We don’t purposely seek out short selling opportunities, but when basic due diligence reveals such a disconnect from reality (along with a pattern of behavior which gives you zero confidence in management teams), we will act accordingly. Formulating a thesis and becoming confident with the said conclusions are the easy parts. The hardest part is getting the timing right.
Similar to the chart above, let’s start in the spring of 2021. Covid vaccinations were just starting to trickle into the general population as many were still confined to working remotely from home. Millennials were cashing in their stimulus checks with few options to spend it on travel or entertainment. Markets were roaring back to life, rebounding from the Covid lows aided by the unprecedented $Trillions being pumped in from the Fed, all in an attempt to stimulate the economy. The new form of entertainment for the pandemic times involved a simple internet connection and a PC, tablet or smartphone. With easy to use trading platforms such as RobinHood, Coinbase and Etoro, retail was entering the investing game (or rather the speculating/casino game) en masse. With investing memes spreading like a wildefire on social media, Reddit and Wallstreet Bets, the gamification of investing pushed up stocks such as Gamestop and AMC to unprecedented levels. Speculative interest was also crossing asset classes and migrating from equities to cryptocurrencies as well, with Bitcoin in the early innings of a monumental 2021 run. There were very few publicly listed bitcoin miners (or at least none with a notable mcap), the most well known was Riot Blockchain, a miner with that was recently under SEC investigation for securities fraud.
That spring we came across an ambitious new entrant to the bitcoin mining landscape, Gryphon Digital Mining. The private company had ambitious plans to be a carbon neutral miner, despite management being relatively inexperienced in the space (look it up, do your own research). What really stood out however was an investor price deck promising high rates of return, the extent to which we have never come close to seeing before (and we’ve certainly seen our fair share of prospectuses and investor presentations).
Normally a project with an IRR of 30% may warrant additional work as it may be a worthwhile investment. Even an IRR 20% is doable (depending on the sector) but in our books, 30% is a good starting benchmark. We normally are pretty skeptical when we see a project IRR in the triple digits. That said, totally blowing past our benchmark, the slide deck above from Gryphon Digital Mining reported not a triple digit IRR… but a 1,000% IRR (lets be clear: one-thousand percent) given a bitcoin price of $50,000. This is next level forecasting. What’s just as telling is that the operation’s IRR is pretty inelastic to increases in power rates. As seen above, when the cost of power (power being the largest cost item to any bitcoin mining operation) nearly doubles from $0.02/kWh to $0.035/kWh – at a BTC price of $50,000 the IRR goes from 1,022% to 961%...essentially the same rate of return despite a 75% increase in the power price! But wait!... There’s more:
The investor presentation also stated that the company has secured power prices “as low as $0.013/kWh”. That’s even below the low end of the sensitivity range! And with bitcoin prices even higher at $55,000 (such as in early May 2021), one can only assume that the IRR projection would have to be well above the 1,022% when the inputs are a BTC price of $55,000 and a power price of say $0.015 kWh. Apart from access to cheap power prices (supposedly), we didn’t see any asset or meaningful tech, IP or patent which would form a competitive advantage. The only discernable “asset” seemed like a somewhat large social media following (on Twitter) populated mostly with childish memes, gifs and the one off news release of questionable value. The goal of becoming a 100% carbon neutral miner certainly is a noble cause but is easily replicated by similar pledges from other miners, all of which understand the value of ESG. Becoming 100% carbon free does make great headlines for promotional purposes however. In anycase, clearly the smart money was not going to find a home with this one as it was hard to take the IRR numbers seriously. The corporate presentation we had went straight to the recycling bin. Some "companies" are best kept private.
This story came back to light just four weeks later when on June 3, 2021, when a small tech company in the data storage/virtualization/containerization/networking space named Sphere 3D (Ticker: ANY) announced a merger agreement with Gryphon Digital Mining. This marked a pivot from whatever it was that Sphere 3D did since 2014 (clearly nothing of substance let alone profitable) to a strategic decision to enter the Bitcoin mining space. On paper, not a bad move since the company has been loss making for an extremely long time, (look at the stock price below). It seems that Sphere 3D was looking to pivot in order to find something new which would revitalize the rock bottom share price via heavy promotion.
