Summary:

Metalpha (NASDAQ: MATH) is transitioning from a small-cap Nasdaq-listed, Chinese supply chain business to a complex OTC underwriter focused on crypto derivatives via a reverse-merger over the past 12-18 months. It is in our opinion the only listed, non-exchange, non-mining APAC exposure one can get in the stock market; it also happens to be one of the smallest, if not the smallest market cap crypto company. No one perceives this stock as a “crypto” play, the stock trades 50k USD / day and doesn’t show up on any comp sheets. We believe as the cycle gets underway, discovery of the stock, and with the team’s delivery, Metalpha should rerate rapidly and is set to deliver 4-17x return to its shareholders over the next 24-36 months.

• Metalpha is mispriced as the reverse-merger dynamics, lack of earning-power show-through, and lack of liquidity obfuscated its potential.

• The core OTC derivative franchise is a solid 1-2% take-rate business where lends itself well to oligopoly. The team is highly experienced in TradFi + Web3 connections to capture this blue-ocean, which is currently completely unoccupied.

• Valuation in-line with private seed deals as a listCo, but traction + team quality materially ahead from top traditional finance firms + strategic backing of Bitmain (both bringing business as well as potentially injecting assets via reverse-merger)

• We believe the setup in transactional volume will allow Metalpha to deliver ~35-50 cents of EPS by 2024/25. Pricing the business at 12x multiple and 80 cents / share of cash balance gets us at least $5.60 / share or 4x upside. Higher multiples or industry frenzy can easily deliver 10-15x upside to the stock with a potential strategic take-out.

Why the opportunity exists:

Target is undergoing a major transition via a reverse-merger into a preeminent Web3 derivative powerhouse.

• Target is transitioning from a small-cap Nasdaq-listed, Chinese supply chain business to a complex OTC underwriter focused on crypto derivatives via a reverse-merger in the past 12-18 months.

• We believe the complexity around reverse-merger dynamics, lack of updated financials, its mere size as an illiquid microcap, and lack of disclosure roadshows / disclosure around the team’s caliber are the main reason of its mispricing.

What the business is + Upside:

Complex derivative underwriting as a scaled player can be a highly lucrative business with a potentially oligopolistic industry structure. Top players can command 90% of market share.

The operation of an OTC, esoteric derivatives desk is straight-forward but not simple:

• Client posts collateral and wants to make a trade.

• Structurer / trader posts a price with spreads embedded; client places the order.

• Target confirms the order and underwrites the risk, traders hedges the exposure internally throughout the lifespan of the order. Client posts more collateral if needed.

• Option expires / terminates. Client reaps PnL, trader unwinds hedges.

The operation is a decent business because:

• Relationship & inertia driven: a client-base of institutions and HNW are generally sticky and recurring customers, whereby good technical sales can drive significant, lasting volume that helps the desk’s exposure – much similar to a good private banker.

• Sizable margins: the complexity makes it easy to embed spreads and margins. A typical order typically translates to 1-2% take-rate on the notional, while clients largely don’t feel the impact.

• Scale advantage with diversification: a larger book (up to a point) with 2-way, highly diversified derivative flow allows for perfect hedge (more margin, less risk), less slippage in hedging, more margin to give (more order won), and better market color (better hedge).

In traditional OTC derivative markets, the top players typically commands 90% market share; but The competitive landscape for Crypto OTC derivatives is wide-open today with no major players owning it.

Compared to other matured markets (such as US equities), crypto exotics option is severely under-developed. A small pickup would translate to meaningful upside to Target’s financials. Crypto’s option notional has a 5x gap to the US stock market, and as much as 50x gap vs. the US exotics options market.

Getting to similar ratio of activity, every 1% market share in crypto exotic options translates to 1.8 Bn of annualized volume, or roughly 9x Target’s FY22 result.

Experienced management team in executing:

We believe Target is composed of a team of Rockstars highly experienced & connected in both Web3 + complex derivatives. Importantly, Bitmain owning 40% of Metalpha means it can direct meaningful derivative flow when it’s selling the mining rigs to the buyers.

Additionally, we believe that as Bitmain goes into the 2024-2026 cycle, Metalpha remains a very interesting target for it to inject assets into for a direct reverse-listing into Nasdaq.

Attractive valuation:

We believe Target’s valuation is highly attractive vs. VC deals we see in the space today. It is a rare case where a publicly listed company offers a better deal than a private investment.

Simple business model driving to 30-50 cents of earnings and 4-7x upside:

Target’s current business model and its respective income statement, therefore, is relatively straightforward as below:

Step-up in Target’s earning power, more visible financials, and more prominent NDR / marketing will be a major catalyst rerating the story in the next 12-18 months.

Over the next 24-36 months with significant ramp in the underwriting business, Target could see 4 – 17x upside depending on crypto enthusiasm and market cycle.

Additionally, given the following blockchain comps as of Aug 2021. Note that all companies had market cap of > 300 mm USD. With a median EV/Sales of 25x, Target could trade to 1Bn + in the next bull cycle.

Risk and Mitigants:

Regulatory risk in dealing with crypto derivatives

• Target is an offshore company dealing with OTC instruments not regulated by the financial bodies and does not serve US clients, while abiding to the highest standards of counterparty risk as per the team’s historical TradFi experience. Counterparties w/ ISDA need no license to operate in Hong Kong, thereby posting no regulatory overhang.

Competition w/ everyone getting into the business / growth miss + fee compression

• We believe that once Target is at scale, its listed status gives it additional layer of trust amongst its customers, while the scale / diversity advantage as well as customer relationship allows it to have a head-start in delivering solid results at least in the next 2-3 years.

Counterparty / credit risk

• We believe Target will continue to diversify its custodians while expanding its banking relationships. It is true, however, that Target is exposed to Binance risk that is unhedgeable.

Expense overrun risk – no earning show-through

• We believe that keeping a tight expense structure and showing EPS growth is key in getting the stock rerating, therefore delivering returns to execs, thereby giving us comfort in cost control.

Staff turnover risk + business operational risk in exposures / hedging

• We believe that making key executive shareholders as well as drafting solid compensation structures with clawbacks the way they had is a good solution to the agency problem.

Majority shareholder risk

• Assuming the crypto market recovers, the key strategic partner is set to profit tremendously and should not pose risk to Target’s growth and operations. As target grows, its concentration on its key strategic partner should also decline.

Bad capital allocation

• Target’s operation is very cash-generative, we will be working with Target to responsibly allocate capital. We will likely have more specificity as the cycle evolves.

Multiples may be capped to “bad business” without rerating

• We believe as the cycle gets underway and as market sees blockchain exposure, Target will no longer be valued purely as a bank / broker but will catch a strategic premium as upside optionality to crypto as a whole (as we have observed in the last cycle). In the worse case, its earnings growth and cash-generation is enough to deliver a solid return to shareholders.

Exit risk – stock is illiquid currently and may not have strategic buyer

• What is illiquid today will not be so given our experience once the company delivers results. We also believe that upon more awareness and better valuation, the company can place a strategic round with blue-chip investors to dramatically improve liquidity while furthering the growth of the company.