Description

MicroStrategy is a speculative bubble squared that I believe will eventually go to zero or very close to it and can easily be paired to mitigate the risk that Bitcoin maintains / increases its value.  As an obvious caveat, the market can remain irrational longer than you can remain solvent, so short in a size that you can tolerate a fair amount of pain if things get increasingly irrational before coming back to reality. 

As quick background, MicroStrategy is a business intelligence software company founded by Michael Saylor that went public in 1998.  Until recently he had the dubious distinction of holding the world record for most money lost by an individual in a single day ($6B in 2000 as the first iteration of MSTR Bubble stock collapsed). 

The core business of MSTR may give you an indication on why MS decided to pursue the Hail Mary strategy of buying Bitcoin.  The software business has seen flat “Adjusted EBITDA” of 85mm for the last four years, or a reduction from $70mm to $14mm if you consider stock comp expense a real thing – and revenue and gross profit are down 10% in the most recent quarter.  What multiple should an old-world software business that has no growth and generates no cash flow after stock comp and capex receive?  We can be generous and just say $1.25B or ~15x adjusted EBITDA and move on since it won’t change the thesis.

The real value of MSTR is in its Bitcoin holdings.  In 2020 MSTR decided to begin using the cash on its balance sheet to buy Bitcoin.  Given the environment that was pervasive during Covid this caused a massive run-up in the share price at which point MSTR issued more shares to buy more Bitcoin.  It has subsequently issued convertible debt to purchase more Bitcoin, though for all its engineering and leveraging its Bitcoin per share (a metric it likes to tout) has only increased by 16% since the end of 2021 while its net debt per share has increased by 30%.

Valuation

At current prices MSTR trades at a premium to its NAV of 182%, implying 65% downside from the current price if it traded for the value of its business plus the value of its Bitcoin holdings.  There is in additionally the substantial inefficiency of owning Bitcoin in a taxable structure (in an upside) and the risk of getting forcibly liquidated of Bitcoin holdings due to leverage (in a downside).

Notably this ignores and tax impact of actually selling the company’s Bitcoin.  Buying here at $1611, in order for the company to sell its Bitcoin and pay you back an after-tax return of your investment, Bitcoin would need to go to $167,000 per BTC or 162% just to break even (ignoring taxes on dividends).

So what’s the pitch?  Why invest in MSTR rather than just buying Bitcoin?

NO FEES – yes indeed, rather than paying 21bps to BlackRock to buy IBIT you only have to pay a 180% NAV premium and then cover the continued stock market expense to Michael Saylor and co.

Leveraged BTC Play: Yes, there is indeed debt on the company, but it is not a levered Bitcoin play.  You only get 40c of Bitcoin for every $1 of MSTR you buy, if you want a levered Bitcoin play buy Bitcoin or IBIT on margin, easy.  Instead, you have the risk of the company being liquidated at low Bitcoin prices due to the company’s leverage.

In the event Bitcoin prices are lower when the debt matures or if at any time there is a material drawdown (likely somewhere in the 16-25k / Bitcoin) there will be forced sale of Bitcoin at lower prices (as occurred in 2022).  Below is the maturity schedule of MSTR’s debt

Benefit from MSTR being able to trade in and out of Bitcoin: Michael Saylor is in no way a Bitcoin trader, In 2022 MSTR purchased 8,813 Bitcoins for an average price of $32,670/BTC and sold 704 Bitcoins for an average price of $16,786/BTC, a loss of a cool 49% on an intra-year trade.  One would assume those sales were forced due to liquidity / financing reasons.  Great to own a super volatile asset in a levered structure that forces you to sell at the lows.  Since that time leverage has increased by 2x and his Bitcoin purchased has been at 2x previous prices, so should be fun to see what happens on the next Bitcoin drawdown.

In fact, MSTR has purchased Bitcoin at a premium to its average trading level every single year, and its only sale was at a substantial discount to average Bitcoin prices for the period:

Other highlights / lowlights on MSTR

Michael Saylor controls the company thought dual voting class.  He’s a daily Bitcoin pumper and a stock dumper (Saylor has exercised and sold ~800mm of stock YTD). 

Last week they announced a 10/1 split, likely a move to keep max volatility and liquidity in the stock.  Given their strategy to be a “Levered Bitcoin Play”, they have issued billions in convertible debt, but due to coverage concerns they can only issue this during bitcoin peaks, at lower bitcoin prices they will be constrained or even have to sell as happened modestly in 2022.

