“Health warning”: I have only spent a few hours researching MicroStrategy and writing this article. If you wish to consider investing in the stock or bonds of MicroStrategy, you should do your own research as there is extensive company and 3rd party analytical resources available. This is not a recommendation to buy or sell the stock or bonds of MSTR, only my two cents. I do not own the stock. All prices used below are as of the close on Nov 26th 2024.
I realise that I am a “day late and a dollar short” in writing about MicroStrategy (MSTR). In fact, before spending a few hours looking at the company, I knew little about it aside from the fact that its founder and major shareholder – Michael Saylor – is one of the most visible and vocal advocates for Bitcoin. The main reason I have paid little attention to MSTR is because I am not a “crypto bro”. As I have written before in this blog, I bought – and sadly sold – Bitcoin in 2017. I originally bought Bitcoin (along with Ethereum and Ripple) at the time because I believed in the cause for cryptocurrencies, specifically that they were about to blossom as an alternative to fiat currencies, ripening into a broadly accepted medium of exchange. However, this concept did not gain momentum during the short period I was involved in cryptocurrencies, and in fact still looks very elusive to me even today. Nonetheless, a combination of factors – including more mainstream acceptance of digital currencies and a good dose of FOMO – has driven Bitcoin and some of its brethren to record levels. Hindsight is 20/20, and exiting Bitcoin at the end of 2017 looks like one of my stupider decisions, although it was certainly not my first and will not be my last. Welcome to the world of investing!
As I mentioned in the prelude to this article, there are investors and analysts with massively more knowledge of MSTR than me because they have been following the company for years. I am a relative neophyte in this respect, but felt the need to do a bit of work on the company given its performance since the election of “crypto friendly” president-elect Trump. As Bitcoin has headed to the moon since Mr Trump’s election on November 4th the shares of MSTR have followed suit, reflecting the fact that the company is mostly a leveraged bet on the direction of Bitcoin. As you can see in the graph below, the appreciation of MSTR shares has put the appreciation of Bitcoin to shame since the beginning of the year, really accelerating in early November.
While BTC is “only up” 121% YtD, MSTR has surged 456% over the same period. The company’s market cap has grown to $81.5 billion, making it easily one of the top 100 listed companies in the US. The returns on MSTR over the last four years have far outpaced those of better-known runners like NVDA and TSLA, and have certainly outperformed all of the infamous “Mag 7” stocks. The question is, “is this too good to be true, or will MSTR prove to have staying power”?
What does MSTR do?
MSTR advertises itself as a software development company, with the company’s website stating on the first page of its mission that its focus is “to make every enterprise a more intelligent enterprise”. This reflects the company’s roots, dating back to its founding in 1989, well before cryptocurrencies were even a concept. The company has 1,930 employees (at end of 2023), and is based in Tysons Corner, VA. It is NASDAQ-listed. Although its roots were as a software developer and an advisory firm for intelligent software, MSTR began to transition to a leveraged buyer of Bitcoin in August 2020 under then-CEO Michael Saylor, and is recognised today much more as a repository for a significant number of Bitcoins than as a software / consultancy company. MSTR owned 386,700 Bitcoins as of November 25th 2024, which is 1.95% of the total outstanding stock. Recall that earlier this year, the SEC approved spot Bitcoin ETFs, immediately after which several ETF sponsors – including Blackrock (iShares), Fidelity, VanEck, Franklin Templeton and Grayscale – launched spot Bitcoin ETFs. However, even before spot Bitcoin ETFs came on the scene, investors could effectively invest in MSTR as a proxy for the benchmark cryptocurrency. Not only is MSTR a prolific buyer of Bitcoin, but the company uses leverage regularly as part of its strategy to buy sizeable chunks of the digital currency.
Since Bitcoin offers no yield and generates no cash flow, the operating performance of MSTR almost exclusively reflects the performance of the legacy software development and consultancy portion of the business. Recent financials suggest that the performance of the
business has been volatile and has done relatively poorly (although the subscription services segment had a nice YoY increase in 3Q2024). MSTR last had positive quarterly EBITDA in 3Q2022; EBITDA has been negative each quarter since then. To better understand the company’s most recent results, you can find their third quarter investor presentation here, and their third quarter 10Q here. Although I believe there is value in the software / consultancy operating business, MSTR has attracted a following mainly because of its sizeable holdings of Bitcoin. The company is transparent in acknowledging this, appropriately describing itself now as “the first and largest Bitcoin Treasury Company”.
