Description

Albany, New York based Mechanical Technology began reporting financials to the SEC again in November after a couple of years as a dark company following their voluntary delisting from Nasdaq.  Michael Toporek, co-founder of New York based private equity firm Brookstone Partners, took the ceo reins of this tiny $8 million revenue company this Fall.  In a Dec. 23rd letter to shareholders, he revealed big ambitions for their Ecochain subsidiary focused on blockchain data centers, primarily bitcoin mining operations, that was formed in January 2020.  In fact, Toporek hopes to grow the bitcoin mining operations by the end of 2021 to 50MW, larger than publicly-traded Riot Blockchain that sports an $850 million market cap.  As MKTY grows the bitcoin mining operations, the stock may re-rate closer to those of publicly-traded comparables.  However, Toporek is a disciplined financial manager that is not just trying to take advantage of the bitcoin Ponzi-scheme. Rather, he's trying to build profitable data centers to serve banks, insurance companies, logistics operations, etcetera as they adopt blockchain computing.  The desired role is to be "the AWS for blockchain".  In short, MKTY is a startup now run by an experienced and disciplined executive with big ambitions in a hot area but with a sound long-term business model.  It's not cheap, but it's very cheap compared to existing blockchain comparables.  Some investors might consider a MKTY long paired with a short position in RIOT or other publicly-traded bitcoin miners (I'm just long MKTY).

HISTORY

Mechanical Technology has been around a long-time running various businesses.  Around 1998, they spun off fuel-cell company Plug Power.  They continued R&D on methyl alchohol based fuel cells to power mobile devices, primarily laptop computers at the time.  The lithium-ion battery improved enough to take away the mobile device application and MKTY discontinued development of their fuel cells.  All that remained was a $7 or $8 million revenue instruments business.  The primary products were a PBS system that attached some instruments to jet engines and used software to monitor vibrations as the engine speed is swept.  Weights are added in recommended places to balance the engine minimizing vibration and extending engine life.  The Air Force has used these systems for decades generally under 5 year $10 million dollar contracts.  In 2020, the Air Force bought an unusually large ($3.4 million) number of systems and MKTY has earned $2 million year-to-date as the PBS systems sport 70%+ gross margins.  The second major products are capacitance sensors historically used for semi-conductor wafer inspection.  The latest MKTY version, the Accumeasure D, uses a digital amplifier to achieve sub-nanometer resolution superior to competitors.  The improved digital amplifier in this technology is opening up new markets, but even in the more mature semiconductor wafer inspection markets MKTY achieves 70%+ gross margins on this product.  Despite the high gross margins on these products, the company is just too small to cover the fixed costs and the company operated near break-even most years for many years.  Ownership by management and directors was light and I'd guess nobody cared too much that the stock languished near $1.  MKTY is trying to grow their products now under the leadership of recent hire Binyamin.  The capacitance sensors are targeted for use in additional GE windmill models and for measurement of dielectric thickness for electric vehicle batteries.  The PBS systems are targeted for commercial applications like freight aircraft engine balancing.  Management's comments indicate they believe they can grow this historically flat instruments business.

In January 2016, MKTY's management at the time had been spending heavily on R&D to develop the Accumeasure D.  The company was posting losses but had a line of credit with the local bank.  However, when they visited the bank to enlarge their line of credit they were informed that they were in violation of covenants.  The debt-free company was in cash-preservation mode to survive when I attended the annual meeting in June 2016.  Later that year the problem was solved by selling 39% of the company to nearby private equity firm Brookstone Partners for about 72 cents a share (20% below market price).  The ceo retired shortly after and was not replaced by Brookstone to save money.  The existing CFO took on the additional CEO duties and other cost cuts were made to get the company profitable.  Brookstone's (Toporek was on the board) year-long search for an acquisition that met their disciplined valuation requirements resulted in nothing.  The company paid a one-time dividend around 28 cents (mostly the cash from Brookstone's investment) and went dark to save money.

