Starboard sees a chance to create value at Riot Platforms

Business: Riot Platforms is a bitcoin mining and digital infrastructure company. It has bitcoin mining operations in central Texas and Kentucky, and electrical switchgear engineering and fabrication operations in Denver. It operates a bitcoin-driven infrastructure platform. Its segments include Bitcoin Mining and Engineering. The Bitcoin Mining segment is engaged in bitcoin mining. The Engineering segment designs and manufacturers power distribution equipment and custom engineered electrical products.

Stock Market Value: $3.97B ($11.55 per share)

Ownership: n/a

Average Cost: n/a

Activist Commentary: Starboard is a very successful activist investor and has extensive experience helping companies focus on operational efficiency and margin improvement. Starboard has taken a total of 155 prior activist campaigns in its history and has an average return of 23.27% versus 15.27% for the Russell 2000 over the same period.

Starboard has acquired a position in Riot Platforms and sees opportunities for operational and strategic value creation.

Riot Platforms is engaged in both the mining of bitcoin, as well as owning and operating its own mining facilities. Vertical integration enables Riot to directly control its operations and manage input costs such as power and overhead fees, as opposed to renting out space from third-party data center operators. Riot has two business segments: Bitcoin Mining and Engineering (designing and manufacturing power distribution equipment and custom-engineered electrical products). The company is one of the largest publicly traded bitcoin miners with over 1 gigawatt (GW) of developed power capacity between its facilities in Rockdale, Texas; Corsicana, Texas; and Kentucky. Riot also owns 16,728 bitcoins.

Despite bitcoin being up approximately 130% this year and an incoming presidential administration favorable to cryptocurrency, Riot’s stock price has declined by 24% prior to the announcement of Starboard’s position versus an average year-to-date return of over 100% for its peers. This significant underperformance in a company with such strong tailwinds can only mean an extreme lack of confidence in management – and for good reason. First, spending on selling, general and administrative expenses is out of control up to $225 million in the past year up from $67 million in 2022. Part of the reason for this is the stock-based compensation paid to executives. Despite continually delivering losses and with a three-year return of -54.7%, management has paid themselves 11.5%, 9.5%, and 32.12% of total revenue in stock-based compensation over the past three years. Accordingly, the company has the highest power cost plus cash SG&A expense per coin in the space, despite having access to relatively cheap power, as well as the highest stock compensation per coin. Accordingly, the company has delivered negative net operating income in each of the past three years, with its largest operating loss ever this year of $304 million. Add to this a horrible corporate governance track record with a five-person staggered board and instances of nepotism within the higher levels of the company. As a result, Riot trades at one of the cheapest multiples in the industry on the basis of enterprise value to earnings before interest, taxes, depreciation, and amortization and EV to PH/s (petahash per second, a measure of computational power).

Starboard has extensive experience in corporate governance and helping boards “professionalize” companies and optimize operations. Just the addition of a Starboard representative to the board would give the markets tremendous confidence that management is on the path toward shareholder value creation. Starboard is an exceptional activist with expertise in improving operational performance and margins, skills which any management team should be excited to have in an engaged shareholder. The firm will no doubt advocate for the company to reduce its needlessly high SG&A expenses and right-size executive compensation to reflect business performance.

But the good news for the board and management is that Starboard’s second part of the firm’s plan can make them all rich: Pursue the massive demand opportunity from hyperscalers or large-scale cloud computing companies that operate data centers and provide cloud infrastructure and services. These companies, such as Amazon Web Services, Microsoft Azure and Google Cloud, to name a few of the largest, have been in a battle to contract out and build sites to run their High-Performance Computing (HPC) and Artificial Intelligence (AI) data center operations. Crypto mining facilities share several key inputs with these applications that make them excellent candidates for contracting out their capacity or converting their crypto operations, namely high-performance computing infrastructure, access to energy (preferably renewable), energy management expertise, and operational scalability, among others. While the specific needs of hyperscalers are not identical to those of crypto miners, it is much quicker and cheaper for them to convert existing facilities in a year or two rather than taking several years to build their own facilities from the ground up.