If the company gauges its success on its share price appreciation, the strategy most certainly seems to have been an overwhelming success. The extract below from their most recent investor presentation captures MSTR’s share performance since August 2020 relative to the performance of its underlying asset Bitcoin and several high growth and well-known tech companies.
What gives MSTR sizzle?
The answer to that question is very simple – it’s the combination of BTC, which has been on a tear, and the use of inexpensive leverage. When the price of a leveraged asset, including stock, is increasing in value, the leverage turbocharges the returns. When a leveraged asset is falling in value, the leverage cuts the other way, which can create all sorts of issues that I will touch on later.
The financial / treasury management of MSTR is centred around a balanced capital structure that is split between debt and equity. As far as its debt complex, the company recently repaid its only secured bond issue, so all of the company’s debt is now unsecured. This means that the substantial stock of Bitcoin that the company owns is completely unencumbered. Moreover, the company is not overly burdened with interest expense on its debt, because it mainly relies on low or zero-coupon convertible bonds, which according to the most recent investor presentation, have a blended cost of only 0.811%/annum (circa $35m of interest expense/annum). Investors have shown they are eager to invest in MSTR, not surprising given that the stock is up 20x since the company adopted its Bitcoin strategy in mid-2020. Convertible bond investors have also been richly rewarded, with a blended return on the company’s convertible bond issues (according to the company) of 90% at the end of the third quarter, compared to the return on Bitcoin over the same period of 47%. (See p 28 of the recent investor presentation.) With much fanfare and reflecting its strategy of using 1:1 debt: equity to buy Bitcoin, the company enacted a shelf registration of $21 billion of common stock and $21 billion of public debt in August 2024. Since the end of the 3Q2024, the company has issued an additional $3 billion of convertible bonds (upsized from $1.75 billion), with a coupon of 0% and a conversion premium of 55%. I’m not a convertible bond expert by any means, but the cost of this debt seems absolutely dirt cheap. The new bond is the 6th in a series of convertible bonds on which MSTR has largely tethered its future, increasing the total amount of convertible bond debt outstanding to $7.2 billion. One more juicy thing that shareholders liked is that the company did a 10-for-1 share split in July 2024.
Is MSTR over-valued?
My simple answer to this is a resounding “yes”, although like any stock or asset, it is arguably worth what investors are willing to pay for it. Let’s look at the fundamentals. The company’s market value is currently $81.5 billion. Including $7.2 billion of debt valued at pro forma book value for the recent $3 billion issue, the enterprise value of MSTR is around $88.7 billion[1]. The EV can be split into a valuation of the operating business of the company, and the value of the core BTC reserves. Assuming the software design / consultancy business is worth 15x sales – perhaps a generous valuation for a money-losing business – this would value the operating business of MSTR at circa $7 billion, meaning that the BTC reserves are being valued at $81.7 billion. If we subtract the existing book value of debt from the Bitcoin reserves, this will provide an unleveraged value of $74.5 billion for the reserves, meaning that the value of the company’s 386,700 Bitcoins is circa $192,655 per coin, more than double the current value of Bitcoin ($91,985 at close November 26th).
If we look at MSTR more as a financial institution (albeit unregulated), then we could look at the market cap of equity to the company’s book value. This can’t even be realistically considered, because most banks trade at around 1x to 2x book value. For example, JPM trades at 2.12x book, and GS trades at 1.75x book. Asset management firms like Blackrock or private equity firms like Carlyle trade at richer market-to-book levels, which appear to be around 3.5x. With book capital of $3.8 billion, this would imply that best case the market value of MSTR’s stock should be around $13 billion to $14 billion, which is of course well below the actual market value of MSTR. Obviously, such a low valuation makes no sense because the actual value of the company’s assets (principally Bitcoin) are worth substantially more than this. Even if you consider MSTR’s operating business worthless, the value of the company’s Bitcoin reserves at a current market price of $91,985 per coin is $35.6 billion (ignoring leverage, since some converts are in the money and one in particular is not).
