“Concealing truth is like wearing embroidered clothes and traveling by night”
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You should assume that as of the publication date of his reports and research, Marcus Aurelius and possibly any companies affiliated with him and their members, partners, employees, consultants, clients and/or investors (the “Marcus Aurelius Affiliates”) have a short position in the stock (and/or options, swaps, and other derivatives related to the stock) and bonds of Canaan. They therefore stand to realize significant gains in the event that the prices of either equity or debt securities of Canaan decline. Marcus Aurelius and the Marcus Aurelius Affiliates intend to continue transactions in the securities of Canaan for an indefinite period after his first report on a subject company at any time hereafter regardless of initial position and the views stated in Marcus Aurelius’ research. Marcus Aurelius will not update any report or information on this website to reflect such positions or changes in such positions.
Please note that Marcus Aurelius, the author of this report, and the “Marcus Aurelius Affiliates” are not in any way associated with Aurelius Capital Management, LP, a private investment firm based in New York, and any affiliates of or funds managed by the latter company.
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We are short Canaan (NASDAQ: CAN).
We view CAN as the latest US-listed Chinese company to have deceived investors about its business. After failing three times to list itself on Asian exchanges since 2016, CAN took advantage of these frothy markets to complete a NASDAQ IPO in November 2019. Shares surged by more than 80% in a single trading day last week, pushing the company’s market cap above $1 Billion, in a move that appears to have enticed thousands of unsuspecting retail investors into the speculative fervor. But our investigation of this bitcoin mining machine maker reveals undisclosed related party transactions, irregularities involving many customers and distributors, as well as a business model that we view as broken. Regardless of your outlook on the future of Bitcoin, we believe that CAN’s business is simply far worse than promoted. We therefore see significant downside potential and believe the stock is uninvestible.
The precipitous fall in Bitcoin’s price from a high over nearly $20,000 in 2017 to below $5,000 in 2018/2019 led to a sharp revenue declines for bitcoin mining machine makers like CAN by upending the underlying economics of mining. It also led to the collapse of various crypto mining scams and ponzi schemes. Just last month it was reported that Bitmain, the dominant bitcoin mining machine manufacturer with at least 75% market share, would abort its NASDAQ listing attempt after allegations of links to a giant collapsed Ponzi scheme emerged. CAN had also attempted to bring itself public since 2016 but failed on three separate occasions:
- In 2016, CAN attempted a reverse merger with a company on the Shenzhen Stock Exchange but suspended the process due to the “tightened regulatory environment” in China. (Here)
- In 2017, CAN attempted to list on China’s NEEQ exchange but that attempt was also suspended. (Here)
- In 2018, CAN submitted an application to list on the Hong Kong Stock Exchange but the filing lapsed in 2019 and the exchange CEO declared that “cryptocurrency mining machines fail to meet the Hong Kong Stock Exchange’s listing principle of ‘suitability’”. (Here)
Amidst this backdrop, we view the NASDAQ, which listed CAN via a November 2019 JOBS Act IPO, as the company’s dumping ground of last resort. Notably, CAN abruptly lost Credit Suisse as its lead underwriter shortly before the listing which is highly unusual because investment bankers are notoriously reluctant to walk away from fees. The offering was also scaled back significantly, CAN initially intended to raise $400 million in capital but only obtained $90 million, and CAN’s shares priced at the low end of the range. CAN’s auditor, PWC Zhong Tian LLP, gives us little additional comfort because the firm was charged by the SEC in 2012 for violating U.S. securities laws by refusing to provide documents related to its audits of Chinese companies being investigated for fraud.
Undisclosed Related Party Transactions Contaminate CAN’s Stock Promotion
Transactions with related parties and/or sham entities have been a hallmark of the fraudulent US-listed Chinese companies that have often used these dealings to artificially inflate revenue or otherwise falsify their financials. We detected these kinds of transactions in both of the Chinese companies we have exposed, Kingold Jewelry (KGJI) and Pingtan Marine (PME), the stock prices of which have subsequently collapsed by more than 80% and 70% respectively since our reports were published.