This is a strategy that several of Riot’s competitors have pursued much to the delight of their shareholders. Earlier this year, Core Scientific, another bitcoin miner, entered into an agreement with CoreWeave, an Nvidia-backed AI data center startup, to deliver 500 megawatts of capacity to host CoreWeave’s HPC operations. This arrangement is worth $8.7 billion in cumulative revenue over 12 years to Core Scientific, which is set to generate about $1 million in incremental cash flow per 1 MW contracted under the deal at a 75% to 80% profit margin, far more than what it would receive from its normal bitcoin mining operations. In response to Core Scientific’s first announcement of its partnership with CoreWeave in June, Core Scientific’s stock price rocketed 40% the following day and is up nearly 220% since. Despite being the fifth largest miner by hash rate, it is now the second in terms of market cap. Bit Digital, Hive Digital, Hut 8 and Iren have also already made the switch to mixed use with several other miners piloting or exploring the potential to capitalize on this massive opportunity. The stocks of Bitcoin mining firms that have already shifted capacity to HPC have delivered an average YTD return of 105.8% versus an average of -3.4% for peers who had not yet announced plans to do so (Riot, Mara Holdings, and CleanSpark).

The good news for Riot shareholders is that the company is in an excellent position to capitalize on the massive opportunity presented by leasing capacity to hyperscalers. The Rockdale, Texas bitcoin mining facility is the largest in North America with 700 MW of developed capacity. Its Corsicana, Texas facility, currently has 400 MW of capacity and, upon completion, is expected to have approximately 1 GW.  These plants have characteristics favorable to hyperscalers (access to energy, near major metro areas, low latency and controlled natural disaster risk). Extrapolating from the Core Scientific deal, Riot has the opportunity to generate $1 million of cash flow per MW on hyperscaling. The Corsicana facility will soon have 600 MW of unused capacity that can be contracted out right now to hyperscalers without affecting any of the company’s present bitcoin mining operations. Assuming Riot converted only the 600 MW it is working to bring online at its Corsicana facility, it could generate an incremental $600 million in cash flow annually (versus $313 million of revenue today). If Riot were able to convert the additional full 1.1 GW of its projected total capacity at Rockdale and Corsicana, that number could almost triple. Additionally, if the company signs a deal like Core Scientific did with CoreWeave, the hyperscaler will pay for virtually all of the capex to build or convert these operations. Moreover, in July, Riot acquired Block Mining with its Kentucky facilities and is aiming to increase its capacity from 60 MW to 300 MW, which might not be ideal for hyperscalers, but could certainly at least be used for bitcoin.

There are certainly traditional Starboard-type of levers in this engagement for shareholder value creation such as operational improvements, divestiture of non-core businesses and investments, as well as improved corporate governance.  However, the core element of the firm’s campaign and message to management is simple: Look around you. Riot is being lapped by its competitors for failing to capitalize on the massive opportunity presented by leasing capacity to hyperscalers. Every announcement of such a contract understandably sends their peers’ stock on a soaring trajectory. And Riot is in an excellent position to capitalize on this.

Riot has already come out and said that it has spoken with Starboard on several occasions, welcomes the firm’s input and looks forward to ongoing constructive dialogue in order to create value for all shareholders. However, it would not be unreasonable at first glance to think Starboard may encounter difficulties based on the company scoring very low in corporate governance metrics, its staggered five-person board with just one seat available at its next meeting, and recent actions evidencing that the company is focused solely on being the largest vertically integrated bitcoin miner. Shareholder activism often comes down to making an incontrovertible argument. Starboard has one here, at least for the 600 MW that is not being used yet. Once management sees money coming in, allowing them to grow into the outsized compensation they have been receiving, it is not a long jump to converting their other capacity.

Moreover, Riot recently purchased $510 million of bitcoin on the open market using the proceeds from a convertible senior notes offering, reflecting that it may want to acquire bitcoin today at a rate which exceeds its current mining capacity. There would be no better way to accomplish that goal than converting some of its capacity for hyperscalers to generate strong and stable cash flow well in excess of what its normal operations would. If Riot is really so adamant about owning bitcoin, it could use some of this excess cash flow to acquire some of the bitcoin it would have otherwise mined. Management must decide whether Riot wants to be a professionally run company that optimizes value for all involved or whether it just wants to be a bitcoin miner. If management decides on the latter, it will be choosing to not only forego billions of dollars in value but put itself on a path of a potential distracting and expensive proxy fight with Starboard over the next two years – at the end of which management could walk away with nothing. We do not see this happening as there seems to be a lot of room for compromise here.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Riot Platforms is owned in the fund.