Simply comparing the market cap of the company ($81.5 billion) to the actual value of its Bitcoin reserves ($35.6 billion) shows that MSTR is well over-valued. In addition, an investor must keep in mind that MicroStrategy is involved in substantially riskier and more speculative (albeit higher return) activities than banks or other asset management firms. With a current market cap of $81.5 billion, there is a massive gap between the intrinsic value of the company and what MSTR investors think the company is worth. History has proven that companies that are riding the wave of momentum often get ahead of their skies, and this seems very much to be the case now for MSTR.
What could go wrong?
By “go wrong”, this could mean the share price falling sharply, the convertible bond holders losing money (or suffering an opportunity cost by just getting their money back with de minimus current yield), or the company getting in trouble. In every case, I would expect the problem to be related to a significant and steady fall in the price of the company’s principal asset, Bitcoin.
From the perspective of owning the shares and as discussed in the previous section, there is clearly a massive premium built into the market price of MSTR. I suspect that the shares of MSTR would tumble quickly in a BTC bear market, driven both by a deterioration in the actual value of the Bitcoin reserves of MSTR (as the price falls), and compression of the rather absurd 21.6x market-to-book value at which the shares are currently trading. On the other hand, Bitcoin going “to the moon” would bring in more and more investors, many suffering from FOMO, although these investors would be the ones that suffer the most in a “Bitcoin down” scenario. MSTR’s capital structure, the nature of its business, and its reliance on Bitcoin almost certainly guarantee that the road ahead for investors will have plenty of ups and downs.
As far as debt investors, the face amount of legacy bonds seems well covered by Bitcoin reserves today. I cannot imagine BTC falling back to $20,000 per coin, which would be the level at which creditors might be in jeopardy. The more likely cost to convertible bond holders in a “lower Bitcoin” scenario would be the opportunity cost associated with earning a near-nil return when much higher yields are available today in non-convertible bonds in the marketplace. This creditor risk profile might also change if the company introduces other types of debt in its capital structure, or decides to use debt more aggressively. But for now, the major risk seems to be loss of current return.
Having said that, I can imagine a scenario in which MSTR is brought to its knees by the price of Bitcoin rapidly declining, leading to a loss of confidence by creditors. Although the company uses unsecured convertible notes, its maturity profile might be deemed to be somewhat risky if – due to the stock stagnating or falling – the bonds have to be repaid (rather than converted). The company’s maturity profile is below, taken from their most recent investor presentation (p 16):
As the table above indicates, the company has pending maturities every year from 2027 to 2032, noting that the recent $3 billion convertible due 2029 is not included in this table (because it was issued in November). The company’s core operating business generates no cash flow to repay the debt, so the company is reliant on access to the debt and/or equity capital markets to meet debt maturities, or it would have to sell assets (i.e. some of its Bitcoin reserves). I consider this scenario highly unlikely at the moment given the direction of travel of Bitcoin, but it is not an impossible scenario to imagine. More than one company has been tripped up by insufficient cash flow to meet debt maturities when investors sour on providing financing and the capital markets close, even if their balance sheet appears relatively solid.
I will end this section by noting that MSTR stock has a short interest that is very high, in the neighbourhood of the area that used to characterise Tesla (TSLA). At 15.5% short interest (as a percent of float), there are a significant number of investors betting against MSTR, not surprising given its elevated valuation. However, I would caution investors that – similar to using leverage – large short interests in shares can cut both ways. If the shares continue to gap up, it will force short players to cover their positions, which leads to more and more upward momentum, creating a vicious cycle that short investors have seen play out before at great cost.
Conclusion
The last few days have been a perfect illustration of what can go wrong. Having closed at $473.83/share one week ago and reaching an intraday high the next day of $543.00/share, MSTR shares have been heading south quickly as Bitcoin wobbled and has been falling. The shares closed on November 26th at $353.79/share, down 25% in one week (and 35% off its intraday high last Thursday), compared to Bitcoin which is down 7.7% from its intraday high last week. As I said earlier, leverage can cut both ways, and you are seeing this action at the moment.
[1] I could not get levels on the MSTR bonds because I do not have the resources at hand. However, the company reported at the end of the third quarter that most of its convertible bond issues were well “in the money” and were trading at a substantial premium over book. Since then, Bitcoin has raced higher, and the premium has probably increased. However, the market value of the recently issued $3 billion 0% convertible bond must be trading well below book value now given the timing of its issuance and its duration. To keep things simple and acknowledging that I lack the resources, I have chosen to simply use pro forma book value of the convertible bonds, including the recent $3 billion issue.