That’s why we were troubled to discover that just one month before CAN’s NASDAQ IPO, a tiny Hong Kong stock named Grandshores (HK 1647) announced a purported “strategic partnership” with CAN and agreed to purchase up to $150 Million USD worth of equipment in 2020, an amount that nearly equals CAN’s entire trailing twelve month revenues of approximately $177 million USD. We find the transaction farcical on its face because Grandshore’s market cap is a mere $50 Million USD and it reports having only $16 Million USD in cash on hand, nowhere near the financial wherewithal to buy this much equipment. Even Hong Kong analysts referenced in this Chinese media article (here) expressed doubt the deal would ever be consummated. Documents show that Grandshores is a clear related party because its Chairman, Yao Yongjie, is an “Angel investor” of CAN and owns 9.7% of CAN’s shares outstanding through entities he controls. Yet this transaction is not mentioned anywhere in CAN’s SEC filings.
Source: Captures from HK 1647 filing and SEC filing.
We doubt it’s a coincidence that shortly before the Grandshores deal was executed, an October 2019 article in Bitcoin Magazine was published touting that CAN “expects $1 Billion-Plus [RMB]” in sales in 2020 (below). The article stated CAN’s Sales Director declared that the company had already “received letters of intent demanding 500,000 units in total of its latest, powerful A10 and A11 miners, and they expect the number to surpass 1 million in 2020”. We therefore wonder if the giant Grandshores letter of intent, which we view as largely bogus, was used by CAN as a device to hype its financial prospects to investors.
Related party transactions also boosted sales prior to CAN’s Chinese listing attempts. Chinese documents filed as part of CAN’s reverse merger attempt in Shenzhen show that an entity named Hangzhou Weitui Information Technology Company (“HW”) suddenly became one of CAN’s largest customers during 2016 and contributed to the rapid increase in CAN’s reported sales. HW is a clear related party because documents state it was originally controlled by CAN’s Co-Chairman, Jianping Kong, and later transferred in 2017 to one of CAN’s “independent” Board Members, Qifeng Sun, who CAN states “oversees Canaan’s sales and marketing activities in China”. Although the related party nature of HW was disclosed in the Chinese documents, it has not been mentioned in CAN’s SEC filings.
Troubling, we question if HW may exist just to do business with CAN. According to a Chinese media article (here), HW even registered itself at an address in the same building “one wall away” from CAN’s headquarters. The SAIC filings indicate HW only had four employees total (Here), increased its registered capital from RMB 1 million to RMB 50 million shortly before it became a customer but then reduced its capital back to 1 Million RMB in 2017 after CAN’s reverse merger failed (here).
Note: Google translation of article
Similarly, an entity named Shimian was founded in 2016 by employees of a CAN subsidiary in a relatively remote county in Sichuan Province China. Chinese documents state Shimian became a customer in 2016 (here) but then abruptly dissolved itself in 2018.
Significant Irregularities Involving Customers Discredit CAN’s Business Claims
CAN reports that more than 87% of its sales are to customers in China, which stands in sharp contrast to Bitmain which attributes only 33% of its sales to China. The quality and durability of CAN’s Chinese customer base is therefore of paramount importance for investors. This is exactly why we were disturbed to find that, in addition to related parties, other major customers identified in the Chinese listing documents filed by CAN include businesses that appear to be in entirely different industries. For example:
- One of CAN’s top five accounts receivable during 2017, 2016, and 2015 is a company named Tianjin Garments Import & Export Co. (天津服装进出口股份有限公司). The company’s website (captured below) states that its products are primarily “clothing, fabrics, blankets, and stone carvings”.
- Another one of the top five accounts receivable during 2017 is listed as a company named Guangdong Xuntong Technology CO Ltd (广东迅通科技股份有限公司). But that company’s website (here) states it sells a video surveillance product to Chinese government enterprises.
An article published by The Beijing News in 2016 flagged CAN’s dealings with HW and Tianjin Garments and also questioned why several of the company’s other large customers were listed as being Chinese individuals:
Source: Capture from the Beijjing News using Google Translate
CAN’s largest customer in 2016 was listed as an individual named Chen Jian (陈建). We believe this is likely the same Chen Jian who is identified in internet postings (here, here) as the industry operator allegedly behind a chinese crypto scam involving the now defunct 3ico.com that left investors who suffered losses protesting with banners in the streets (below).
