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Overview
Mechanical Technology Inc. (MKTY, Financial), which is soon to be renamed Soluna Holdings, operates two businesses: MTI Instruments and Soluna Computing. Both businesses are profitable and growing at a fast rate while producing high returns on invested capital. The company was unknown for some time until fund manager Michael Toporek (founder of Brookstone Partners) took over as CEO, increased profitability, kick-started growth and brought it out of the darkness in 2018.
The company is now listed on the Nasdaq with 12.7 million shares outstanding and a market cap of $103 million. Toporek currently owns 38.2% of Mechanical Technology and has only increased his position in the company since taking control.
MTI Instruments
MTI is engaged in the design, manufacturing and selling of vibration measurement and system balancing solutions, precision linear displacement sensors, instruments and system solutions and wafer inspection tools. These products are critical to the manufacturing and inspection of airplanes, electric vehicle batteries, semiconductor wafers and a plethora of other products.
Most of MTI’s revenue (42.9% as of 2020) is generated from the U.S. Air Force. This high customer concentration is slightly concerning, but the Air Force has proven to be willing to continue buying its products. These products mainly consist of portable balancing systems and precision instrument products, which are critical to the inspection of aircraft and related equipment, so it would be difficult for customers to switch suppliers. Therefore, I believe MTI will be able to maintain the Air Force as a customer in the coming years.
Since 2020, management has indicated that MTI has seen significant increased interest for its PBS, diagnostic equipment and semiconductor products. The new interest has been from EV manufacturers and semiconductor companies. The management team has noted they are actively in communication with such companies and expect the development of these new market opportunities to accelerate growth.
MTI Instruments’ growth and profitability have been impressive over the past several years.
Source: Mechanical Technology
Revenue grew a healthy 36%, while net income increased 397%. This is fast growth, which I see continuing in the future. Of course, I don’t expect net income to continue climbing at such an eye-popping pace in the coming years.
Based on what management has been communicating to shareholders, revenue and profitability growth will continue into the long term. I estimate MTI will grow at a compound annual rate of 15% over the next five years.
MTI seems to be an efficient company with a large addressable market that operates profitably and will be able to grow both profits and revenue over the coming years. Though management has stated MTI will not be a major contributor to earnings in the future, it remains a quality subsidiary. There is also a possibility that management chooses to spin-off MTI into its own stock or sell the business outright to fund the crypto mining operations and its future growth. I do not see this happening soon, but maybe in the future.
Soluna Computing
Soluna Computing is Mechanical Technology’s crypto mining operation.
On Aug. 12, the company announced that its subsidiary, EcoChain, was acquiring Soluna Computing. Management also announced the company will be renamed “Soluna Holdings,” along with EcoChain being renaming “Soluna Computing”.
Source: Mechanical Technology.
Following the acquisition announcement, management gave a presentation laying out the new crypto mining operation and its target goals for the coming years.
Source: Mechanical Technology.
EcoChain is on target to produce at least 50 megawatts by year-end 2021. Soluna Computing has a massive pipeline of over 300 MW that will be integrated into the mining operation over the next several years. As the MW are integrated, revenue and earnings will skyrocket.
Source: Mechanical Technology.
This acquisition will place Soluna in the top three of mining companies in terms of MW produced, making it a major player in the crypto mining industry.
The CEO has communicated that the long-term goal is to provide low-cost alternative energy data centers for all things related to blockchain and crypto mining.
Key advantages
Soluna Computing operates as one of the few 100% environmentally-friendly crypto miners. As stated in the company’s presentation, it will generate most of its MW power through wind, along with utilizing natural gas when necessary.
Source: Mechanical Technology
This is an advantage over competitors as companies and governments have expressed concern over the negative effects crypto miners are having on the environment. If Soluna can continue to maintain its eco-friendly image, it will likely become the preferred supplier for many customers.
Although Soluna chose to enter the crypto mining space, it has significant data center infrastructure and advantageous power costs that give it the ability to pivot to many industries that require computing. I believe this is management’s long-term intention.
