The Hidden Concerns of MSTR, the Largest BTC Listed Company

On August 1, Nasdaq-listed company MicroStrategy (MSTR) released its Q2 2023 report, announcing a significant increase in its holdings of 12,800 BTC. The market has expressed concerns about the company’s leveraged Bitcoin purchases. MicroStrategy has spent a total of $4.53 billion to acquire Bitcoin, with over $4 billion being funded through bond issuance or stock financing. While excessive leverage is generally not a good thing, it has become a low-cost, low-risk strategy for MicroStrategy. However, due to limited cash flow from its software business, the company does not have extra funds. Currently, it seems to face difficulties in raising funds from the bond market and can only roll over its debt through equity financing. This essentially binds the company’s fate to the price of BTC. If BTC does not experience a significant increase in price before the debt repayment period in 2025, MicroStrategy’s game may not be sustainable.

Bitcoin Holdings:

As the largest publicly traded holder of Bitcoin, MicroStrategy initially acquired Bitcoin as a defensive strategy to protect its balance sheet. However, it has now become their second core strategy. MicroStrategy has two company strategies: acquiring and holding Bitcoin, and developing its enterprise analytics software business. They believe that these two strategies set them apart and provide long-term value.

Earlier, the company stated that over $50 million in excess capital would be invested in Bitcoin. However, subsequent statements mentioned that they will continue to monitor market conditions to determine whether additional financing will be conducted to purchase more Bitcoin.

MicroStrategy started investing in Bitcoin in August 2020, shortly after the outbreak of the COVID-19 pandemic. As of July 31, 2023, the company holds 152,800 BTC with a total cost of $4.53 billion, approximately $29,672 per Bitcoin, which is almost in line with the current market price (August 1: $29,218). Among them, 90% of the Bitcoin is unencumbered, meaning that these Bitcoin have not been used as collateral for any loans or debts.

Chart showing MicroStrategy’s BTC holdings changes (MacroStrategy is a subsidiary of MicroStrategy)

From the chart, we can see that MSTR made quick purchases before Q1 2022, and then remained almost stagnant in the following three quarters as the market declined. Subsequently, in 2023, with the market rebound, the pace of purchases accelerated.

Financing Structure:

Their methods of expanding the balance sheet mainly include equity, debt, and convertible bond issuance.

Bond Issuance

Despite MSTR’s quarterly increase in Bitcoin holdings, the company’s debt structure remains relatively robust. It has approximately $2.2 billion in debt with an average annual fixed interest rate of 1.6%. The annual fixed interest expense is about $36 million. This is mainly because the company has utilized convertible notes for financing.

As of the latest financial report for the second quarter of 2023, the company’s main debts include:

  • 6.125% senior secured bonds due in 2028 (secured by 15,731 bitcoins), with an issue amount of USD 500 million and annual interest expense of approximately USD 30.6 million. (Issued in June 2021)

  • 0.75% interest rate convertible senior bonds due in December 2025, with an issue amount of USD 650 million and annual interest expense of approximately USD 4.9 million. (Issued in December 2020)

  • 0% interest rate convertible senior bonds due in February 2027, with an issue amount of USD 1.05 billion and no annual interest expense. (Issued in February 2021)

MicroStrategy has no debt due from 2023 to 2024. The debt maturity dates start from 2025 and go no later than 2028. This means that MicroStrategy can at least smoothly pass the Bitcoin halving in 2024.

Among them, convertible bonds are hybrid financial instruments that have both bond characteristics and stock characteristics. Taking the USD 1.05 billion convertible bonds issued in 2021 as an example:

Issue amount: The issue amount is USD 900 million, including the initial purchasers’ right to purchase an additional USD 150 million of notes within a 13-day period.

Nature of notes: Unsecured senior debt without regular interest, and the principal amount will not appreciate. They will mature on February 15, 2027.

Redemption: MicroStrategy can redeem the notes in cash on or after February 20, 2024, subject to certain conditions, at a redemption price equal to 100% of the principal amount of the notes plus any accrued and unpaid special interest.

Conversion: The notes can be converted into cash, MicroStrategy’s Class A common stock, or a combination of both. The initial conversion rate is 0.6981 shares per USD 1,000 principal amount of notes, equivalent to an initial conversion price of approximately USD 1,432.46 per share. This represents a premium of approximately 50% over the last reported sale price of MicroStrategy Class A common stock on Nasdaq of USD 955.00 per share on February 16, 2021. Noteholders can also convert their notes prior to the maturity date, provided that the trading price of the stock is 130% of the exercise price of USD 1,400.

By issuing convertible bonds, MicroStrategy has raised funds without directly assuming significant interest expenses. At the same time, it controls the immediate dilution of equity.

Why do investors choose to invest in zero-coupon convertible bonds? The main reasons include:

  1. Upside potential of stocks: Convertible bonds can be converted into the company’s common stock under certain conditions. If the company’s stock price rises above the target price, investors can choose to convert the bonds into stocks and enjoy the benefits of the increase in stock price. This is one of the main motivations for investors to choose zero-coupon convertible bonds.

