One cannot go a single day without multiple commentaries about Bitcoin crossing the wires; from the nightly news stories to critical comments of all-star CEOs, the topic has become one of the most popular of the day. And, it doesn’t take much effort to scroll through the comment sections of most articles to find comparisons to the Great Tulip Bubble of 1637. However, this article has nothing to do with comparing the Bitcoin cryptocurrency to a centuries old financial mania.
Rather than discuss the pricing mechanism of Bitcoin, current valuation, or even the future of cryptocurrencies and blockchain technologies, we are going to look at the current market valuation of Bitcoin Services Inc. (OTCPK:BTSC), formally known as Tulip Biomed Inc. We will discuss the current share structure of the company, evaluate the operation of the company’s business line, and perform a simple present value comparison of potential revenue to current market cap as determined by per share price. Finally, we will look at recent trading activity to speculate on the source of the recent price run-up based on average daily volume and trade frequency.
The company was initially founded in 1997 and incorporated in Nevada as JJL Miami Enterprises, Inc. Over the years, it went through various iterations of business names and models, including BMX Holdings, Direct Music Group, Cell Bio-Systems, and Tulip Biomed. Under circumstances unrelated to the current iteration of the business, the company’s business was abandoned without dissolution or liquidation, and so shareholders submitted an application in accordance with Nevada Title 7 to take custody of the firm under court order. This application was approved in December 2015, and the company was reinstated in good standing in January 2016. In February 2016, the company changed names to Bitcoin Services Inc. and took the appropriate legal steps to dissolve incorporation in Nevada and establish the firm in Florida.
At that time, the company changed business objectives and actively entered the Bitcoin/Cryptocurrency market. From the company’s recent filings:
Our business operations are Internet based to the consumer and consist of two separate streams, as follows: (1) bitcoin and the mining of other cryptocurrencies, and (2) blockchain software development. The principal products and services are the mining of bitcoins, and the development and sale of blockchain software.
To execute on this strategy, in July 2016, the company purchased capital equipment needed to mine Bitcoin as described in this press release and announced that it was diversifying its mining operations to Litecoin, Dogecoin, and Ethereum. In July of this past year, the company converted incorporation to the state of Colorado.
The company has a complex structure of equity, which is both interesting and somewhat concerning, with four separate share classes. Issuance of shares has been fully disclosed and is outlined in the company’s corporate filings. In addition to the 1,770MM shares of common stock authorized (with 639MM outstanding as of August 2017), there are three additional preferred share classes that can obfuscate potential dilution and skews control of the company away from the common shareholders.
Series A Preferred Stock is a convertible issue with dividend and liquidation preferences. They are convertible at the shareholders’ election on a one for one basis. They have no voting rights until converted, and at present, do not have a declared dividend. 100MM of these shares are authorized, with 9MM shares currently outstanding as of August 2017.
Series B Preferred Stock is also convertible and without voting rights until converted. However, conversion of class B preferred shares requires a vote or consent of at least a simple majority, resulting in complete conversion of all class B preferred shares to common shares. There are currently 20MM Class B Preferred Shares authorized with 5.3MM shares outstanding as of August 2017. These shares also convert at a one for one rate.
Finally, there is Class C Preferred Stock. There are 10 shares of class C stock authorized, and all shares have been issued and are outstanding. The shares have voting rights “equal to that number of common shares which is not less than sixty percent (60%) of the vote required to approve any action…”. These bases control the company away from the common shareholders and to the preferred C shareholders to the exclusion of all others.
Without regards to any concerns over the capital structure of the company, the next step in our process is to examine operations. As previously discussed, the company runs a network of cryptocurrency mining servers, specifically 15 Bitmain Antminer S7 batch 8’s. These servers are well respected in the industry and are manufactured by Bitmain Masters of New York. However, these servers have recently been outmoded and replaced by Antminer S9’s.
Nevertheless, that does not mean that Bitcoin Services Incorporated server farm is not profitable. To the contrary, with current Bitcoin prices, the firm is running a very profitable business relative to electrical costs. However, were Bitcoin to drop in value to prices seen in the not so distant past, profitability could be drastically squeezed. To understand the potential risks associated with mining with these particular servers, one must understand the capabilities of them relative to the current cryptocurrency markets; specifically understanding the mining rate capable of these servers.
BuyBitCoinWorldwide has proved a detailed review of the Antminer S7 that includes the mining rate. However, keep in mind that when the review was written, the price of Bitcoin was less than $700. Numerous resources are available that will allow readers to learn more about Bitcoin, cryptocurrencies in general, and the “mining” process that is used to “create” new tokens.
Other than the mining of cryptocurrency, the company has no other lines of operation, and we must therefore assume this is the only source of operational revenue. Prior quarters’ financial statements have disclosed $63K and $69K in total revenue for the first two quarters of 2017. Third quarter earnings have yet to be released, and although there has been a dramatic increase in the price of Bitcoin since the beginning of the year, I do not expect a corresponding dramatic increase in revenue based on an increased difficulty in Bitcoin mining.
Overview of Mining Rates
One of the beautiful attributes of Bitcoin cryptocurrency is the steady state rate of mining by marketplace participants. In order to “mine” a Bitcoin, one must participate in the clearing process by dedicating computing power or server space to the network. In simplest terms, these are the “mining” servers such as the Antminer S7. There are a number of factors that determine both the rate of coins mined and the profitability of mining.
The first is the power or speed of the server running. This is twofold in that it determines gross electrical costs as well as number of calculations the server can perform in a given period of time. The faster the server, the higher the rate it will generate Bitcoins. However, the higher the power consumption, the more expensive the server will be to run. The processor speed of the Antminer S7 is known, and the average rate of electricity in Denver Colorado, where Bitcoin Services Inc. operates is $0.10 per kWh.