Sphere 3D management also had a chequered past (again, do your own research) with the CEO having a history of running penny stocks (mining exploration, healthcare and now tech) into the ground with documented (Ontario Provincial Court) admissions of guilt for making false or misleading statements. That said, as per the June 3, 2021 Sphere 3D press release, the merger agreement was scheduled to close in Q3/2021, with Sphere 3D shareholders owning approximately 23% of the company and Gryphon shareholders owning the remaining 77%). Effectively, since the merger was announced, privately held Gryphon began trading by proxy via Sphere 3D.
What followed in the next few months was an epic promotional climb from $1.74 pre-deal announcement on June 2, 2021, to a high close of $8.13 or +367% on October 13, 2021, and then back to the $1.74 as at, April 14, 2022. Below are the chain of events since the June 3 2021 merger announcement:
September 8, 2021 (ANY close $7.08, +17.0%): Sphere 3D closes a $192.1M direct offering ATM at $8.50 consisting of 1 share and 1 half warrant with an exercise price of $9.50. Proceeds are to be used to purchase 60,000 crypto miners and reach a combined capacity with Gryphon of 6.4 Exahash. This was big news because it overshadowed the fact that that the merger completion date will be pushed back to Q4/2021.
September 22, 2021 (ANY close $6.35, +9.7%): Sphere 3D secures 60,000 Antminer S19j Pros, with delivery beginning in November 2021. An $85M payment is made. Gryphon expects delivery for 7,200 Antminers for a combined order of 67,200 miners.
September 27, 2021 (ANY close $6.73, +14.5%): Promoting the alleged goal of being a carbon neutral miner, an article appears (planted?) on SeekingAlpha stating that Elon Musk is “likely” to join the Gryphon BOD after the merger with Sphere 3D is completed sometime in Q4/2021. When asked about the rumor, management simply declined to comment (as opposed to saying, there clearly is ZERO truth to it). Regardless, that bit of catnip made the rounds on social media and retail just gobbled it up as the stock ended up nearly +15%
October 13, 2021 (ANY close $8.13, +15.6% - multi-year high): The largest single hosting services deal in Core Scientific’s history was announced. This was a deal for 230MW of carbon neutral mining hosting capacity managed by Core Scientific which would accommodate up to 71,000 bitcoin mining machines. For a company just starting to receive delivery of mining equipment, this was a monumental press release. The share price reacted accordingly as it hit a multi year high on back of the news. In hindsight, all downhill from here.
November 16, 2021 (ANY close $5.76, -15.8% ): Sphere 3D reports its Q3/2021 financial results (insignificant revenues of $1.0M and a net loss of $1.2M) but the big news was that the much anticipated merger with Gryphon was being pushed back yet again, now anticipated for Q1/2022.
January 12, 2022 (ANY close $3.12, -1.8%): Amid a plummeting share price spurred on by yet another merger delay, Sphere and Gryphon publish an FAQ in an attempt to quell investor backlash and in order to offer minimal clarity on developments. The FAQ was in essence an attempt to end any conversation by issuing a blanket statement essentially amounting to – due to the pending merger, we are not permitted to disclose or provide any additional information until deal completion. The only point to note (as filed from the F-4 registration statement from January 5, 2022) was what is highlighted in yellow, below:
With investor appetite waning given yet another merger delay, the stock spent most of January languishing in the $2.00 range, well below the required $4.00 minimum price for the merger. Meanwhile, the clock was ticking as the Q1/2022 deadline was fast approaching. Now was time to go big and really rev up the promotional engine:
February 4, 2022 (ANY close $3.02, +31.2%): A deal was reached to acquire an additional 60,000 bitcoin mining machines to complement the previous order for 60,000 S19j Pro miners. This new 60,000 unit order was supposedly for next generation NuMiner NM440 bitcoin miners which had advanced stats which blew the competition out of the water in terms of hashrate (TH/s) and power efficiency at 20.2 joules/TH (translating to a 75% reduction in energy consumption…supposedly) . With a hash rate of 440 TH/s, these next generation miners completely blew away the operating stats of the S19j Pros at “just” 104 TH/s. Below were some pics from the website, www.numiner.com
The NuMiner website still says that their NuMiner, NM440 is the “the world’s most powerful and environmentally friendly bitcoin mining technology”. The actual picture above was since removed from the corporate website however. Moreover, the only news item on the corporate website happens to be the February 3, 2022 press release about the monumental purchase agreement with Sphere 3D. It sure doesn’t seem as if the sales contracts are rolling in despite the next generation stats. Incredibly, the contract signed by Sphere 3D for all these next generation Numiner units was for up to $1.70B (yes, $Billion). For a perennial loss making company with a mcap of approximately $150M, this is really going big. The press release also added that NuMiner Chairman Anthony Melman was supposed to join the Gryphon BOD once the merger with Sphere would close. As over the top as this all sounds, this press release once again made the rounds on social media. Retail ate it up as the stock advanced by over 30% and climbed back to $3.02.