  2. Capital protection: Compared to direct stock purchases, convertible bonds provide better capital protection. Even if the company’s stock price falls, investors can still redeem the face value of the bonds, and the bonds have priority in repayment compared to stocks. This provides investors with a way to reduce investment risk while enjoying the upside potential of stocks.

So convertible bonds are equivalent to holding both bonds and call options on MicroStrategy stock. However, considering that the current stock price of MSTR is only $434, the stock price needs to increase by more than 3.3 times by February 2027 for investors to be profitable. Therefore, once the stock price of MSTR, or strictly speaking, the price of Bitcoin, cannot increase by more than 3 times from now on, MSTR has essentially used this money for free for 6 years.

Stock Issuance

MicroStrategy issued a total of $1.723 billion of Class A common stock in 2021, 2022, and 2023, with an average sale price of $424 per share. The main purpose of these stock issuances was to purchase Bitcoin in each quarter of stock issuance and to repay debt in the first quarter of 2023.

The issuance dates of these stocks are as follows:

  1. Raised $404 million through a rights offering plan in the third quarter of 2021, with an average issuance price of $728 per share

  2. Raised $596 million in the third quarter of 2021, with an average issuance price of $694 per share

  3. Raised $47 million in the fourth quarter of 2022, with an average issuance price of $213 per share

  4. Raised $341 million in the first quarter of 2023, with an average issuance price of $253 per share

  5. Raised $335 million in the second quarter of 2023, with an average issuance price of $310 per share

Figure: MSTR stock issuance price and scale from 2021 to present

On August 1, 2023, with the release of the second-quarter report, MSTR announced the launch of a new $750 million rights offering plan, which is the largest rights offering financing scale in history. The purpose is still to continue supporting the company’s strategy of purchasing and holding Bitcoin on a large scale.

Financial Health Analysis

MicroStrategy’s annual revenue has been relatively stable in the past few years, reaching $499 million in 2022. However, it has basically remained at around $500 million since 2013. As a software company, it is somewhat worrying that software sales revenue cannot expand during the boom period of technology companies.

Figure: MSTR annual total revenue (annual)

And since the first two quarters of this year, the revenue has remained almost unchanged, at a level of $120 million.

Figure: MSTR annual total revenue (quarterly)

Figure: MSTR net profit (annual)

Although MicroStrategy recorded a net profit of $483 million in the first half of this year in the financial report, its software business is still not profitable, with an operating loss of $30 million in the first half of the year. The net profit is mainly due to the recognition of $513.5 million in income tax benefits.

These gains do not represent the actual cash received by the company, but rather various tax incentives and deductions that the company can deduct from its total revenue when calculating pre-tax profits, mainly due to the previous depreciation of Bitcoin. In accounting treatment, a company’s asset impairment, business losses, etc., may generate income tax benefits because it can use these losses to offset future taxes.

Figure: MSTR Net Profit (Quarterly)

In addition, although the revenue level is $500 million, the company actually does not have any excess cash flow. Although the average cost of debt is only 1.6%, the debt generates interest expenses of over $36 million per year, accounting for more than half of the company’s cash reserves, forcing the company to continue issuing new bonds or issuing new shares to raise interest. If the cash reserves bottom out, it may jeopardize the investment in the software business and further affect operating revenue.

Figure: MSTR Cash and Cash Equivalents (Quarterly)

From the current balance sheet of MSTR, the total assets of $3.363 billion ($2.346 billion in BTC) are actually undervalued. This is mainly due to the calculation of the value of BTC only considering the depreciation compared to cost, even if the price rises afterwards, it will not be included in the statistics. Therefore, it has resulted in a non-permanent impairment loss of $2.2 billion. In reality, based on the current price of BTC approaching $30,000, MSTR’s total assets should be $5.56 billion, corresponding to a debt of $2.73 billion.

Figure: MSTR Balance Sheet (Q2 2023)

Source: TrendResearch, SeekingAlpha

Although MSTR’s business model has tried its best to reduce debt pressure, the overall company’s prospects and the price of Bitcoin are deeply intertwined. If the price of Bitcoin cannot sustain a continuous rise at the current level, MSTR’s continuous fundraising may become difficult. For example, this quarter MSTR announced the launch of the largest $750 million equity offering plan in history. It is currently unclear how it will be implemented, but the company’s stock fell 6.4% the day after the announcement.

From the specific situation of MicroStrategy, issuing new shares directly has lower costs compared to conventional bonds, while issuing convertible bonds is slightly more difficult, requiring carefully designed terms to attract investors, which is obviously not easy in the current bear market of digital currencies.

It can be seen that MSTR’s three major bond issuances were all issued during the peak period of the last BTC bull market (December 2020 to June 2021), and after the third quarter of 2021, it mainly relied on equity financing. This also reflects the difficulty MSTR may face in the bond market for financing or bearing high interest rates. After all, the current benchmark yield for junk bonds in the United States is 8%+, and it is not sustainable to roll over existing debt at this cost, so it can only bet on a significant increase in BTC before the debt repayment period in 2025.

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