The concerns of MicroStrategy, the largest publicly traded Bitcoin company
Excessive leverage is not a good thing, but for MicroStrategy, it has become a low-cost, low-risk strategy.Written by: LD Capital
On August 1, Nasdaq-listed company MicroStrategy (MSTR) released its Q2 2023 report, significantly increasing its holdings by 12,800 BTC. The market is generally concerned about the leveraged purchase of Bitcoin, as the company has spent a total of $4.53 billion to acquire Bitcoin, with over $4 billion raised through bond or stock issuance. Typically, excessive leverage is not a good thing, but for MSTR, it has become a low-cost, low-risk strategy. However, due to limitations in its software business development, the company actually does not have excess cash flow, and financing in the bond market seems difficult, forcing it to roll over debt through equity financing, which effectively ties BTC prices deeply together. If BTC does not rise significantly before the debt repayment period in 2025, MSTR's strategy 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, but it has now become their second core strategy. MicroStrategy has two corporate strategies: acquiring and holding Bitcoin, and developing its enterprise analytics software business. They believe these two strategies set their business apart and provide long-term value.
The company previously stated that excess capital exceeding $50 million would be invested in Bitcoin, but subsequent statements indicated they would continue to monitor market conditions to determine whether to seek additional financing to purchase more Bitcoin.
MicroStrategy began 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 Bitcoins, with a total cost of $4.53 billion, or $29,672 per Bitcoin, nearly in line with the current market price ($29,218 on August 1). Of these, 90% of the Bitcoins are uncollateralized, meaning they are not used as collateral for any loans or debts.
Figure: Changes in MicroStrategy's BTC Holdings (MacroStrategy is a subsidiary of MicroStrategy)
Source: MSTR, TrendResearch
It can be seen that MSTR purchased Bitcoin rapidly before Q1 2022, while in the following three quarters, as the market declined sharply, they almost stood still. Then in 2023, with the market warming up, they accelerated their purchasing pace.
Financing Structure
They expanded their balance sheet primarily through equity, debt, and convertible bond issuance.
Bond Issuance
Although MSTR has been increasing its Bitcoin holdings each quarter, and Bitcoin prices have plummeted since the end of 2021, the company's debt structure remains relatively robust, with approximately $2.2 billion in debt, an average fixed annual interest rate of 1.6%, and annual fixed interest expenses of about $36 million, mainly because the company used convertible notes to finance.
As of the latest Q2 2023 financial report, the company's main debts include:
- 6.125% senior secured bonds maturing in 2028 (secured by 15,731 BTC), issued for $500 million, with annual interest expenses of about $30.6 million. (Issued in June 2021)
- 0.75% convertible senior bonds maturing in December 2025, issued for $650 million, with annual interest expenses of about $4.9 million. (Issued in December 2020)
- 0% convertible senior bonds maturing in February 2027, issued for $1.05 billion, with no annual interest expenses. (Issued in February 2021)
MicroStrategy has no debt maturing from 2023 to 2024. Its debt maturity dates start from 2025, with the latest being in 2028. This means MicroStrategy can at least smoothly navigate through the Bitcoin halving in 2024.
Source: MSTR, TrendResearch
Convertible bonds are a hybrid financial instrument that has both bond and stock characteristics. Taking the $1.05 billion convertible bond issued in 2021 as an example:
Issue Amount: The issue amount is $900 million, including an initial purchaser's right to purchase an additional $150 million of notes within a 13-day period.
Nature of the Notes: Unsecured senior debt, with no regular interest, and the principal amount does not appreciate. They will mature on February 15, 2027.
Redemption: MicroStrategy can redeem the notes for cash on or after February 20, 2024, under specific conditions, at a redemption price equal to 100% of the principal amount of the notes plus any accrued but 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 for every $1,000 principal amount of the notes, equivalent to an initial conversion price of about $1,432.46 per share. This represents a premium of about 50% over the last reported sale price of MicroStrategy's Class A common stock at $955.00 per share on Nasdaq on February 16, 2021. Noteholders can also convert their notes before maturity, provided the stock's trading price must be 130% of the exercise price of $1,400.
By issuing convertible bonds, MicroStrategy has raised funds without directly bearing large interest expenses while also controlling the immediate dilution effect on equity.
Why are investors willing to choose zero-coupon convertible bonds? The main reasons include:
- Potential for Stock Price Appreciation: Convertible bonds can be converted into the company's common stock under specific conditions. If the company's stock price rises above the target price, investors can choose to convert the bonds into stock, thus benefiting from the stock price appreciation. This is one of the main motivations for investors to choose zero-coupon convertible bonds.
- Capital Protection: Compared to directly purchasing stock, convertible bonds offer better capital protection. Even if the company's stock price declines, investors can still redeem the bonds at face value, and bonds have priority in repayment over stocks. This provides investors with a way to enjoy the potential for stock price appreciation while reducing investment risk.