They have been able to borrow at low rates in convertible note form, but as the stock over time has less insane vol to it the refinancing will either be very difficult to do or likely at meaningfully higher rates.

Views on Bitcoin

Bitcoin is a speculative asset that has seen tremendous positive returns over the last 14 years since it was conceived.  It first got on the radar of investors in the space in late 2013/14 when it ran up to $1000 per Bitcoin from its initial levels of 10c per Bitcoin in 2010.  It then crashed back to $200 before getting on everyone’s radar in late 2017 gaining to $20,000 per BTC, before crashing down to $3k per BTC.  It then got on EVERYONE’s radar in 2021 during covid when people had free money to speculate on all sorts of great ideas like Gamestop, AMC, and all variety of crypto coins, including Fraud coin, Ponzi coin, Cumrocket coin, and of course Bitcoin, which peaked at $69k in late ’21 before crashing to $15k in late 22.  The latest rally which began in the beginning of ‘23 has seen Bitcoin rise to $73,700 before coming back down to its current level of $63,800.

So where is it heading?  In the end it is a question of supply and demand.  Bitcoin doesn’t do anything, it doesn’t generate any cash flows, it’s a perceived “store of value” or digital gold proxy so it is purely a question of what price the marginal buyer/seller transacts at in the market.  Given the near religious following BTC has and the tendency for true believers to HODL (or not sell at any price), there can be wild swings upwards when there is a new group of buyers entering the market.

A few reasons I feel we may be near the top for Bitcoin:

Hard to imagine an environment more bullishly speculative than the 2021 covid period of free money, meme/casino environment, and nothing else to do with the cash, Bitcoin hit $69k.  Then in the beginning of this year there was the introduction of ETFs that finally allowed everyone who wanted to buy Bitcoin to buy it without having to procure wallets or join Coinbase.  So anyone globally with a brokerage account could finally buy Bitcoin with ease.  There was also the “halving”, which is a once every four year or so event that reduces by half the amount of Bitcoin miners receive for their work that was supposed to drive a large appreciation in Bitcoin price, but since it occurred in early April Bitcoin has gone down by ~20%.  Given all these factors Bitcoin topped out (so far) at $73k, like three years ago.

With certain exceptions of drug dealers, criminals, or people trying to get money out of a country, most people buying and owning Bitcoin are doing so with the hope and expectation that the price will rise.  With the supply of Bitcoin increasing modestly each year, to keep prices rising or stable it requires more buyers each year.  A recent online poll of 64k respondents asked what the “most important thing”; Bitcoin rank #1, followed by “Family and Friends” and then “AI”.  I’m going to argue that this level of interest and enthusiasm is peaky and not sustainable.  If prices don’t continue to rise, there is really no reason to own / buy Bitcoin, so thus we need every year to have more buyers than the year before for an asset that doesn’t do anything.  This is certainly possible, and it’s had a great run, but I’d put my bet that once the weight of holding up the prices starts to falter, we’ll have more sellers than buyers, and if this last spike on ETF/Halving only got us 5% above the previous high from 3 years ago the bull case may soon erode and that’s really all there is here.  The original bull case that Bitcoin will be our means of transacting for goods and services is completely out the window, usage never took off, its expensive to transact, and the energy consumption even at these tiny levels of usage are out of control (higher energy consumption that Sweden even with almost no-one using it for anything other than speculative buying and selling). 

OK, so I’m clearly bearish on Bitcoin and think the whole crypto environment is horrendously wasteful.  But we can look at the history and I’m humble enough to know I may be wrong and in either case there is a good case to be made for being able to sleep at night during irrational moves.  So for most people I would recommend pairing the short of MSTR with a long position in IBIT (long 17.5 shares of IBIT for every share of MSTR shorted hedges the BTC and just captures the unfounded premium, chose your own ratio based on how bullish / bearish you are on Bitcoin prices from here to take advantage of the insane premium currently in MSTR).

Risks

Bitcoin keeps moving upwards – mitigant is to hedge with IBIT

Premium remains or increases – mitigant is to not make the short too large to tolerate increasing levels of irrationality.  We are at the peak historical premium which has historically corrected down and you have the upside of a donut if things get ugly for Bitcoin even temporarily.

Catalyst

Bubbles pop, Bitcoin eventually goes down again

Debt Maturities - Refinancing at higher rates / worse terms

Requirement to liquidate bitcoin again at low prices