2 of 4: Financial Update

From the desk of the CFO: Financial update 28 September 2018
I have great pleasure in presenting our tokenholders with this update. Sometime has lapsed since February 2018 when The MoonLite Project completed its Initial Coin Offering (“ICO”) and acquired the necessary capital to build a world class mining facility and team. We have since made significant progress and are soon approaching the ‘golden hour’, where all our hard work and planning will be put to the test as we switch on our first phase of miners and add to the cumulative hash rate of Bitcoin and other cryptocurrency networks.

We deem the role that mining plays in the cryptocurrency ecosystem as essential to ensure the overall health and efficient functioning of the networks as intended by their creators and communities. MoonLite is particularly well positioned to fulfil this role. We have sourced only the cleanest forms of energy, and the most efficient miners, to reduce our overall footprint and secure the longevity and sustainability of the project. We have appointed a top-talent team and have access to the best equipment on the market.

We have preserved our capital during these market conditions, and since time is a factor in market cycles, the probability that the bear market is nearing its terminus increases with each day that passes. We are hopeful that Bitcoin has created enough support around the $6k mark to warrant the possibility that the worst is over.

We are now in a position where we have access to sufficient data to reasonably quantify and estimate forecasted cash-flow, capital expenditure and profitability; albeit in the short term. In this report, I will detail and touch on the financial aspects of the project.

Disclaimer:         
This report is only intended to be used as a guideline for expectations as figures are estimated and may contain material uncertainties and assumptions, and therefore material differences may exist in the actual results achieved, and such differences should be expected. Furthermore, this report is only intended for current token-holders and is not for marketing or soliciting additional investment. No form of assurance has been obtained for anything disclosed herein; financial or otherwise. We assume that the user is well versed in financial management and fully accepts the risk of loss or otherwise associated with investing in a project of this nature. Nothing stated herein should be construed as financial advice. Always consult your personal financial advisor prior to making any investment decisions.

Let’s get to it then!

The following topics will be discussed in numeric order:

  1. Bitcoin difficulty and economics
  2. Forecasted Cash-flow
  3. Dividend and Reinvestment Strategy
  4. Conclusion
  1. Bitcoin difficulty and economics

We have performed detailed analysis and calculations of Bitcoin’s increase in difficulty. We have analysed figures from 1 January 2014 up to 28 September 2018. For this period, Bitcoin difficulty has been rising at a nominal, compounded 28 times per year, rate of interest of 144.92%. We have therefore depreciated our cash-flows at this rate assuming this trend will continue.

If we assume a constant price of Bitcoin, the Bitcoin mining industry is unique in its business model in that Gross Profits are forever diminishing at a leveraged rate since direct variable costs in the form of utility costs remain constant. Unlike most other industries, we aren’t in control of our selling price. Focus is therefore turned towards operational and equipment efficiencies and risk management.

It has been in MoonLite’s favour to not have begun hashing yet, contrary to criticism from competitors. We have protected our capital, and the probability of us hashing at higher Bitcoin prices with better equipment has increased. Our longer-term mining strategy will include liquidating both equipment and cryptocurrency at or near cycle highs and hold more cash during a downturn, and then reinvest again as we find a market bottom. Mining equipment prices are highly correlated to the Bitcoin market cycle and is not immune to fluctuations in social mood, and we will look to exploit this characteristic.

I quote the work of Adam S. Hayes, CFA, in his publication titled “Bitcoin price and its marginal cost of production: support for a fundamental value”, where he states;

Challenging the views of Mr. Dimon and the grim hypotheses of some skeptical researchers, Hayes (2016) suggests that bitcoin does indeed have a quantifiable intrinsic value and formalizes a pricing model based on its marginal cost of production: “mining,” or the process of creating new bitcoins through concerted computational effort requires the consumption of electric power, which incurs a real monetary cost for mining participants, and thus the value of bitcoin is the embodied costs of production (on the margin).” 

