Overview:
When I last wrote about Soluna Holdings Inc. (SLNH, Financial) back in August of 2021, the company was named Mechanical Technologies (MKTY) and the stock was just shy of $8 per share.
Since then, the company has changed its name, ticker and website, completely transforming its image to a renewable energy-focused crypto miner buying curtailed energy from power companies.
A growing problem
The renewable energy market continues to grow as companies and governments strive for zero carbon emissions. A large (yet widely unknown) problem power plants have to deal with is curtailed energy, which is energy that is wasted due to deliberate reduction in output below what could have been produced to manage the supply and demand. It is estimated that over 225 terawatt hours of renewable energy are wasted on a yearly basis. To put that into perspective, it is equivalent to over 132 million barrels of oil, 26% of the global solar energy production in 2020 or 14% of the global wind production in 2020.
Curtailed energy creates problems for power companies that include lost profits, tax credits and the inability to easily ramp up or down the amount of power sent to the grid. Until very recently, there has been no reliable solution for power plants looking to contain the amount of lost energy.
Computing is a better battery
Computing power has been growing as a percent of global energy consumption for a long time. By 2030, it is estimated that 20% of GEC will be made up of computing power. What if a company could solve the problem of energy curtailment using computing demand as a solution?
(All slides taken from company's Earnings Power Presentation)
Soluna builds modular data centers that take excess renewable energy generated by power plants and converts it to low-cost global computing. It is an incredible solution to a very real problem. What’s even better is the benefits Soluna is providing to the power companies. Using Soluna’s solution, a power plant can:
- Generate max energy capacity.
- Earn tax credits that would otherwise be lost.
- Earn revenue that would otherwise be lost.
- Increase flexibility to handle spikes in energy demand.
This is an incredible service that allows power companies to generate max capacity and easily handle the volatility of demand. Soluna’s modular data centers are a better battery because, instead of paying to store electrons, it takes the energy and efficiently uses it to generate revenue for both the power company and itself.
This unique strategy provides lower power costs to Soluna. Currently, the company pays roughly 2.3 cents per kilowatt hour compared to the industry average of five cents per KwH. Comparing it to close competitors like Riot Blockchain (RIOT, Financial) and Hut 8 Mining (HUT, Financial), which both have an average KwH cost over 3 cents, Soluna holds a very intrinsic cost advantage.
Expanding the pipeline
On Jan. 19, Soluna Holdings released an Earnings Power Illustration detailing its strategy and estimated financial outlook for 2022.
When I last wrote, Soluna was working toward energizing 50 megawatts by the end of December, a goal it accomplished. The company is now focused on energizing 100 MW and scaling to 3.0 EH by year-end 2022 and 4.0 EH by the first quarter of 2023. This growth can be attributed to the company’s new Dorothy Project.
All projects Soluna builds have to meet a strict return on invested capital payback time. Management requires all projects to have returned 100% of invested capital within three years. As you can see, Dorothy is expected to return all invested capital in 26 months, meeting the required payback period. The fact that management has such a conviction about ROIC and capital allocation should be very encouraging for shareholders.
Below is a slide showing Soluna’s total projects and their status:
Once again, all projects are returning invested capital at a high rate, with project Edith already paid off and achieving impressive returns.
Soluna will continue taking on new projects as the company plans to originate 600 MW worth of projects by the end of the year. This growth in projects is a very positive development for the company and will provide an avenue for growth for a very long time.
Financial estimations
Management provided an interesting slide showing their financial estimates for the company based on 153 MW. Management referred investors specifically to the contribution margin at a bitcoin price of $45,000.By the end of fourth-quarter 2022, Soluna will have the ability to produce at least $114 million in earnings on an annual basis, with an upside of $158 million with bitcoin at $60,000. Management continued to provide projections into the first quarter of 2023, which has earnings just shy of $140 million on an annual basis and a bitcoin price of $45,000 and $193 million in earnings on a bitcoin price of $60,000.
What’s really incredible are the numbers with bitcoin at $20,000. If bitcoin does collapse to that range, Soluna will make around $53 million in earnings on an annual basis assuming 153 MW. That kind of earnings protection is very rare and something hardly any other mining company could say. Given the company’s cost per KwH and that they convert all mined bitcoin to cash on a daily basis, Soluna could survive a very large price drop.
Soluna will produce a healthy amount of earnings this year to fund growth as well. The company currently has 52 MW energized and operating. Using the same slide of estimations, the company is on track to produce at least $30 million to $65 million in earnings this year assuming bitcoin ranges from $20,000 to $45,000. If bitcoin continues to climb to $65,000, the earnings for this year would come in at roughly $85 million.
The company's market cap as of the time of writing is $108 million. Given the fact Soluna will be producing more earnings than the current market cap in less than a few years, the current valuation seems almost laughable. Although, in order to reach that amount of earnings, Soluna must answer the biggest question all shareholders have right now: How are they going to pay for this growth?
Paying for expansion
Although these numbers are incredible, management has yet to answer how this growth is going to be funded.
To cut to the chase, it will cost roughly $300 million to expand to 153 MW by the end of the year. Management’s plan is to take the 100 MWs and break it into four 25 MW sections, with one section being energized each quarter. This allows the company more flexibility as it just has to fund 25 MW each quarter, versus trying to fund 50 MW or more within a single quarter.
Management intends to be creative with how they fund this endeavor, using various forms of financing and equity partnerships.
Management suggested the company can finance roughly 70% of the expansion budget via debt, preferred shares and project equity, while the rest will come from cash plus 2022 earnings.
