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As cryptocurrencies soar, investors are turning toward mining plays like SOS Limited (NYSE:SOS) stock. It’s a questionable, and even dangerous, strategy.
Source: Mark Agnor / Shutterstock.com
That’s not because cryptocurrencies are due for a collapse. I don’t believe that at all. In fact, I believe the opposite. I’m a long-time crypto bull.
In theory, the upside for the biggest cryptocurrencies should boost miners like SOS. But in practice, there are real concerns for SOS stock and others like it.
Owning crypto remains a smart strategy. I’m not sure the same can be said for crypto mining stocks, and in particular SOS.
History Repeats
Back in 2017, when Bitcoin and the blockchain first gained some real attention, a number of companies pivoted into the space. Nearly all of them were failing at their original business models. (That’s not a surprise, obviously: successful businesses don’t often move into entirely new markets.)
The pivots into crypto and/or blockchain often sparked big rallies from investors and traders looking for the “next big thing.” Those rallies generally fizzled out as Bitcoin plunged over 70% and blockchain initiatives failed to get off the ground.
In 2020 and 2021, we’ve seen history repeat — at least the first part. Formerly failing companies — one a so-called “patent troll” — have decided to get in the mining game.
SOS is following that playbook, even if it’s later than others. As recently as last year, the company was trying to build a peer-to-peer lending business in China.
Changing government regulations largely ended that plan, so in August SOS sold that business. It announced that it had “created a SOS cloud emergency rescue service,” while also “focus[ing] on the research and development of big data, cloud computing, Internet of Things, blockchain and artificial intelligence.” (‘Focus’ doesn’t appear to be the right word given that immense planned reach.)
That pivot didn’t do anything for SOS stock. So in January, SOS got in the mining game. A week later, it announced the purchase of 14,000 mining rigs.
Not long after, SOS stock took off, coincidentally or not at the same time as the wave of Reddit-fueled rallies that month. SOS now is up 348% year-to-date.
The Problems With SOS Stock
Again, we’ve seen this movie before. It usually ends badly for shareholders.
To be fair, this time might be different. The mining business model is more tangible than the pie-in-the-sky blockchain strategies espoused in 2017 and early 2018. If cryptocurrencies keep rising, crypto mining stocks can theoretically keep doing well.
But SOS stock itself has some problems. A pair of short seller reports published last month highlighted a few.
Now, I know there’s a narrative that short sellers are ethically questionable, and even evil. Whether an investor agrees with that narrative, they still should listen to what bears have to say.
And, again, they make some fair points. I won’t get into the social media debate over where the headquarters is, or the motivations of SOS short sellers. But SOS did admit that HY International, its counterparty in the mining rig purchase, was a shell company. It walked away from a letter of intent to purchase a supposed Canadian blockchain company, FXK Tech, which bears argued too was a shell.
I’m not picking sides here. I’m simply saying this: there are some red flags here. And for those of us who saw what happened in 2017 and 2018, those red flags can’t be ignored just because they were raised by traders who are short SOS stock.
How This Works
But let’s take a step back, ignore the short sellers and ignore the history. Let’s understand what SOS is trying to do, and what SOS stock is worth.
I don’t believe at this point an investor can put much value on the non-mining business. In December, SOS did highlight projections for strong revenue growth in its data business. But gross margins are estimated just 9%, leaving estimated gross profit under $5 million. That’s not enough to really move the needle against a market capitalization over $800 million.
It’s the mining business that has to move SOS stock higher. Yet the 15,000 rigs were purchased for just $20 million.
Here’s why and how SOS was able to procure such a huge order amid a shortage of available rigs and components: the rigs are used, as SOS itself said in its response to the short seller reports.
That’s an important consideration. Crypto mining is a race. The best equipment is a huge advantage. Even SOS’s claimed advantages in electricity costs can’t offset hardware deficiencies.
Those deficiencies become more problematic over time, as the so-called “difficulty rate” increases. So as SOS talks up its mining efforts for the first quarter, investors need to understand that the returns from the existing equipment over time is going to decrease.
And when you add that consideration to the mix, SOS stock starts to look awfully dangerous. Again, this is a company worth over $800 million largely on the back of $20 million in used equipment. Near-term results might look good, but they’re going to decline over time.
The bulls hyping SOS stock on social media aren’t raising these problems. At some point, the market will.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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