As an aside, we consulted with people deeply involved with cryptocurrency and the mining of bitcoin and the near unanimous consensus was that the specs for the NM440 NuMiners are likely to be complete fiction. Assuming the latest 7nm chipsets installed in the mining unit and assuming an overclock rate of 10%, in order to achieve the 440 TH/s at an efficiency of 20.2 joules/TH, nearly 3,000 chips would be needed per mining unit, greatly increasing the volume of the individual miner which may now look like the size of a fridge (filled with hash boards, heat sinks and water cooling equipment all packed inside tightly). For comparison, the S19j Pro has a chip count of “only” 342. The volume may be reduced somewhat if using the latest TSMC 5nm architecture, but now we’re really talking state of the art and expensive. One would expect in the least that NuMiner press release that they are using Intel or TSMC chipsets, but once again, the only press release found on their corporate website is the February 3 Sphere 3D purchase agreement. There is no chance that a loss making microcap that just pivoted into the bitcoin mining sector can ever expect delivery for 60,000 fridge sized mining units, let alone be able to furnish the 486Mw of electricity needed to run that massive fleet (at approximately 8,100 watts per miner, do the math). Were we to expect a follow-up press release stating that Sphere 3D and Gryphon are in the midst of project financing to build an AP100 Westinghouse nuclear power plant ? Its great to think big, but throwing around numbers like this (let alone the $1.7B NuMiner purchase price) is an insult to common sense. Like we said, the smart money was never there, but meme fueled promotion had retail eating this up. Shame on both management teams.
If the numbers alone don’t point to fraud, the image itself should. Cerebras Systems, a company building computer systems (CS-2 units) for ML and AI applications, was alerted on February 7 to the image of the NM440 as seen above, and issued the statement below:
Essentially the NuMiner image was a photoshopped image of Cerebras’ CS-2 systems with some Mountain Dew green color added (maybe to make it look cool ?), along with the NuMiner logo emblazoned on the side. This is what it’s come to, the lowest form of imitation. This entire NuMiner fiasco is essentially a level 2 inception scam. After the initial +30% bump to the Sphere 3D stock price following the February 3 press release, the stock did trend lower as we go closer to quarter end and never came near the $4.00/share level needed for the merger.
On April 4, 2022 the merger was called off after “mutual agreement not to proceed with the merger”. Both companies continue to work together through a previously disclosed Master Services Agreement however.
All that said, Elon Musk never did end up joining the Gryphon BOD. We can only assume he had other ventures such as leading the automotive revolution (Tesla), launching rockets for NASA (SpaceX) and populating low earth orbit with constellations of satellites for new-age communication (Starlink) which kept him busy. But good try Gryphon.
Anyway, this is the Coles Notes version which led to our thesis and conviction. There’s much more here, but you get the point. Sadly many were conned and ended up losing everything. A history of deception and promotion is likely so ingrained by those who do it, that the very same playbook will likely continue in the future. What’s important is due diligence, recognizing what’s going on and realizing that before any catch-up to reality (crash), there is sufficient runway for outsized gains before the crash. If caught early enough, the only question is on timing, when to exit and then when to short. We don't short on valuation, but will consider it for specific cases when outright fraud is suspected and uncovered. As the CEO of Gryphon Digital Mining stated in the press release dated October 13, 2021, “Working with and hiring the best is a fundamental philosophy at Gryphon Digital Mining”. This entire fiasco was a textbook pump & dump.
Position yourselves accordingly.