Starboard sees a chance to create value at Riot Platforms

Business: Platforms of revolt is a digital infrastructure and bitcoin mining company. It has bitcoin mining operations in central Texas and Kentucky, and electrical engineering and switchgear manufacturing operations in Denver. It operates a bitcoin-driven infrastructure platform. Its segments include Bitcoin Mining and Engineering. The Bitcoin Mining segment is engaged in bitcoin mining. The Engineering segment designs and manufactures power distribution equipment and custom electrical products.

Stock Market Value: $3.97B ($11.55 per share)

Properties: n/a

Average cost: n/a

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

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

Riot Platforms is engaged in bitcoin mining, as well as 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, as opposed to renting space from third-party data center operators . Riot has two business segments: Bitcoin Mining and Engineering (design and manufacture of power distribution equipment and custom electrical products). The company is one of the largest publicly traded bitcoin miners with more than 1 gigawatt (GW) of power capacity deployed between its facilities in Rockdale, Texas; Corsicana, Texas; and Kentucky. Riot also owns 16,728 bitcoins.

In spite bitcoin up roughly 130% this year and an incoming presidential administration favorable to cryptocurrency, Riot’s stock price dropped 24% prior to Starboard’s position announcement vs. a year-to-date average return of more of 100% for their peers. This significant underperformance in a company with such strong headwinds can only mean an extreme lack of confidence in management – and for good reason. First, spending on selling, general and administrative expenses is out of control up to $225 million in the past year from $67 million in 2022. Part of the reason for this is stock-based compensation paid to executives. Despite still making losses and with a three-year return of -54.7%, management has paid out 11.5%, 9.5% and 32.12% of total revenue in stock-based compensation over the past three years . As a result, the company has the highest cost of power plus SG&A expense of cash per coin in the space, despite having access to relatively cheap power, as well as the highest stock compensation per coin. As a result, the company has delivered negative net operating income in each of the past three years, with its biggest operating loss ever this year of $304 million. Add to that a horrible record of corporate governance with a five-person board and cases of nepotism at the highest levels of the company. As a result, Riot trades at one of the best multiples in the industry on an enterprise value basis to earnings before interest, taxes, depreciation and amortization and EV at PH/s (petahash per second, a measure of computational power).

Starboard has extensive experience in corporate governance and helping boards to “professionalize” companies and optimize operations. Just adding a Starboard representative to the board would give the markets tremendous confidence that management is on track to create shareholder value. Starboard is an exceptional activist with expertise in improving operational performance and margins, skills that any management team should be excited to have in an engaged shareholder. The firm will no doubt support the company to reduce its unnecessarily high SG&A expenses and fair executive compensation to reflect business performance.

But the good news for board and management is that Starboard’s second part of the company’s plan can make everyone rich: Pursue massive demand opportunities from hyperscalers or large-scale cloud computing companies that operate data centers. data and provide infrastructure and cloud 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 contract and build sites to run their High-Performance Computing (HPC) and Intelligence Artificial (AI). data center operations. Crypto mining installations share several key inputs with these applications that make them excellent candidates to contract their capacity or convert their cryptographic operations, i.e. high-performance IT infrastructures, access to energy (preferably renewable), know-how energy management, and operational scalability, among. 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 a year or two instead of taking several years to build their own ease from the ground.

This is a strategy that many of Riot’s competitors have pursued much to the delight of their shareholders. Earlier this year, Core Scientific, another bitcoin miner, struck a deal with CoreWeave, an AI data center startup backed by Nvidia, to providing 500 megawatts of capacity to accommodate CoreWeave’s HPC operations. This agreement is worth $8.7 billion in cumulative revenue over 12 years to Core Scientific, which will generate approximately $1 million in incremental cash flow per 1 MW contracted under the agreement at a profit margin of 75% to 80%, much more than it is. it would receive from its normal bitcoin mining operations. In response to Core Scientific’s first announcement of its partnership with CoreWeave in June, Core Scientific’s stock price jumped 40% the next day and is up nearly 220% since then. Despite being the fifth largest miner by hash rate, it is now second in terms of market capitalization. Bit Digital, Hive Digital, Hut 8 and Iren have also already made the switch to mixed use with many other miners piloting or exploring the potential to capitalize on this massive opportunity. Shares of Bitcoin mining companies that have already switched capacity to HPC have delivered an average YTD return of 105.8% versus an average of -3.4% for peers that have not announced plans to do so 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 massive opportunity presented by the ability to lease hyperscalers. The Rockdale, Texas, bitcoin mining facility is the largest in North America with 700 MW of developed capacity. Its Corsicana, Texas facility currently has 400 MW of capacity and, upon completion, is expected to have approximately 1 GW. These plants have characteristics favorable to hyperscalers (access to energy, close to major metropolitan areas, low latency and controlled natural disaster risk). Extrapolating from the Core Scientific deal, Riot has the opportunity to generate $1 million in cash flow per MW in hyperscaling. The Corsicana facility will soon have 600 MW of unused capacity that can now be contracted to hyperscalers without affecting any of the company’s current bitcoin mining operations. Assuming that Riot converted only the 600 MW it is working to bring online at its Corsicana facility, it could generate an increase of $600 million in cash flow per year (against $313 million in revenue today). If Riot was able to convert the additional 1.1 GW of its total projected capacity at Rockdale and Corsicana, this number could almost triple. Also, if the company signs an agreement like Core Scientific did with CoreWeave, the hyperscaler will pay for almost all the capex to build or convert these operations. Also, in JulyRiot has acquired Block Mining with its Kentucky facilities 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 the creation of value for shareholders, such as operational improvements, the sale of non-core companies and investments, as well as improved corporate governance. However, the core element of the company’s campaign and the message to management is simple: Look around you. Riot is being lambasted by its competitors for not taking advantage of the massive opportunity presented by the ability to lease to hyperscalers. Each announcement of such an understanding contract sends the shares of its peers on an upward trajectory. And Riot is in an excellent position to capitalize on this.

Riot has already come out and said it has spoken with Starboard on several occasions, welcomes the company’s input and expects an ongoing constructive dialogue to create value for all shareholders. However, it would not be unreasonable at first glance to think that Starboard may encounter difficulties based on the company scoring very low in corporate governance metrics, its five-person board adrift with only one seat available at its next meeting , and recent actions that evidence that The company is focused solely on being the largest vertically integrated bitcoin miner. Shareholder activism often boils down to making an incontrovertible argument. Starboard has one here, at least for the 600 MW that are not being used. Once management sees the money coming in, allowing them to grow in the excess compensation they have received, it is not a long leap to convert their other capacity.

Also, Riot recently acquired $510 million worth of bitcoin on the open market using the proceeds from a senior convertible note offering, which reflects that it might want to acquire bitcoin today at a rate that exceeds its current mining capacity. There would be no better way to achieve that goal than converting part of their capacity for hyperscalers to generate a strong and stable cash flow in addition to their normal operations. If Riot is really that determined to own 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 all involved or if it just wants to be a bitcoin miner. If management decides on the latter, it will choose not only to give up billions of dollars in value, but set itself on a path to a potentially distracting and expensive proxy fight with Starboard over the next two years — at the end of which management could walk. away with nothing. We don’t see that happening as there seems to be a lot of room for compromise here.

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 investments 13D activists. Riot Platforms is possible in the background.