mining. The Engineering segment designs and manufactures custom-designed power distribution equipment and electrical products.

stock market value: $3.97 billion ($11.55 per share)

Property: n/a

Average cost: n/a

Activist comment: Starboard is a highly successful activist investor and has extensive experience helping companies focus on operational efficiency and margin improvement. Starboard has run a total of 155 previous activist campaigns in its history and has an average return of 23.27% versus the Russell 2000’s 15.27% over the same period.

Starboard has acquired a position in Riot Platforms and sees opportunities for operational and strategic value creation.

Riot Platforms is dedicated to both mining bitcoins and owning and operating its own mining facilities. Vertical integration allows Riot to directly control its operations and manage input costs, such as energy and overhead, rather than renting space to third-party data center operators. Riot has two business segments: Bitcoin Mining and Engineering (design and manufacturing of power distribution equipment and custom electrical products). The company is one of the largest publicly traded bitcoin miners with over 1 gigawatt (GW) of power capacity developed between its facilities in Rockdale, Texas; Corsicana, Texas; and Kentucky. Riot also owns 16,728 bitcoins.

Although bitcoin Up roughly 130% this year and a crypto-friendly incoming presidential administration, Riot’s stock price is down 24% ahead of Starboard’s announcement of its position against average year-to-date performance. year of more than 100% for their peers. This significant underperformance in a company with such strong tailwinds can only mean an extreme lack of confidence in management, and rightly so. First, spending on sales, general and administrative expenses is out of control: up to $225 million last year, up from $67 million in 2022. Part of the reason for this is the stock-based compensation paid to the executives. Despite continually making losses and with a three-year return of -54.7%, management has paid itself 11.5%, 9.5% and 32.12% of total revenues in stock-based compensation for the past three years. Consequently, the company has the highest energy cost plus cash SG&A expenses per currency in the space, despite having access to relatively cheap energy, as well as the highest equity compensation per currency. Consequently, the company has generated negative net operating income in each of the last three years, with its largest operating loss this year of $304 million. Add to this a horrible record of corporate governance with a five-person tiered board of directors and cases of nepotism within the upper levels of the company. As a result, Riot trades at one of the cheapest multiples in the industry based on enterprise value of earnings before interest, taxes, depreciation and amortization and EV to PH/s (petahash per second, a measure of computing power ).

Starboard has extensive experience in corporate governance and helps boards of directors “professionalize” companies and optimize operations. The mere addition of a Starboard representative to the board would give the markets enormous confidence that management is on the path to creating value for shareholders. Starboard is an exceptional activist with experience in improving operating performance and margins, skills that any management team should be excited to have in an engaged shareholder. The firm will undoubtedly advocate for the company to reduce its unnecessarily high SG&A expenses and appropriately size executive compensation to reflect business performance.

But the good news for the board and management is that the second part of Starboard’s company plan can make them all richer: seizing the massive demand opportunity from hyperscalers, or large-scale cloud computing companies that operate hubs. and provide cloud infrastructure and services. These companies, such as Amazon Web Services, Microsoft Azure and Google Cloud, to name a few of the largest, have been in a battle to outsource and build sites to run their High Performance Computing (HPC) and Artificial Intelligence (AI). data center operations. Crypto mining facilities share several key inputs with these applications that make them excellent candidates for outsourcing their capacity or converting their crypto operations, namely high-performance computing infrastructure, access to energy (preferably renewable), energy management expertise, and operational scalability, among others. others. While the specific needs of hyperscalers are not identical to those of crypto miners, it is much faster and cheaper for them to convert existing facilities in one or two years rather than taking several years to build their own facilities from scratch.