Source: Mechanical Technology.
A unique strategy the company has been implementing is building data centers used to purchase excess renewable energy. This is a smart strategy that provides enhanced power infrastructure and operational flexibility.
Most importantly, Soluna also holds another intrinsic advantage over competitors: power cost. Compared to other miners, Soluna is the best in class.
Below are the power costs of each company broken down:
- Riot Blockchain (RIOT, Financial) – 2.5 cents to 5 cents depending on location.
- Hut 8 (HUT, Financial) – 2.8 cents via $25 million paydown with supplier.
- Bitfarms (BITF, Financial) – 2.2 cents to 4 cents depending on location.
- Marathon – 2.8 cents via equity deal with Beowulf Energy.
- Digihost (TSXV:DGHI, Financial) – 3.8 cents.
- Soluna – 2.3 cents.
The future is profitability:
By the end of 2021, the company is on track to hit its target of 50 MW produced. In the presentation, management laid out how much revenue and profit Soluna would generate in a full year assuming 50 MW produced and a bitcoin price of $45,000:
Source: Mechanical Technology.
I estimate that Soluna will be able to produce at least $500,000 in Ebitda per MW produced. Management has indicated the company should be able to produce between $654,000 to $834,000 per MW in contributing margin (their version of gross margin). Soluna spends a negligible amount on research and development expenses, so I estimate $1.5 million to $3 million will be spent on selling, general and administrative expenses annually. Given what we know, it seems that most of the contributing margin will result in Ebitda.
What can we estimate earnings power to be over the next three years? As stated, management expects the company will reach at least 50 MW by year-end. By the end of 2022, management estimates it will reach 250 MW. Considering the pipeline and future earnings power, I estimate the company will reach at least 350 MW by year-end 2023. Although Soluna has shown it can produce closer to $800,000 in Ebitda per MW, I will be very conservative and use $500,000 per MW in the estimates below:
Source: Mechanical Technology.
In a full year of 50 MW, Soluna will produce at least $25 million in Ebitda. A full year of 250 MW should produce at least $125 million. This is a massive amount of growth in just a few years, but it is very attainable. Management has stated they have “set the groundwork to achieve our target goals” using various methods to increase cash equivalents without heavy dilution, including a recent preferred share issuance.
Clearly there is massive upside potential as earnings and revenue growth explodes in the coming years. However, does management have the skill and capital discipline to carry out the plan?
Quality management
There are many experienced board members and executives at Mechanical Technology, but I would like to take a close look at Toporek.
Below are some excerpts from his CEO letter:
- “I would like to bring a new paradigm of increased transparency to the Company.”
- “Our intention is to communicate with shareholders regularly on our goals and the Company’s progress in meeting those goals.”
- “As significant shareholders, management’s goal is to earn strong returns on investors capital.”
- “We also set the groundwork to achieve our target goal for EcoChain for 2021.”
- Toporek stated that they want to be “The AWS for blockchain.”
As stated earlier, Toporek owns 38% of the company, so any dilution or stock price decline would affect him the most. As of 2020, Toporek takes a salary of $25,000, including option grants. This is undoubtedly low and sends a strong message to shareholders that he’s not milking the company for his own profit. It also tells me he thinks the long-term appreciation from his shares will be much higher than any salary or compensation package they could offer him.
Finally, Toporek has made good on his word. Since 2016, he has used capital discipline to turn the company towards profitability and create a valuable crypto mining subsidiary. His capital allocation, transparency and communication are truly unmatched in the industry.
The rest of the management teamshares his views on capital discipline and maintaining a high return on invested capital for all ventures. On almost every shareholder call, the term ROIC is consistently used by the chief operating officer, chief financial officer and CEO. It is very refreshing to see managers that are focused on being quality capital allocators.
Risks
I see a few risks that could slow the company’s growth or earnings power in the future.