Thus, convertible bonds are akin to holding both bonds and call options on MicroStrategy stock simultaneously. However, considering that MSTR's stock price is currently only $434, the stock price needs to increase more than 3.3 times by February 2027 for investors to profit. Therefore, if MSTR's stock, or more precisely, the price of Bitcoin does not rise more than three times from now, MSTR effectively has used this money for free for six years.
Stock Issuance
MicroStrategy issued a total of $1.723 billion in Class A common stock in 2021, 2022, and 2023, with an average selling price of $424 per share. The primary use of these stock issuances was to purchase Bitcoin during all stock issuance quarters and to repay debt in Q1 2023.
The issuance times of these stocks are as follows:
- In Q3 2021, raised $404 million through a rights offering, with an average issuance price of $728 per share.
- In Q3 2021, raised $596 million, with an average issuance price of $694 per share.
- In Q4 2022, raised $47 million, with an average issuance price of $213 per share.
- In Q1 2023, raised $341 million, with an average issuance price of $253 per share.
- In Q2 2023, raised $335 million, with an average issuance price of $310 per share.
Figure: MSTR Stock Issuance Prices and Sizes from 2021 to Present
Source: MSTR, TrendResearch
On August 1, 2023, with the release of the Q2 report, MSTR announced the launch of a new $750 million rights offering plan, the largest in its history, aimed at continuing to support the company's large-scale acquisition and holding of Bitcoin.
Financial Health Analysis
MicroStrategy's annual revenue has been relatively stable over the past few years, with $499 million in 2022, but it has remained around $500 million since 2013, which is somewhat concerning for a software company that has been unable to expand its software sales revenue during the tech boom.
Figure: MSTR Annual Total Revenue (Annual)
Source: TrendResearch, SeekingAlpha
Moreover, revenue has shown almost no change in the first two quarters of this year, remaining at around $120 million.
Figure: MSTR Annual Total Revenue (Quarterly)
Figure: MSTR Net Profit (Annual)
Source: TrendResearch, SeekingAlpha
Although the financial report shows that MicroStrategy recorded a net profit of $483 million in the first half of this year, its software business operations remain unprofitable, with an operating loss of $30 million in the first half. The net profit primarily results from recording $513.5 million in income tax benefits.
These benefits do not equate to actual cash received by the company but are various tax incentives and credits that the company can deduct from total revenue when calculating pre-tax profits, mainly due to previous Bitcoin impairments. In accounting terms, a company's asset impairments and business losses can generate income tax benefits because they can offset future tax liabilities.
Figure: MSTR Net Profit (Quarterly)
Source: TrendResearch, SeekingAlpha
Furthermore, despite having revenue at the $500 million level, the company actually does not have excess cash flow. Although the average cost of debt is only 1.6%, the annual interest expense of $36 million accounts for more than half of the company's cash reserves, forcing the company to continue issuing new bonds or new shares to raise interest. If cash reserves run low, it could jeopardize investments in the software business, further impacting operational revenue.
Figure: MSTR Cash and Cash Equivalents Reserves (Quarterly)
From the current MSTR balance sheet, total assets are $3.363 billion ($2.346 billion is BTC), which is actually undervalued, mainly because the value calculation of BTC only accounts for impairment against the cost, and even if the price later rebounds, it will not be included in the statistics, resulting in a non-permanent impairment loss of $2.2 billion. Based on the current BTC price of nearly $30,000, MSTR's total assets should be $5.556 billion, corresponding to $2.73 billion in debt.
Figure: MSTR Balance Sheet (Q2 2023)
Source: TrendResearch, SeekingAlpha
Although MSTR's business model has tried to reduce debt pressure, the overall performance of its traditional business is poor, so the company's operational prospects are deeply tied to Bitcoin prices. If Bitcoin prices cannot achieve sustained increases at current levels, MSTR's continued fundraising may become difficult. For example, this quarter MSTR announced the launch of the largest $750 million rights offering plan in history, and it remains unclear how it will be implemented, but the announcement caused the company's stock to drop 6.4% the next day.
From MicroStrategy's specific situation, directly issuing new shares is relatively cheaper than conventional bonds, while issuing convertible bonds is slightly more challenging, requiring carefully designed terms to attract investors, which is evidently not easy in the current bear market for digital currencies.
It can be seen that MSTR's three main bonds were issued during the peak of the last BTC bull market (December 2020 to June 2021), while after Q3 2021, equity financing became the main focus, reflecting that MSTR may face difficulties in bond market financing or may not be able to bear high interest rates. After all, the current yield benchmark for U.S. junk bonds is 8%+, and rolling over existing debt at this cost is unsustainable, leaving them to bet on a significant rise in BTC before the 2025 debt repayment period.