The company has already taken steps to increase its cash:
- As of Sept. 30, the company held $16 million in cash.
- On Oct. 21, it had a $16.3 million convertible notes offering (notes convert at $9.18 per share, 1.7ml common shares).
- On Dec. 23, 2021, it had a $7.8 million preferred share offering. (Preferred liquidation price of $25, unconvertable until August 2026).
- As of Sept. 30, $7 million from the 833,000 warrants outstanding with an $6.82/$8.24 conversion price and 1.8 million more from the convertible that would bring in $27 million ($12.50 at $18 strikes).
- On Jan.18, the company signed a $14 million equipment financing deal with NYDIG.
- Future sale of MTI Instruments (estimated selling price of $25 million to $35 million).
In total, we’re looking at $85 million to $100 million in cash depending on the amount of warrant conversion and the price that the instruments business will be sold for. This leaves roughly $200 million to $215 million left of expansion to be funded (not including 2022 earnings). Until we are provided with further details, we can only assume the remaining will be a mixture of the various financing options.
CEO Michael Toporek stated during the presentation that the focus is to find non-dilutive ways to build out the pipeline. Toporek is the largest shareholder and has the most to lose from dilution, so I believe he will be creative and find ways to overcome this challenge. I believe the stock price growth this year will largely be determined based on what avenues of financing the company uses, so be sure to keep a close eye on the developments.
Let’s take a look at two potential scenarios. The first will be if Soluna finances the remaining growth budget with preferred shares, which would be non-dilutive to common shareholders given their structure. Scenario two will show the outcome if Soluna uses common share issuances to fund growth.
I will not include 2022 earnings in both scenarios. I want to paint a very conservative picture where the company has to fund growth without the use of earnings.
Scenario A - Preferred share issuance (non-dilutive):
- $175 million to $200 million preferreds at 10% yield
- $17.5 million to $20 million in yearly dividend expenses
- Plus $10 million in corporate expenses (per the annual filing)
- (b) Plus 20% capital expenditure on revenue (assumes bitcoin price of $45,000)
- Total annual expense: $61 million to $64 million
- Earnings of 153 MW: $139 million (assumes bitcoin price of $45,000)
- Less annual expense: $64 million
- Total free cash flow: $75 million
- (a) 21 million shares outstanding
- $75 million FCF/21 million shares = $3.57 FCF
- (c) P/FCF Multiple - 2.5x
(a) I am using the worst-case scenario, which is all warrants, the convertible note and merger stock agreement all convert to common shares, equating to 21 million total shares outstanding. Warrant conversion (2.6 million shares) + convertible notes (1.7 million shares) + merger consideration agreement with SCI (2.97 million shares) + 13 million current shares outstanding = 21 million shares outstanding give or take.
(b) This number will fluctuate depending on the year, but a 20% capex rate seems very reasonable.
(c) Multiple is based on the price of the stock as of writing.
Scenario B - Common share issuance (dilutive):
- (a) $200 million common share issuance (26,666,666 shares)
- $10 million corporate expenses
- 20% capital expenditure on revenue (assumes bitcoin price of $45,000)
- Total annual expense: $44 million
- Earnings of 153 MW: $139 million (assumes bitcoin price of $45,000)
- Less annual expense: $44 million
- Total free cash flow: $95 million
- (b) 47 million shares outstanding
- $95 million FCF/47 million shares = $2.02 FCF
- (c) Price/FCF multiple: 4.5
(a) Assumes an issuance price of $7.50 per share.
(b) 21 shares outstanding + 26 million issuance. Once again, I will use the worst-case scenario in that all warrants, notes and merger agreement are converted to shares.
(c) Multiple based on the price of the stock as of writing.
In both scenarios, Soluna generates at least $75 million in free cash flow (without the use of 2022 earnings to fund growth, which most likely would not be the case). Obviously, no shareholder would like to see scenario B, the issuance of common shares. However, if management does decide to take that route, the price-to-free cash flow ratio would stay under 5, which is incredible. The amount of earnings Soluna will generate in either scenario offers a large margin of safety for shareholders. Whether management decides to use dilutive or non-dilutive strategies, the amount of free cash generated will remain very large.
Overall, this is the biggest challenge hovering over the company and the stock's outlook. I believe reality will play out much differently than the two scenarios I laid out. It would seem reasonable, especially given Toporek's comments on trying to be non-dilutive, that management will use a mixture of the financing options listed above. Fortunately, there are many (non-dilutive) doors open for the company, including project equity, equipment financing, various debt facilities and even joint ventures, all of which I expect management to use. I think we will see a very creative financing plan from Toporek that will please shareholders and the company’s financial operations. Management has been perfect in execution thus far, and I have no reason not to think they will continue to successfully execute their strategy to the benefit of all shareholders.
Beyond mining
Although Soluna remains purely a crypto miner today, management has aspirations far beyond that. Remember, the company's goal is to solve the problem of wasted renewable energy through the use of computing, not to become a world's leading crypto miner. This means that as the company expands it’s MW pipeline, we could see a transition where it starts taking on computing clients, which is a model that produces higher profits and less revenue volatility.
According to management, this has been its vision from the beginning, as they mention in almost every monthly shareholders' call. The data center industry is massive and quite profitable if one can execute a successful strategy. Soluna has experienced and qualified personnel ready to carry out their expansion plans.
Summary:
Soluna has massive potential and a clear path to success. The company’s experienced management, key operating principles, and intrinsic advantages all have proven capable of growing the company efficiently. If management continues to execute their expansion plan successfully, the company's market cap is in for major appreciation.
