Investor interest in alternative financial businesses has skyrocketed in the past few years, as developments such as Peer-to-Peer lending and Bitcoins have grabbed headlines across the globe.
Directmoney Ltd (ASX: DM1) listed on the ASX back in July, Trade Me Group Ltd (ASX: TME) bought a big chunk in NZ peer-to-peer lender Harmoney, and Westpac Banking Corp (ASX: WBC) has exposure to the sector through its stake in SocietyOne.
Now, Australia (and the world) is getting its first listed Bitcoin trader, in the form of Bitcoin Group Limited (ASX: BCG), which recently released its prospectus to interested investors. I'll dig into the meat of the offering further down the page, but here's a broad outline:
- 100,000,000 shares to be issued at $0.20 each
- Afterwards, there will be a total of 164,870,930 shares on issue including existing shares (market cap of ~$32m)
- Management to own 9.2% of the company, with the public owning 60.7% and remainder owned by significant investors
- Minimum investment $2,000
- Offer closes 30 October
- Purpose of the offer is to fund growth and increase working capital, as well as repay small director loans
So What?
To their credit, Bitcoin Group has presented a comparatively straightforward and easy to understand prospectus, which is necessary given the largely uncharted territory it is asking people to invest in.
In short, the company uses specialised computer processors to 'mine' Bitcoins by solving time-consuming and processor-intensive equations. When an equation 'block' is solved, the solver (Bitcoin Group) receives a bounty of 25 Bitcoins. This bounty halves – called 'Block Halving' – every 210,000 blocks, and is expected to drop to 12.5 Bitcoins around July 2016.
More processing power will result in Bitcoins being earned faster, however, the difficulty of the equation is recalculated every 2,016 blocks, so that the previous 2,016 blocks would have taken exactly two weeks had everyone been mining at this difficulty. Bitcoin Group can get ahead of the curve if it adds processing power faster than the market average.
According to management, this reflects a fixed market opportunity of 108,000 Bitcoins per month, roughly $35m at today's prices – at least until 'Block Halving' occurs or the value of Bitcoins change. By my calculations, 2,016 blocks every two weeks is 4,032 blocks per month, or 100,800 Bitcoins per month (at 25 coins per block). I am uncertain if this reflects an error in my calculations or a typo in the prospectus.
Bitcoin Group produces approximately 1.57% of the global mining output, or roughly AU$550,000 per month. Although incorporated in September last year, the Group did not commence operations until the beginning of 2015 and earned AU$1.7m in the year to 30 June 2015. $431,000 of this came out as Gross Profit, from which other expenses are subtracted, leaving $69,000 as comprehensive income for the group.
The Risks
As readers can see, only a small portion of earnings came out as profits, and much of that was in the form of 'fair value gains' on Bitcoin valuations. It is uncertain how much faster profits will scale up compared to costs as the business grows.
Management intends to operate by using Bitcoins for goods and services wherever possible, and will use earnings to reinvest in further Bitcoin Mining apparatus. There are no dividend plans in place. Given that the number of Bitcoins received from mining halves every four years, management would appear to be investing heavily into a shrinking source of income.
However, the value of these mining activities depends on the relative value of Bitcoins, which has been known to fluctuate wildly and, at AU$337 each, is below the AU$400 target figure used by management in the prospectus.
Management also notes that the actual value of Bitcoins usually rises when 'Block Halving' occurs, although it seems likely that other factors such as the demand for Bitcoins will play a part. Increasing public usage of Bitcoins will be required to maintain value (given a constantly increasing supply of currency), though there is the potential for massive increases in value (given that only 100,000 are created per month) if they are adopted wholesale.
Another major risk is the fact that the amount of processing power in the market could reasonably be expected to rise over time, yet the actual amount of Bitcoins created will remain constant. I believe this could result in perpetual heavy capital investment on behalf of Bitcoin Group. It could still be a winning business model, but much depends on the value of Bitcoins over time.
It is also worth noting that the vast majority of the company's business is conducted in China through a wholly-owned subsidiary and Australian-listed Chinese companies do not have a sterling reputation for business. While it may be unfair to tar Bitcoin with this brush, it is something to be aware of.
Now What?
I could go on for several pages detailing on the 'what-ifs' and risks associated with an investment in Bitcoin Group. Due to space limitations I can't, but I highly recommend interested investors do their own research into Bitcoin mining, the history of Bitcoin, Bitcoin value, and economic circumstances that affect the value of Bitcoins. A brief refresher course on how currencies work would be valuable, and reading the entire prospectus should be considered mandatory.
Until the company builds up more of a track record, Bitcoin Group looks too risky to be any more than a tiny stake in an investor's portfolio.
