Overview

Microstrategy (MSTR) is a Business Intelligence software company founded and led by Michael Saylor. The company, operating for over three decades, has been written up twice on VIC, both were long equity recommendations. The 2018 write-up does a good job explaining the core software business and provides some useful background and can be found here:  https://www.valueinvestorsclub.com/idea/MICROSTRATEGY_INC/7380120768

I am recommending a long position in the Microstrategy 6 ⅛ notes of ‘28.  I intended to post this report immediately after the FTX implosion when the bonds cratered to 72, however the bonds quickly bounced to their current 77-78 levels. I still believe there is compelling value at current levels even though additional short-term dislocation in the crypto markets is likely which could lead to lower prices on the bonds. 

The decision to post a bond investment idea is informed by a desire to generate superior equity-like risk adjusted returns. The challenging macro environment has compelled me to evaluate opportunities higher up the capital structure where possible.    

Thesis

The Microstrategy 6 ⅛ notes of ‘28, at the current price of 78, offer a compelling risk reward. The bonds provide an 11.5% yield to worst and downside protection coming from their 1st lien on the core Business intelligence software business. At current prices, the notes trade at ~ 50% LTV of the core business if BTC goes to 0, with potential short term upside coming from a rebound in bitcoin prices, or perhaps just stabilization in the crypto ecosystem. 

While my analysis assumes the bonds are well covered even if Bitcoin goes to zero, one could ascribe expected value to the company’s 130,000 bitcoins. From a behavioral perspective (‘ie’ it’s a collectible that some people consider valuable), there is a greater than zero % probability that BTC will have a value in excess of 0 in 2028 when the bonds mature. As such, I think of their 130,000 Bitcoins, currently worth $2.03B or 4x the $500mm face amount of the bonds, net, as simply a hidden asset providing optionality for additional asset coverage. (By way of analogy, if they owned substantial amounts of fairly liquid, valuable rare art or coins or baseball cards I'd would think of them similarly.)   

My core thesis is predicted on the value of the software business covering the bonds, however upside volatility on bitcoin would likely drive the bonds higher and accelerate the IRR, creating a shorter term trading opportunity, while a long crypto winter and downside moves in bitcoin can potentially be somewhat offset by the 7.85% current yield and a 1st lien on the core software business.  

I'm not bullish on Bitcoin nor do I own any BTC, and in fact was short MSTR’s equity for much of 2022 until covering a couple of weeks ago. My involvement on the short side ultimately led me to consider the merits of the bonds.  

Why this opportunity exists?

Institutional money managers fear career risk investing in a company so closely associated with cryptocurrency led by one of its biggest evangelists. Philosophically many are offended by Saylor turning a public company into a de facto Bitcoin ETF. Value investors who would normally be excited to own a software business at 6x trailing free cash flow while earning an 8% yield are deterred by the company’s sizable bitcoin assets which are hard to value and overwhelm the narrative.  

Who is this recommendation for?

If you are passionately anti-crypo or bitcoin, or feel it’s a ponzi scheme or scam, insist every investment including associated hidden assets should have discernable intrinsic value, or if you are offended that Saylor has levered up his software company to speculate massively on bitcoin and turn MSTR into a defacto bitcoin etf, then this investment ( and write-up ) is not for you ;) 

Company Description    

MicroStrategy Incorporated provides business intelligence software and related services. The Company provides a platform that enables departments and enterprises to deploy web-based reporting and analysis solutions. MicroStrategy also offers consulting, training, and support services. MicroStrategy serves retail, finance, telecommunications, insurance, and healthcare sectors.   

Microstrategy 

(as of 12/8/22 close)

Amount

Value @

Debt/

($mms)

Price

Market

EBITDA

Rate

Digital Assets Sub (Macrostrategy)

Snr Secured TL of '3/25

205

3.75%+SOFR

Holdco (Microstrategy)

Cash

60

60

6.125% Snr Secured Notes of '6/28

500

0.78

390

6.13%

Total Secured Holdco Net Debt

440

330

3.9

0.75% snr unsec converts of '12/25

650

0.60

388

0.75%

0% snr unsec converts of '2/27

1,050

0.38

399

0%

Total Unsecured Debt

1,700

787

Total Net Debt

2,140

1,117

13.1

Equity

-Shares

11.3

-Price

202.57

Equity Value

2,290

26.9

EV

4,430

Revenue (LTM)

500

Adj EBITDA (LTM)

85

_____________

* Macrostrategy - TL subject to minimum loan to collateral value of 50% collateralized by BTC

** 6.125% notes hold senior liens to all other assets including software business + non-pledged digital assets

- has springing maturity to converts subject to less than 130% of convert proceeds 91 days prior to respective maturities

- Cannot be primed, can add approx $80mm of debt pari passu using various baskets

*** Current value of BTC owned = 130,000 * $17,200 = $2.24B ($2B net of TL)

FY Ended

LTM

($ mms)

12/31/19

12/31/20

12/31/21

9/30/22

Revenue

$486.3

$480.7

$510.8

$501.1

Cost of Revenue

  100.0

           91.1

        91.9

    100.2

Gross Profit

$386.4

$389.7

$418.9

400.9

Gross Margin 

79%

81%

82%

80%

Operating Income

($1.0)

($13.6)

($784.5)

($1,207.4)

Depreciation and Amortization

      8.6

          13.3

        11.4

        9.6

Share-Based Compensation Expense

    10.2

          11.2

        44.1

      59.7

Digital Asset Impairment Losses

          - 

          70.7

      830.6

  1,235.2

EBITDA

$17.8

$81.6

$101.6

$97.1

EBITDA Margin 

4%

17%

20%

19%

EBITDA

$17.8

$81.6

$101.6

$97.1

-Cash Interest

    (0.0)

          (0.2)

      (20.4)

    (35.0)

-Cash Taxes

    (5.9)

          (6.8)

        (7.0)

      (4.0)

Change in Working Capital

      4.9

        (22.8)

        11.1

      (4.0)

Other

    44.1

            1.8

          8.6

      18.3

Cash Flow from Operations

$60.9

$53.6

$93.8

$72.4

less Cap Ex

  (10.2)

          (3.7)

        (2.7)

      (2.7)

Adj FCF

$50.7

$50.0

$91.1

$69.8