Yes, CAN appears to have had some “legitimate” customers. The largest 2017 account receivable, for example was from an individual name WU Gang (吴钢 ) who we believe to be the founder of a company named Bixin. However, Bixin states that its Bitcoin mining pool has since been shuttered, which is likely symptomatic of the deterioration of bitcoin mining economics.
Source: Bixin Twitter
While neither CAN’s Hong Kong listing application or its SEC filings disclose the names of its current top customers, we find it highly irregular that CAN abruptly deleted 8 of the 11 unique distributors that were featured on its website shortly before the company’s NASDAQ IPO (as archived by waybackmachine in May 2019).
One of these deleted distributors, Nova Bit Mining Solutions, is apparently controlled by one of CAN’s sales representatives, Andres Romero. Romero’s own LinkedIn profile lists himself as both “Global Sales” for CAN and the CEO of Nova Bit. In a 2018 Youtube Video, Romero identified himself as a CAN VP of Marketing and invited viewers to an event in Dubai. CAN suddenly deleted Romero from its website sometime in the last few weeks (we archived it here) but used to feature him as a company “agent”. Nova Bit’s website continues to state it is “official distributors” of CAN although multiple calls to the phone number listed on Nova Bit’s website went unanswered with a message “the Google Voice subscriber is not available”.
Our review of the other seven deleted distributors reveals that most appear to be small, defunct, or otherwise incapable of buying material amounts of product from CAN:
- Minerwarez: There is minimal inventory offered on the website, no phone number or address listed, company has a limited web presence.
- Distribufied: Does not appear to be in operation because the website states “enter your email to be notified of our official launch”. The website also doesn’t list either a phone number or address.
- Bitmart: A crypto retailer in South Africa (pictured below), with a sign that reads “invest in crypto currency mining and earn between 6% and 15% returns per month”.
- AMC: Appears defunct with an inactive website and dormant twitter account. The company previously touted “aircraft mileage coin” on twitter and an archived version of its website.
- Mybtcmining: This entity also appears defunct and has an inactive website.
- Miners Gate: A website with the same name currently touts “150% daily” returns via a bitcoin mining pool although it is unclear to us if this is the same Miners Gate that CAN had referenced on its website. If this is CAN’s partner, it has posted a fake UK registration claiming its license number is “123456”.
Source: captures from www.miners-gate.com
- New Mining Company: This is a Russian concern of unknown size soliciting contracts of $50k minimum to host mining equipment at its site.
We find these deletions highly problematic because it suggests that the state of CAN’s business is far worse than it would like investors to believe. We also note that each of the remaining distributors currently highlighted on CAN’s website also appear relatively small:
- CryptoUniverse: Touted as the only official partner in Russia and Asia, the website (here) solicits investors to join a mining pool in exchange for purported returns with cartoonish marketing videos (here, here) featuring models. There is also a European entity (here) that, according to an industry operator we spoke with, is likely small.
Source: Captures from CryptoUniverse website and Twitter.
- Blokforge: As the only listed distributor in the US, the company operates a store in Arizona and has only three employees we could find on Linkedin.
- P2P: Located in Siberia, it recently re-appeared on CAN’s website after having been previously deleted. The company’s website advertises “fully equipped 40-foot sea containers for mining”.
CAN’s Business Model Appears Broken
After CAN’s reported sales grew from approximately $182 Million in 2017 to $377 Million in 2018, sales have plunged to just $132 million through the first 9 months of 2019. Yet the existence of related party transactions, irregularities with customers and distributors, and other findings presented in our report makes us skeptical that business was ever even as “good” as CAN would like investors to believe. We also found, for example, that CAN was sued in 2019 by a Chinese vendor (here) for allegedly not paying an invoice of approximately $1.7 million. The vendor states that CAN said it couldn’t pay because of “sales problems and market circumstances” (our translation).