- Brookstone Partners could take advantage of the company due to its majority equity stake. Although this is in the realm of possibility, it is extremely unlikely. If management accomplishes their goals, the company will become very valuable, so Brookstone would profit more than anyone. I believe there is a strong alignment of interest between shareholders and management that would prevent such an event from taking place.
- Mechanical Technology is connected to the cryptocurrency markets, including the price of bitcoin. This connection can bring more volatility to the stock depending on the price movement of bitcoin and other cryptocurrencies. Soluna is not directly connected to the price of bitcoin in terms of investment profits or losses because they convert all their bitcoin to dollars on a daily basis, therefore they do not hold any crypto on their balance sheet (unlike Riot Blockchain and other miners). In the past, the stock price has not been seriously affected by fluctuations in bitcoin prices, thus this risk is likely alleviated.
- A crypto market collapse. This is an extremely low possibility, but in the event of a crypto market collapse due to certain regulation or government intervention, Mechanical Technology’s stock would likely take an initial hit. Management has addressed this issue with the conclusion that as long as the company produces power, they can flip to any industry that is involved with computing that requires data center space. So long as they keep producing power at a low price, this risk is minimized and they will always have a pivot option.
Valuation
Thanks to the information management provided regarding their crypto mining operations and MTI business, a reasonable estimate of value can be achieved. My valuation will be based on what I believe the company can do in the near future.
Mechanical Technology currently has $12 million in cash and recently completed a preferred stock issuance, which provided an additional $18 million. Overall, I estimate the company’s cash position to be around $30 million currently. I believe most, if not all, those funds will go towards upgrading to new equipment for its crypto operations. These purchases are necessary to the growth of Soluna and will benefit the company in the long term.
Because the company has not yet started to incorporate the full Soluna pipeline, I will base my valuation off what Mechanical Technology will do in a full year, assuming Soluna Holdings will conservatively produce at least 50 MW:
- Revenue – $65 million
- Net income – $26 million
- Less: Maintenance capital expenditure of $5 million.
- Free cash – $21 million
- Earnings per share – $2.05
- Price-earnings ratio – 15
- Estimated stock price – $30.70
- Upside to current price – 377%
Not including the future earnings from the increase in MW throughout 2022-23 and assuming Soluna will produce at least 50 MW in a full year going forward, the stock is significantly undervalued. Additionally, considering that MW produced will be five to six times higher in a few years as the company fully incorporates Soluna’s pipeline, earnings will grow exponentially, giving Mechanical Technology the ability to be a massive multi-bagger within five years.
Catalysts
There are several potential events or catalysts that could have a positive effect on the stock:
- Quarterly earnings: As the crypto mining subsidiary grows, the revenue and earnings growth will start to show up in the quarterly reports. This is the biggest catalyst that will most likely propel the stock higher in the coming years.
- New name and ticker: The company will change its name and ticker after the Soluna acquisition closes in late October. I believe changing the name from Mechanical Technologyto Soluna Holdings could drive more coverage from investors and funds that could potentially affect the stock price.
- Mergers and acquisitions:I believe management is open to merging or acquiring a smaller crypto miner or related companies. I don’t see this strategy as a key growth driver for the long term, but it is a possibility. Any such action could prove to be a catalyst for the stock’s growth.
Conclusion
Mechanical Technologies is an appealing investment for many reasons.
The company has strong environmental and power cost advantages over competitors that will protect its margins and growth in the future. Mechanical Technology’s earnings and revenue are also set to skyrocket as it integrates its newly acquired pipeline of power over the next three years.
The CEO is also aligned with shareholders, encourages transparency and communication and sets attainable goals while maintaining a long-term vision for the company.
If Soluna only produced 50 MW on a yearly basis, which I believe it will, given the earnings growth that would occur, the company is selling for a significant discount.
Overall, I believe Mechanical Technologies is a quality company with growing and profitable subsidiaries as well as a stellar management team who I believe will execute their plans to the fullest. If the company meets its goals, it could indeed become the Amazon Web Services for blockchain.
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