Quick Take

Canaan (CAN) went public in November 2019, selling 10 million ADSs at $9.00 each in a U.S. IPO.

The firm has developed Bitcoin mining and artificial intelligence-specific computing chips.

CAN will see continued strong demand for its Bitcoin mining machines due to the continued price rise of Bitcoin, but its AI chip business awaits a new chip before it has a chance to contribute meaningfully to revenue.

I’m cautiously Bullish on CAN due to the continued strong rise in the value of Bitcoin and its effect on miner demand for new machines.

Company

Huangzhou, China-based Canaan was founded in 2013 with an initial focus on developing ASIC applications for Bitcoin mining under the brand Avalon Miner and has since expanded its portfolio with the Kendryte K210 chip.

Management is headed by founder and CEO Nangeng Zhang, who was previously an assistant researcher at the Beijing Remote Sensing and Communication Technology Institution.

The company was the second largest designer and manufacturer of Bitcoin mining hardware globally in terms of total computing power sold in H1 2019, accounting for 21.9% of the combined computing power of all the Bitcoin mining machines sold globally, as per data from Frost & Sullivan.

Kendryte K210, also referred to as ‘Kendryte AI’ is an Artificial Intelligence [AI] edge computing chip based on the Risk-V open-source hardware instruction set architecture that has been backed by companies like Alibaba (BABA), Google (GOOG), Samsung (KRX:005930), Qualcomm (QCOM), and Antmicro.

Markets

Canaan operates in two primary markets: Bitcoin mining processors and edge AI chips.

Most of its revenue comes from its legacy Bitcoin mining chip segment, while management is seeking to diversify away from the highly cyclical nature of the Bitcoin mining space into other adjacent areas, such as edge AI processors.

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According to a 2018 market research report by Technavio, the global cryptocurrency mining hardware market is projected to grow over $2.2 billion by 2022, representing a CAGR of 10% between 2018 and 2022.

The main factor driving forecast market growth is the profitability of cryptocurrency mining ventures.

Management says that in 2017 the ASIC hardware segment held the largest market share of 74% of the market and is projected to dominate the industry during the period, decreasing by only 3% through 2022, according to a Frost & Sullivan report.

Due to rapid IoT and 5G technology development, it is expected that the combined edge AI chips and cloud AI chips markets will grow at a CAGR of about 45.1% between 2018 and 2023.

The edge AI chip segment alone will register a CAGR of about 62.1% as compared to a CAGR of approximately 22.3% for the cloud edge AI chip segment from 2018 to 2023.

Edge AI chips and cloud AI chips accounted for 43.9% and 56.1%, respectively, of the total AI chips market in 2018.

Recent Performance

Topline revenue by quarter has varied significantly in the quarters since the firm’s U.S. public debut:

Gross profit by quarter has fluctuated sharply over the past five quarters:

Operating income by quarter has approached breakeven in the most recent reporting period of Q2 2020:

Earnings per share (Diluted) have also approached breakeven for Q2 2020:

Source for chart data: Seeking Alpha

In the past 12 months, Canaan’s stock price has dropped 62 percent vs. the U.S. Tech index’ rise of 73.3 percent and the overall U.S. market’s growth of 19.8 percent, as the chart below indicates:

Source: Simply Wall Street

Valuation Metrics

Below is a table of relevant capitalization and valuation figures for the company:

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Measure

Amount

Market Capitalization

$515,460,000

Enterprise Value

$472,030,000

Price / Sales

2.56

Enterprise Value / Sales

2.42

Enterprise Value / EBITDA

-0.37

Revenue Growth Rate

31.83%

Earnings Per Share

-$0.74

Source: Company Financials

As a reference, a relevant public comparable to Canaan would be Ebang International (EBON); shown below is a comparison of their primary valuation metrics:

Metric

Ebang Int’l (EBON)

Canaan (CAN)

Variance

Price / Sales

10.10

2.56

-74.6%

Enterprise Value / Sales

10.41

2.42

-76.8%

Enterprise Value / EBITDA

-40.43

-0.37

-99.1%

Revenue Growth Rate

-65.8%

31.8%

-148.4%

Source: Seeking Alpha

Commentary

In its last earnings call, covering Q2 2020’s results, management highlighted the rise in the price of Bitcoin (BTC-USD) which translated into increasing profitability for miners and thereby increasing demand for machines with the firm’s processors installed.

Also, the advent of the rainy season in China, which causes miners to physically move their equipment to take advantage of lower cost hydropower electricity, also results in improved profitability and increasing demand.

As a consequence, the firm sold out of its Bitcoin machines and began accepting pre-orders for deliveries in Q4 2020 and Q1 2021.

Canaan’s CEO also highlighted its continuing R&D efforts to improve chip performance, although many industry observers believe most of the performance gains have already been obtained by chip makers such as Canaan and that further performance improvements will be of a lesser degree.

Its AI product segment saw some customer gains during the quarter for various edge use cases as management continues to pursue the goal of creating an open source AI application platform to enhance the value of its processor capabilities.

As to its financial results, Q2 2020 resulted in strong sequential topline revenue growth over Q1 as well as sharply reduced operating losses.

Some of the operating cost reductions were due to lower R&D material costs.

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Earnings made progress, with the firm losing 2 cents per share in Q2 vs. 4 cents in Q1 2020.

Canaan ended Q2 with about $75 million in cash and equivalents.

Since the end of Q2 2020, the price of Bitcoin has risen dramatically, thus increasing the profitability of miners, despite the increase in mining difficulty.

While Canaan’s Bitcoin business will likely benefit from Bitcoin’s price rise and miner demand, the firm’s narrative has been its desire to diversify into AI edge computing chips.

Management has provided nothing in the way of detail (that I can find) in terms of revenue for the AI segment.

Instead, the CEO said ‘We are working around the clock to develop our next generation AI chip, the K510.’

So, it appears its existing AI chip is likely not performing in the marketplace the way management wants.

For now, we’ll likely see an increase in demand for its Bitcoin mining machines but no significant revenue increase from its AI segment.

I’m cautiously Bullish on the stock price as a function of overall bullishness on the price of Bitcoin as it appears to be well into a strong runup in price.

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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.



Via SeekingAlpha.com