In January 2020, the company formed a new subsidiary called Ecochain to pursue the blockchain data center business.  They bought a central Washington state mining facilty out of bankruptcy for roughly $200K in May and completed the upgrade of equipment by November.  That facility currently operates at 2 MW.  This sudden expansion to bitcoin mining didn't come from nowhere.  Brookstone Partners has been in the business of developing windmill sites in the past.  A few years before the Ecochain formation, Toporek had started up Soluna in Canada to develop a windmill site in Morocco near the border of the Sahara desert and the Atlantic Ocean.  The wind blows 25mph+ most of the time all year around there, but the population is low and the electrical grid isn't fully developed.  Toporek seeks to use the abundant low-cost windmill-generated electricity to power blockchain data centers at the foot of the windmills.  The bitcoin network has 10,000 nodes so if one node doesn't participate on a particular block calculation the other 9999 will keep the bitcoin network functioning.  This means the chief problem with windmill power, intermittency, may be tolerated as a blockchain data center can ramp up and down their power usage with the wind.  Definitely a neat idea, but the Soluna engineers share some of their problems getting this done on the Soluna website.  The latest one is that the grid in Morocco doesn't have enough sensors installed for them to predict demand well enough to manage the data centers.  After three years of engineering, they still haven't built a windmill in Morocco.  The Soluna staff is operating the Ecochain facility in Washington and it seems likely they will continue to suppport Ecochain's ambitions in 2021.  MKTY invested $750K to buy 2% of Soluna in January and that cash may be paying the Soluna engineers salaries.  MKTY has an option to invest $3.25 million more in Soluna.  Toporek personally owns 35% or so of Soluna and Brookstone owns just 3%.  There definitely are conflicts of interest here with Toporek as ceo and MKTY's money supporting Soluna.  I'm personally impressed with Toporek's management of MKTY since Brookstone's investment and not too concerned about the conflicts.

THE FUTURE GROWTH PLAN

Toporek's letter to shareholders lays out plans for Ecochain to expand to a second larger blochain data center site in 2021.  In fact, they hope to have enough already ordered equipment installed to be operating at 5MW in Q1.  Further equipment purchases probably requiring a significant capital raise will allow expansion to 50MW by year-end 2021.  For comparison, $850 million market cap Riot Blockchain currently operates at 20MW with plans to expand to 46MW by May 2021.  Toporek hopes to be of similar size to RIOT by year-end and Toporek also disclosed that Ecochain is developing a second site that will operate at 25MW supplied with electricity at just 2.5 cents per kilowatt-hour.  The Washington site runs on hydroelectric power at a very low 4 cents per kilowatt hour.  I'd speculate the 2.5 cent price is probably coming from a windmill site.  Soluna's CTO notes that electricity costs are about 40% of the cost of mining bitcoin. 

RIOT Blockchain's $850 million valuation seems crazy to me.  After all, Toporek can apparently in just one year duplicate RIOT's bitcoin mining operations.  If Bitcoin prices go higher, more mining equipment will be installed to fight for the available Bitcoin.  Being the low-cost miner seems to be the only business model that matters in the long run.  Using low-cost electricity is the primary way to achieve lower costs.  Toporek's business model seems sound and MKTY could achieve a profitable business with their data centers running on cheaper electricity.  The letter notes a return on capital target of 15% to 25% on their data centers.

Longer-term the growth of blockchain applications will go far beyond Bitcoin.  George Gilder predicts in his book "Life After Google" and in talks on youtube that the entire internet will be run on blockchains.  This will resolve the hacking problem and allow people to surf the web without Google and Facebook gathering personal information about them.  The Soluna ceo notes that they want to provide the blockchain data centers that companies need similar to the way Amazon Web Services provided all the cloud infrastructure.  Peter Thiel has endorsed Gilder's book and has invested in blockchain data centers himself.  This investment is a speculation on bitcoin and investors are likely to drive bitcoin miners higher if bitcoin prices go higher.  However, even if bitcoin crashes there is likely still going to be a need for low-cost blockchain data centers for banking and insurance etcetera.  I believe Toporek is trying to build a real company and not just a bitcoin Ponzi scheme.

I believe Toporek is trying to take advantage of their publicly-traded status to finance the data center build out.  The company had gone dark in 2018 to save money.  Early this year, they filed a form 10 to resume reporting to the SEC.  When Covid upset the financial markets, they withdrew the form 10.  It was refiled in the Fall and they became a reporting company again in November.  The data center build outs will cost money and bitcoin miners are valued richly in the financial markets.  Part of the motivation for building out data centers using MKTY may be to raise capital at high valuations.

RISKS

While the long-term target is blockchain data centers serving corporations, the data center builds are being financed currently by mining bitcoin.  A crash in the bitcoin price will be a problem.  

There are conflicts of interest here with Toporek.

MKTY doesn't have the cash to finance 50MW of bitcoin mining equipment.  A capital raise is coming probably in Q1 2021.

Catalyst

Dark company becoming public again

Discovery by bitcoin miner investors