The next determinate is the block rate. When Bitcoin was first introduced, the number of Bitcoins released per block was 50. This rate got reduced by half to 25 in 2012, and in half again earlier this year to 12.5. It will be further reduced as Bitcoins become released to 6.25 in the future, with most estimating year 2020-2021. A history of block rewards can be found at Bitcoinmining.com, with estimates of future reductions found at Bitcoinblockhalf.com.
Another determinant of mining rate is the difficulty assigned based on global network capabilities. Because the algorithm used is designed to release only a certain amount of blocks in a given period of time, there is a self-correcting variable in the calculation to minimize production; this is the difficulty rate. The more miners there are attempting to clear transaction and create new blocks, the harder it actually becomes. This is based upon design and can have a significant effect on both rate and profitability. However, difficulty can either increase or decrease, based on the recent history of tokens released and overall network capabilities. Bitinfocharts.com provides a good visual of how difficulty has increased as the network has grown and block rates have dropped.
[As an aside, there has been a 400% increase in difficulty since the beginning of this year, a 300% increase in 2016, a 150% increase in 2015, and >2700% increase in 2014]
Modeling Bitcoin Services Mining Operation
Based upon current difficulty and potential increases due to new servers coming online, and given the information on speed and power above, as well as block release rates, we can model the rate of Bitcoin production capable of the company’s operations. Coinwarz provides a handy calculator that automatically incorporates difficulty, block rate, and current Bitcoin price to determined profitability. We will assume current difficulty rates increasing at a very conservative 10% rate quarterly, assume steady electric costs, and continued mining throughout 2020 when mining becomes unprofitable due to the reduction of the block rate to 6.25.
Based on our assumptions, the mining rate naturally decreases over time until the point where mining becomes unprofitable. Based on current hash rates and the rate of increase of miners coming online, rates could be significantly lower, especially if Bitcoin prices remain high. By the time the block rate is reduced to 6.25 from the current 12.5, unless there is no change in difficulty rate, the electrical costs alone would preclude profitable mining using the existing servers.
Given this information, our model indicates the mining of 14.269 Bitcoins over the next 13 months.
Present Value Calculation
In the most simple valuation, we can calculate the present value of the mining operation as a perpetuity assuming a base discount rate and the given mining rate. If we assume a 5% return (as used by CryptoCompare’s evaluation of the Antminer S7 Batch 10 here) and the above mining rate of 0.04058191 Bitcoins per month valued at $7,000.00 per Bitcoin, we can calculate and compare the theoretical value of the company’s operations to the current market value assigned by the stock price.
This valuation is contrary to the assumptions above because it assumes no decrease in mining rates, and that Bitcoin Services Inc. can continue operation indefinitely. We will use this as our “back of the napkin” evaluation.
Because Bitcoin Services Inc. has 15 servers in operation, they are collectively mining 1.826 Bitcoins per quarter, or 7.304 Bitcoins per year. Valued at $7,000 per Bitcoin, that means the company is earning $51,128 per year in gross mining revenue. From there, we must subtract operation costs and administrative expenses to determine net revenue. However, let us assume (contrary to the information disclosed in the company’s filings) that these are all $0.00 and the entire mining operation is pure profit. Present value of this cash flow at a 5% discount rate would value the company at $1.02MM.
As recently as last week, the per share price of Bitcoin Services on the OTC markets has ranged from $0.07 per share to over $0.10 per share. Based on the total shares outstanding, the market cap of the company is $51.8MM or roughly fifty times the intrinsic value of the gross cash flows of the mining operation, based on our perpetuity valuation.
A more appropriate valuation would be to determine the Net Present Value of the projected Bitcoin rewards based upon the same discount rate of 5%. Using the above modeled production rates, the NPV of the company’s mining operation is 13.31BTC. If we stick with our $7,000 our BTC price, this values the company’s future cash flows at only $93,000 relative to the $51MM market cap.
This is irrational. In order to justify this level of market capitalization, Bitcoin prices would have to continue to rise to a level where Bitcoin Services Inc. average price of Bitcoin mined is greater than $3,831,000.00.
Granted, the level of exuberance in the Bitcoin and cryptocurrency markets has yet to achieve full froth, and average investors have not begun to participate by any extensive measure. Novice speculators have little experience or knowledge on how to purchase Bitcoin, Litecoin, Dogecoin, or Ethereum, or any other cryptocurrencies. Therefore, they are seeking easy proxies that they hope will provide unrealistic returns similar to the ones early Bitcoin investors have seen.
How can we tell that recent investors in Bitcoin Services Inc. have been small time retail investors rather than serious speculators, institutional, or other qualified investors? Simply look at the trading action on the OTC markets.
By taking the total number of shares traded on the most recent day (Friday, November 10th), 11,918,686 and dividing it by the total number of trades, 874, we can determine that average number of shares per trade were around 13,637. At $0.08 per share, the means that the average dollar amount per trade was just over $1,000. This is indicative of small retail investors. (For a more full explanation of small retail investors compared to large institutions or qualified investors see my car auction allegory here.).
Outlook of Share Price
So, now that we have determined that the current market value and per share price of Bitcoin Services Inc. is irrationally high relative to the true value of operations, and that the majority market participants in the stock are most likely small unsophisticated retail investors, we can presume that the long term outlook of the stock is poor, with a drop of >90% likely. What is not known is how high speculative traders are willing to bid up the price of the company before the inevitable.
The bottom line: If you think that Bitcoin is going to continue to appreciate to levels yet to be dreamed of, please just buy the cryptocurrency and not these shares. This beautiful blossom will wilt, it is just a matter of time.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This information is not investment advice, nor is it a suggestion to either buy or sell any securities. Retail investors should do their own research and fully understand the risks associated with this company.
Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.