On Friday, Hindenburg Research and Culper Research released scathing reports on SOS Ltd (NYSE:SOS), a Chinese cryptocurrency mining company. The two short-sellers claimed that SOS stock was an intricate “pump and dump” scheme that used fake addresses and doctored photos of crypto miners to create an illusion of success.
SOS stock initially sank 25% that day. But as Bitcoin (CCC:BTC) prices recovered over the weekend, SOS bounced back even stronger than before, to the shareholders’ delight. Short-sellers, meanwhile, were handed stinging losses. With SOS back up over $6, what should regular investors do?
The answer is simple: maintain a zero position on SOS and find a different company to buy or short sell. Though SOS Ltd may look like a tempting target to play, its broken business could rally if Bitcoin prices go up. If you decide to short-sell SOS stock, be sure to close your risk by buying Bitcoin call options. SOS might have fooled investors, but its shareholders could still have the last laugh.
SOS Stock: A Short Seller’s Dream
The Bitcoin mining industry has created many valuable investments, including some of my personal favorites. But the rush for riches has also allowed marginal companies to sneak in. These less reputable firms might look profitable on paper, but many feed off investor frenzy, passing off rising crypto prices as profit while losing money on core mining operations.
In 2020, the SEC charged 20 executives and investors from Riot Blockchain (NASDAQ:RIOT) for market manipulation. Though RIOT stock has since recovered, it’s cast a long shadow over the Bitcoin mining industry.
SOS might have taken that fraud to an even higher level.
On Friday, Hindenburg and Culper Research, two well-regarded short-selling firms, took a closer look at SOS Ltd and hated what they found.
The company’s SEC filings, for instance, listed a hotel room as the firm’s headquarters. Its SEC filings also made it appear as if the firm was buying mining rigs from a fake shell company.
But the cherry on top was the damning photographs that SOS had published about their “mining rigs.” Eagle-eyed researchers at Culper were quick to note that SOS’s “miners” weren’t the A10 Pros the company claimed to own. Instead, they were pictures of Avalon’s A1066 miners. Hindenburg went even further and found the original images from SOS’s site belonged to a legitimate rival RHY.
It wouldn’t be the first time short-sellers have accused a Chinese company of these sins. Earlier this month, EHang, an autonomous aviation company, saw shares sink 60% when investigators caught the firm listing fake office addresses and testing sites.
Don’t Short SOS Quite Yet
Investors, however, should tread carefully. Bitcoin mining companies have incredibly high operating leverage, a measure of profit sensitivity to prices. These companies’ overhead costs – which include machinery and enough electricity to power all of Argentina – mean that even small rises in Bitcoin prices can send profits soaring. A more significant crypto bump, meanwhile, could see new billionaires get minted.
SOS, meanwhile, is still a relative minnow in the blockchain mining industry. Its $800 million market capitalization is less than a quarter of rivals Riot Blockchain and Marathon Patent Group (NASDAQ:MARA). Its 15,645 miners on order, meanwhile, should give the firm just over half of Riot’s 1.06 exahash per second (EH/s) mining rate.
In other words, SOS stock is cheap. On a price-to-production-capacity basis alone, the stock could rise 2.0-2.5x on a valuation gap.
That makes shorting SOS a fool’s errand. If Bitcoin rises to $75,000, SOS stock could see a 5x to 10x return, forcing out most naked shorts from their positions. Put options are also costly, with premiums for January 2022 approaching two-thirds of the stock’s total value.
How to Play SOS Stock?
Those looking to profit from SOS stock still have some limited options.
The risk from short positions – assuming you can still find reasonably priced shares – could get offset with out-of-the-money call options on Bitcoin. That would cushion any blow from rising crypto prices dragging SOS up with it.
Long-short strategies could also work, but that assumes the valuation gaps won’t close. U.K-based Argo Blockchain (OTCMKTS:ARBKF) is a cheaper option, but it’s still pricier than untested SOS.
Finally, investors could ignore SOS and buy more robust cryptocurrency companies instead. PayPal (NASDAQ:PYPL) and Square (NYSE:SQ) both look set to profit from Bitcoin adoption, while Coinbase could become the next Facebook (NASDAQ:FB), according to bullish market commentators.
Either way, one thing is certain. Until SOS Ltd can clear its name, it’s best for investors to run, not walk, from this questionable company.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.