Dan Weiskopf on the Crypto/Blockchain Space in Q4

Evan Harp: Thanks so much for sitting down with me, Dan. What are the big things in the blockchain/crypto space that people should be paying attention to in Q4?

Dan Weiskopf: I’ll start with the mining stocks, of which our exposure is about 18%. This is at the low end of our history. The mining industry and the companies and management teams have come a long way since we launched the fund in January 2018 in terms of capital access, operating sophistication, and technology. The mining industry is an absolute necessity for bitcoin to work as a technology platform, so these stocks bring portfolio correlation and beta to the price action of bitcoin. Our approach to managing risk involves holding exposures in the range of 7–9 companies. The industry is experiencing a hurricane of challenges — energy, regulation and bitcoin price, to name a few. We manage risk through diversification across geographies, our knowledge around the various individual business strategies, and connections to various people in the industry. With risk, we hope to see reward. Having been through a bear market in crypto, we would expect that when winter becomes spring we could see a substantial move in this area of the portfolio.

In the meantime, we would expect some of the smaller players to consolidate or work through deals to get scale or even to deleverage. The challenge is, financial leverage does not work when revenues and operating costs are so volatile and not in sync. We recently saw a private company, Compute North, file for bankruptcy. Marathon Digital, a holding in BLOK, hosts mining rigs with Compute North. It is too early to know the direct effects on Marathon and how management might adjust its plans to this news. The two companies are intertwined in certain ways, but Marathon as public company has access to equity capital and also hold about 10,000 bitcoin. We used to believe that “HODLing” bitcoin was a great thing, but today the ability to effectively manage your treasury is becoming that much more critical.

We do not own Cleanspark (CLSK) in BLOK, but saw their deal with Mawson Infrastructure (MIGI) as an example of one company that needed to deleverage wanting to get out of Georgia and another wanting to gain more synergies in expanding its footprint in the area. This is an industry that requires scale to survive and therefore will see some consolidation, but the problem is, direct synergies are hard to find versus simply organic growth through proper capital allocation that is targeted at equipment purchases. Cleanspark is clearly making a fundamental bet around Georgia being one of its clear home bases. Maybe this is because this management views its relationships with access to power in the area as a competitive advantage. Other companies may seek further synergies through vertical integration with power suppliers, construction companies, or offering buyouts of hosting clients. Conversely, some companies, such as HUT8, have taken steps to add other technology lines of business. The high-performance equipment (HPC) has additional use cases beyond just crypto mining.

A year from now, the public players will look very different than today, and yet assuming bitcoin holds the $18,000 to $20,000 level, almost all the companies are trading around 2–3 times EBITDA on an enterprise value basis. Sure, it will be a binary outcome for some, but we think the risk is worth the reward and are optimistic that the price of bitcoin and delta on these stocks will work substantially higher in the future than it is today.

Evan Harp: Oh, the Marathon/Compute North story seems froth with challenge!

Dan Weiskopf: Yeah. So what does that mean? Early in my career, I spent time working on some bankruptcy situations. The good news is that it means that, hopefully, the electric bill is paid for. Sorry, bad joke. The bankruptcy court is set up to protect creditors so the utility company does not have to worry about getting paid. It should be about the same as a standard industrial tenant. However, what this means for Marathon and how they place their future equipment may be a fair question to ask. It is early, but it clearly presents some questions around Marathon’s so-called “asset-light business model.” Marathon’s strategy has always been to focus its capex plans on equipment than facilities, so it is always the tenant and equipment owner rather than the company hosting with a facility. Theoretically, the plus on this is flexibility, higher ROI, and a simple business model, but these benefits also carry some execution risks in the build out and operations of facilities.

Evan Harp: That makes a lot of sense. It’s like it’s not necessarily going to be a stumbling block, but you never know what that transition process is going to be like.

Dan Weiskopf: You don’t know. Marathon put a deposit or loaned Compute North of about $30 million — that’s not coming back anytime soon. I don’t make light of that, but I would expect that money is going to be part of the bankruptcy. Okay. Now, having said that, I think Marathon’s balance sheet otherwise is pretty solid. So they will be okay. Funny thing — everyone assumes operating a data center is easy and most of the companies in that industry get huge multiples and a major pass on execution risk. Think about what was involved in that industry build out 10 years ago. I am pretty sure that it was not so smooth as it seems today.