Based on his study, empirical evidence is given to support the notion that the long-term price of Bitcoin approximates its marginal cost of production. This data is reassuring to miners and mitigates the risk of a total collapse in the Bitcoin price, which would ultimately result in significant impairment of MoonLite’s assets.

An often-overlooked concept I’d like to draw attention to the fact the Bitcoin is a deflationary currency, and is primarily priced against the US Dollar, an inflationary currency. For this reason, mathematically speaking, the price of Bitcoin should forever be increasing. This relationship is expected to offset increasing difficulty over time.

Given the magnitude of quantitative easing by the US Federal Reserve since the credit crises in 2008, it is believed that this inflation has yet to realised in the currency markets, and could potentially result in hyperinflation of the Dollar, as is currently happening in Venezuela. Demand and therefore price of Bitcoin will increase significantly as it functions as a safe haven and hedge against a collapsing fiat currency system, or banking crisis, like the one experienced in Cyprus in 2012 where depositors were paid cents to the dollar on their deposits. These are real risks which currently exist in the global economy and we believe that cryptocurrency provides a much-needed investment alternative.

I find value in remaining our token-holders of these possibilities, because it enforces a longer-term view of why you should be interested in mining Bitcoin or cryptocurrency in the first place. I see significant amounts of impatience in the market, with companies promising unrealistic returns and investors hoping to get rich overnight. It is my opinion that you will get the most out of your time with MoonLite if you stay invested as we transfer from a fiat monetary system to a decentralized, cryptocurrency monetary system.

  1. Forecasted Cash-flow

For the purposes of this update, we have only forecasted cash-flows for 3 months; given the material uncertainties about the Bitcoin price, difficulty and what machines will be available. There are too many moving parts and we would rather update this information in each month’s formal update scheduled to be out by the 21st of each month.

The following assumptions have been made in preparing the cash-flow forecast:

  • Revenue depreciates at 5.20% at each difficulty increase;
  • Past changes in Bitcoin difficulty reasonably inform expectations of future difficulty;
  • Utility costs are $0.038 per KWh;
  • Mining pool fees are 1%;
  • We liquidate all mined currency immediately i.e. no investment accumulation. We stay prudent in bear market conditions; we will respond accordingly should circumstances change.
  • We bring 200 machines online per day as follows:
    • Phase 1A:
      • 1 November 2018 – 6 November 2018; total of 1100 machines.
    • Phase 1B:     
      • 19 November 2018 – 25 November 2018; total of 1350 machines.
    • Phase 2:
      • 1 February 2019 – 15 February 2019; total of 2450 machines.
      • 11 March 2019 – 24 March 2019; total of 3100 machines.
    • Phase 2 cont. :
      • 4 April 2019 – 8 April 2019; total of 1000 machines.
  • Capex costs total $4.372m for our first phase – this includes once off capital costs such as land and buildings. The ROI for Phase 1 is therefore negatively skewed by the fact that it’s being measured against this base intended for scale. The ROI will improve as we add capacity and increase our contribution margin.
  • Break-even BTC price is $4 600 (including all operational and overhead costs). If price goes below this level the project will begin to run at a loss.

Scenario 1 – mining only Phase 1 machines (2450 units) for the period ended 31 January 2019, at a constant BTC price of $6 500:

We expect to generate free cash flow net of all expenses of $176k. This produces an ROI of 5.6% for the 3-month period. The annualized ROI would be 22.4%, it is however not appropriate to annualise this rate because difficulty will increase by an unknown amount.

Scenario 2 – mining only Phase 1 machines (2450 units) for the period ended 31 January 2019, at a constant BTC price of $8 500:

We expect to generate free cash flow net of all expenses of $364k. This produces an ROI of 11.6% for the 3-month period.