Why would CAN, which reported having $36.2 million in cash on its balance sheet as of the end of 2018, be allegedly unable to pay such a relatively small invoice?
At minimum, we believe the plunge in bitcoin prices that began in late 2017 has had a devastating impact on CAN’s business. The crackdown by the Chinese government on bitcoin miners operating on an illicit or unapproved basis, resulting in shutdowns and equipment seizures, likely exacerbated CAN’s problems. This combination may also partially explain why so many of CAN’s “official partners” appear to have become defunct. CAN’s own SEC filings even state that “the bitcoin price drop in 2018 also led to our offering of credit sales, and such Bitcoin price trend also caused our customers who purchased our Bitcoin mining products on credit to be less willing to make payment” (emphasis ours).
CAN’s business model is upside down, in our view, because Bitcoin mining with CAN’s equipment simply does not appear to be economically attractive at current prices. ASIC Miner Value, a website that estimates the profitability of various makes/models of mining equipment, estimates that each of CAN’s models tracked by the site are currently unprofitable as of this week:
Source: recent capture from ASIC Miner Value estimates
The website estimates that 66 models made by other companies are more profitable than Canaan. Bitmain, by contrast, has 16 models that are estimated to produce profits:
Source: recent capture from ASIC Miner Value estimates
Yet even if Bitcoin prices were to surge, we believe CAN will continue to struggle. As demonstrated above, many other machines are more profitable and our research suggests that CAN’s mining equipment isn’t particularly well regarded in the industry. One industry operator we talked to opined that CAN “always seems to be playing catchup” with competitors such as Bitmain and Whatsminer and that CAN’s sales teams are also “totally inferior”. A lawsuit filed in January 2020 by a customer alleges that two of CAN’s machines started on fire immediately after they were first turned on and “over the next six months the rest of the machines stopped working, with many of the machines remaining in stale mode, not even turning on” (below). The customer says Canaan has been giving him “the run-around” so he sued.
Source: Bit of Mazel, LLC v. Canaan Inc. , Kings County New York Index No. 500654/2020
While CAN promotes itself as a “leading provider of supercomputing solutions”, the company discloses that it only spent $26.5 million in Research & Development expenses during 2018 which is a fraction of the $86.9 million that Bitmain reported spending during just the first six months of that year. Consequently, we find it hard to believe CAN will be able to close the gap with its rivals which is problematic because CAN’s existing market share already appears smaller than the company would like investors to believe. Although CAN’s SEC filings claim the company has market share of 23%, closer inspection reveals that the calculation is based on total units shipped in the industry (page 106). When viewed on a reported revenue basis, however, data included in Bitmain’s IPO prospectus (below) shows CAN’s market share falls to only 6.2% as of 2017 (“Company E”, which we believe is CAN, below).
Source: Bitmain prospectus
Furthermore, online search activity for CAN and its Avalonminer machines strikes us as anomalously low, barely even registering relative to Bitmain and its Antminer machines. Similarly, Canaan’s twitter account (here) has only 3,900 followers as compared to 97,000 for Bitmain (here).
Source: Google Trends
We See Enormous Downside Potential in CAN Shares
Despite these factors, CAN’s stock surged by more than 80% in a single trading session last week on no news. The “catalyst” may have been an opinion piece published on an industry website (here) suggesting the stock’s sell off was overblown and that disruptions from Coronavirus wouldn’t harm CAN any more than other manufacturers. In any event, thousands of retail investors appear to have been sucked into the stock as demonstrated by data from Robintrack, a website that tabulates how many Robinhood users hold a particular stock over time, showing a parabolic increase of more than 3,000 investors last week:
Even if you believe CAN’s financial statements, at its present market cap of approximately $900 Million, CAN shares trade at over 5x trailing revenues. This is an enormous premium, in our opinion, for a company that has posted significant declines in revenues along with operating losses of more than $50 million in just the first nine months of 2019. But even worse, our research has uncovered a variety of irregularities and undisclosed dealings that lead us to believe CAN has deceived investors about its business.
We therefore view the stock as uninvestible and see enormous downside potential.
All investors are encouraged to conduct their own due diligence into these factors.