Canaan Shivers as Crypto Winter Chills Demand for Mining Machines

Key Takeaways:

• Canaan’s third-quarter revenue and profit dropped 26% and 90%, respectively, as a downturn in crypto markets dating back to May hurt demand for its mining machines
• The company is bracing for even tougher times ahead as cryptocurrency prices remain under pressure amid rising interest rates and a series of high-profile industry scandals

By Warren Yang

It’s named for the biblical promised land of milk and honey. But these days Canaan Inc. CAN is headed to quite a different place, marching straight into a winter that’s shaping up as long and harsh.

The company, one of the world’s largest bitcoin mining machine makers, said on Monday that its net profit for the third quarter dropped nearly 90% year-on-year to 61.1 million yuan ($8.6 million) as it bore the brunt of a deep slump in cryptocurrency markets that shows no signs of easing. 

Canaan’s revenue also declined by more than a quarter as the sharp drop in virtual currency values hit miners, which in turn curtailed demand for computers used to mint new digital coins. To beef up sales, Canaan cut prices for its products. But that undercut its own profitability, and can only do so much to boost sales during the latest “crypto winter.”

Fortunately for Canaan, some sales that it secured before the crypto crash for delivery in the July-September period cushioned its third-quarter revenue from an even worse drop. And despite the plunge in crypto prices, Canaan boosted revenue from its own mining activity, which it began this year to supplement its core machine-making business by putting its unsold inventory to work.

But then a number of costs and charges ate into the company’s revenue in its latest reporting period. One of the largest of those saw Canaan write down some 220 million yuan of inventory as demand for its products cooled, erasing more than 20% of its total revenue. Its research and development expenses also increased, primarily due to staffing costs. And finally, Canaan was forced to book an impairment charge for its own cryptocurrency holdings as their values fell.

The company is bracing for even tougher times ahead, expecting its fourth-quarter revenue to plunge 86% from a year earlier as orders placed before the plunge in crypto prices are dwindling and the current downturn shows no signs of ending.

The price of bitcoin, the virtual currency that acts as a bellwether for the crypto industry, has been on a downward spiral since the spring, hit by surging inflation that has led investors to flee risky assets in general. Adding to the pressure are a growing number of scandals involving crypto companies that thrived during the good times but are now having difficulty meeting their financial obligations. Bitcoin roared to an all-time high of more than $68,000 just a year ago but now trades below $17,000.   

The latest shock for crypto markets came earlier this month after FTX, one of the world’s largest crypto exchanges that once was valued at more than $30 billion, collapsed, leaving its users unable to withdraw their funds. Just six months earlier, the crypto world suffered another major shock when Luna, a so-called “stable coin” that was supposed to be pegged to the U.S. dollar, lost nearly all its value in a single day.

FTX casualties

The ongoing FTX saga is leaving a trail of other casualties across the crypto universe. In the U.S., crypto lending platform BlockFi is reportedly considering filing for Chapter 11 bankruptcy protection due to its significant exposure to FTX. In Hong Kong, digital asset platform New Huo Technology Holdings Ltd. (1611.HK) said on Monday that it has about $18 million worth of cryptocurrencies sitting with FTX.

The aftermath of FTX’s failure doesn’t end with those who have used its services or have direct financial ties. The scandal, combined with previous negative headlines about crypto in general, have left the industry facing a crisis of confidence. The crisis has put most companies in the industry’s vast food chain at risk, including miners that were already grappling with high electricity bills and must now contend with significantly lower values for the assets they harvest.

Core Scientific CORZ, one of the largest listed mining companies in the U.S., said last month it could go bankrupt and wouldn’t be able to repay debt that came due in October and early this month. Also last month, miner Argo Blockchain plc (ARBKF.L) warned that it could be forced to cease operations after failing to raise fresh capital from a strategic investor.

It’s probably safe to say that countless other miners are struggling to stay afloat, with more bankruptcies likely as their profits shrink or disappear and the venture capital investors who once embraced the group refuse to supply new funding. Those miners’ troubles directly trickle down to machine makers like Canaan. In September, Bitmain Technologies, a major rival to Canaan, lowered the price of a key product to 30% less than market prices that already were already down 70% since the start of the year, according to a CoinDesk report.

Canaan and its competitors will probably have to continue aggressively cutting prices, at the expense of margins, in desperate attempts to avoid letting their inventory pile up. But cutting prices for their machines won’t be enough to boost demand in the current depressed market.

In its earnings release, Canaan said it’s expecting things to keep getting worse for another two quarters. That means the company will need to move into cash-conservation mode to survive the rough times, even as it still needs to spend on new product development.

“At this point, facing a severe winter in the industry, profitability is no longer our first priority,” CEO Zhang Nangeng said on the company’s latest earnings call. “We will get through this difficult time and prepare for the future by shifting our focus to the stability of cash flows, reducing unnecessary expenses and continuing to invest in the research and the development of new products.”

Canaan’s balance sheet looks relatively healthy and clean – for now. Its cash holdings decreased a bit by the end of September from a year earlier, but its short-term liabilities also more than halved, with no interest-bearing debt.

Canaan shares rallied about 17% in the two days after it released its third-quarter results. But that’s probably because bitcoin prices climbed in that period, rather than due to any investor excitement about its business performance. The stock has lost about half of its value from a peak in March before the crypto crisis began.

Canaan’s stock is currently trading at about a third of its IPO price, fetching a price-to-earnings (P/E) ratio of just 1.4, far lower than 11.6 for much smaller rival Ebang International Holdings Inc. EBON. But then again, the even more troubled Ebang has yet to file any financial results for this year, and thus its ratio is based on its 2021 profit during much headier times for crypto companies. Thus, its ratio will inevitably come down when it files any updated information for this year.