Scenario 3 – mining only Phase 1 machines (2450 units) for the period ended 31 January 2019, at a constant BTC price of $10 000:

We expect to generate free cash flow net of all expenses of $506k. This produces an ROI of 16.1% for the 3-month period.

Scenario 4 – mining only Phase 1 machines (2450 units) for the period ended 31 January 2019, at a constant BTC price of $3 500:

We expect to generate free cash flow net of all expenses of $-106k. This produces a negative ROI of -3.4% for the 3-month period.

This information has been summarized in the table below:

I have included columns that show how an increase in BTC price affects the increase in free cash flow, which is to say, our operating leverage. This originates because a BTC price increases Gross Profit margin, yet fixed costs are constant. We can see a 31% increase in Bitcoin price from $6 500 to $8 500 increases free cash flows by 107%, a levered effect of 3.47. Our mining business is therefore, and obviously so, very sensitive to price changes, given our cost structure. As mentioned earlier in this report, it has been beneficial to the holders of MNL to take time with our build. Business risk is decreased substantially with BTC price increases. The team will be monitoring the situation closely as we go live with Phase 1A, to determine what the best approach is for Phase 2 and 3. We will consult closely with our community as things progress so that we make the correct decisions, collectively.

I have further calculated the expected value for Bitcoin based on my ‘best guess’ probabilities for various plausible price points. The BTC expected price is $7 085 yielding cash flow of $231 and an ROI of 7.3% for the 3-month period.  This results in Earnings Per Token (“EPT”) of $0,0064. The current token price is $0.045. If we were to pay a dividend of $0,0064, this would yield 14,22%.

  1. Dividend and Reinvestment Strategy

In our Whitepaper we outline that we will distribute 35% of net profits to token-holders. This is on an annual basis, and therefore dividend distributions may vary from period to period. Based on our analysis of the cash-flow forecast, with BTC prices remaining depressed and difficulty increasing at a compounded rate of 5.20% per period, the most prudent approach to dividends is to first recover the capital acquisition costs and then distribute true profits once these are realised.

Mining is no different to any other business, and a business should only distribute profits to shareholders from retained earnings net of allocations for planned growth and expansion. The idea is that the business itself does the compounding of the profits which results in increased equity value for the shareholders. Once the business matures and reaches its desired capacity, higher dividends get distributed more often.

In the mining industry, and probably because of Cloud Mining contracts, the precedent has been set that a mining business pays dividends almost immediately. We believe that this isn’t the most prudent approach and we will explain why. Let’s say that market conditions deteriorate further but the business can still recoup 100% of the Capex, but dividends have been distributed as per the Whitepaper at 35% from this pool of funds, the business now only has 65% of its initial capital. The business now buys new machines with the cash it has left, and the cycle continues until it is eventually insolvent. We can only assume that this is the situation in which many of these Cloud Mining businesses find themselves and hence they have lost their investors money. Please also note that MNL is not in any way a Cloud Mining company.

We are happy to further this discussion with our token-holders as it is their capital which we manage in a fiduciary capacity, and we will bow to their wishes. But please do trust us to make the right decisions for the longevity of the project and to grow your capital. We at this stage haven’t yet decided on a distribution schedule given the uncertainties currently present in the market. We would however like to make a distribution before Christmas 2018 as previously promised.

In our next update we will further this discussion and perhaps design a more detailed framework whereby we can assess business risk in a more meaningful way based on a capital recovery percentage or sliding-scale, which can then inform the percentage dividend we will allow to be distributed from that batch of miners. This way we can adequately mitigate risk and protect your capital as well as pay a meaningful dividend and set aside adequate funds for expansion so that we can grow equity.

Conclusion         

I hope that you have enjoyed this first financial update. We will continue to add detail as we progress. A lot of work went into ‘behind the scenes’ analysis and calculations to present these figures to you. We strive to constantly improve these updates.

Thank you for joining us on this journey, until next time!

Warm regards;

Robert Graham CA(SA)
Chief Financial Officer

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