This is a strategy that several of Riot’s competitors have followed to the delight of their shareholders. Earlier this year, Core Scientific, another bitcoin miner, signed a deal with CoreWeave, an Nvidia-backed AI data center startup, to deliver 500 megawatts of capacity to host CoreWeave’s HPC operations. This deal is worth $8.7 billion in cumulative revenue over 12 years for Core Scientific, which will generate around $1 million in incremental cash flow for each MW contracted under the deal with a profit margin of 75% to 80%, much more than I expected. would receive from your normal bitcoin mining operations. In response to Core Scientific’s first announcement about its partnership with CoreWeave in June, Core Scientific’s share price soared 40% the next day and is up nearly 220% since then. Despite being the fifth largest miner by hash rate, it is now the second largest in terms of market capitalization. Bit Digital, Hive Digital, Hut 8 and Iren have also already made the switch to mixed use with several other miners testing or exploring the potential to take advantage of this huge opportunity. Shares of Bitcoin mining companies that have already moved capacity to HPC have generated an average year-to-date return of 105.8% versus an average of -3.4% for peers that had not yet announced plans to do so (Riot, Mara Holdings and CleanSpark).

The good news for Riot shareholders is that the company is in an excellent position to capitalize on the enormous opportunity presented by leasing capacity to hyperscalers. The Rockdale, Texas bitcoin mining facility is the largest in North America with 700 MW of developed capacity. Its facility in Corsicana, Texas, currently has 400 MW of capacity and upon completion is expected to be approximately 1 GW. These plants have favorable characteristics for hyperscalers (access to energy, close to major metropolitan areas, low latency, and controlled natural disaster risk). Extrapolating from the deal with Core Scientific, Riot has the opportunity to generate $1 million of cash flow per MW in hyperscale. The Corsicana facility will soon have 600 MW of unused capacity that can be contracted out to hyperscalers right now without affecting any of the company’s current bitcoin mining operations. Assuming Riot converts just the 600 MW it is working to bring online at its Corsicana facility, it could generate incremental cash flow of $600 million annually (versus $313 million in current revenue). If Riot could convert the additional 1.1 GW of its total projected capacity into Rockdale and Corsicana, that figure could almost triple. Additionally, if the company signs a deal like Core Scientific did with CoreWeave, the hyperscaler will pay virtually all of the capital expenditure to build or convert these operations. Furthermore, in JulyRiot acquired Block Mining with its Kentucky facility and aims to increase its capacity from 60 MW to 300 MW, which might not be ideal for hyperscalers, but certainly could at least be used for bitcoin.

There are certainly traditional Starboard-type levers in this commitment to creating shareholder value, such as operational improvements, divestiture of non-core businesses and investments, as well as better corporate governance. However, the core element of the company’s campaign and message to management is simple: look around you. Riot is being outdone by its competitors for not taking advantage of the enormous opportunity that leasing capacity to hyperscalers presents. Understandably, each announcement of such a contract sends the shares of its peers soaring. And Riot is in a great position to capitalize on this.

Riot has already come out and said that it has spoken with Starboard on several occasions, appreciates the company’s input and looks forward to continued constructive dialogue to create value for all shareholders. However, at first glance it would not be unreasonable to think that Starboard could encounter difficulties due to the company scoring very poorly on corporate governance metrics, its staggered five-person board of directors with only one seat open at its next meeting, and the actions recent showing that the company is solely focused on being the largest vertically integrated bitcoin miner. Shareholder activism often comes down to making an incontrovertible argument. Starboard has one here, at least for the 600 MW that is not yet used. Once management sees money coming in, allowing them to grow to the enormous compensation they’ve been receiving, it’s not a long jump to convert their other capability.

Additionally, Riot recently purchased 510 million dollars in bitcoins on the open market using the proceeds from a convertible senior notes offering, reflecting that you may want to acquire bitcoins today at a rate that exceeds your current mining capacity. There would be no better way to achieve that goal than to convert some of its capacity into hyperscalers to generate strong, stable cash flow well above what its normal operations would generate. If Riot is really that adamant about owning bitcoin, it could use some of this excess cash flow to acquire some of the bitcoin it would have otherwise mined. Management must decide if Riot wants to be a professionally managed company that optimizes value for everyone involved or if it simply wants to be a bitcoin miner. If management decides the latter, it will choose not only to give up billions of dollars in value, but will put itself in the path of a potential costly and distracting proxy fight with Starboard over the next two years, at the end of which the Management could walk. away with nothing. We do not believe this will happen, as there seems to be a lot of room for an agreement.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments. Riot Platforms is owned by the fund.