Nevertheless, whether it’s risks associated with energy costs, or the price of bitcoin, or hiring the right management, or being in the right geography from a regulatory standpoint, I’m just glad that we’re very diversified, is the messaging that I would communicate.

Lastly, we own companies that have geographic exposure in North Carolina, Canada, Iceland, Sweden, North Dakota. We don’t own companies that are in New York, right? For particular reasons. Texas is, obviously, overall, fairly big exposure to us. But Riot also had some issues where they made a large acquisition, and then discovered some liabilities that they were unaware of. It’s really hard to believe that these things can happen. But this is the space that we’re in.

Okay, so then the next question is going to be, “Wow, Dan, I don’t understand — if this is a very complicated segment of the blockchain, why do you need to be there? Why not just avoid it?” Right? My answer is clear — one, upside versus downside risk; two, the necessity of the business as it is related to bitcoin; three the delta to bitcoin price action. Remember bitcoin cannot exist without the miners.

Evan Harp: I want to pivot for a second into the comment about energy costs, because I know we’re also coming into a broader global energy crisis that’s obviously going to affect some places more than others. How do you feel like that’s going to play with and interact with the blockchain and crypto space?

Dan Weiskopf: Obviously, I see it affecting the miners. That’s part of the reason why we’re so diversified. Most of the miners claim energy costs in the range of 2.2 megawatts to 7. I know that’s a very wide range. Beyond that, the question ends up being, if energy prices are high, what does that mean as far as the economic growth overall? Usually, a slowdown in prospective economic growth is going to be a headwind for most companies. I would not expect that blockchain would be any different for companies like IBM or Microsoft, but that is why their PE’s multiples have come down. If the economies are slowing down in earnings, that is going to impact some of our companies, but in certain cases that is embedded in the price already.

Evan Harp: How about other things to be on the lookout for in the crypto space outside of miners?

Dan Weiskopf: In Q4, you mean… So, what I would be messaging is, we’re in a position, as portfolio managers, to play defense if we need to play it. That’s a huge difference between a passive fund and an active fund. As an example, it sounds weird, but we’re playing defense with Intel, who provides chips to the miners. We’re picking up a 5% yield by owning that stock. True, Intel’s foray into the blockchain is small in terms of its overall revenues. However, we allocate across seven segments of the blockchain area, and semi-conductor companies is one of the categories, so why not pick up some yield in an area that is under pressure? There is a massive surplus of mining rigs looking for a buyer right now in this fourth quarter. Again, our mandate is to invest in companies which strategically are trying to benefit by the blockchain. Intel, I think, ultimately will be one of those companies. Their timing may not have been optimal, but if you’re thinking long-term, as we are, I think Intel will be fine. And the miners will be fine, because they are a necessity, if you believe in bitcoin now.

So what are we supposed to be looking for in the way of the fourth quarter, you can look for us to maybe continue to be defensive. We’re not likely going to be buying high-beta/no-earnings companies. The companies that we’re investing in do have balance sheets that are not encumbered. Playing defense is what you should be looking for from us, but investors must also note that our mandate of offering exposure to the blockchain does carry above-average beta by its nature.

I guess another thing in the fourth quarter would be what happens with ethereum, which we don’t have a lot of exposure to because it’s just not available. Which, arguably, is a good thing, because it takes some risk or complexity off the table for us. We don’t own ethereum directly and we won’t ever own ethereum directly. So what’s happening with the merge and the risks associated with it won’t affect us now.

There are some questions on whether or not the SEC will deem ethereum a security because so much of it is controlled here in the U.S. That’s a problem that won’t necessarily directly impact us. Having said that, I think ethereum is a really important protocol in the blockchain because so much is done on ethereum. I look forward to further clarity from a regulatory standpoint for the benefit of the companies that are working on the ethereum platform.

Evan Harp: What do you make of the merge so far and the early results of it? I know a lot of people were expecting a big ethereum surge and that didn’t transpire. But then again, at the same time, there hasn’t been much drawdown in the crypto space compared to lots of other spaces.

Dan Weiskopf: We live in an unprecedented world right now as investors, where the long-term U.S. Treasury as measured by TLT is down 30% — more than equities. Putting that into context, your risk-free return is getting decimated. When your risk-free side of your portfolio is feeling this kind of pressure — in the near term, you’ve got to expect a brand-new asset class to be affected, right?

I think people have to look…