Under the leadership of Executive Chairman Michael Saylor, MicroStrategy, now known as Strategy, has amassed an impressive 506,137 bitcoin (BTC), valued at approximately $44 billion at the current market price of around $87,000. To the untrained eye, it may appear that the company possesses a seemingly infinite pool of resources to continue purchasing bitcoin. However, a significant portion of this acquisition strategy has been financed through the issuance of billions of dollars in equity and convertible notes—debt securities convertible into equity under specific conditions—alongside their recent foray into preferred stock, which yields dividends to investors.
However, bitcoin’s price has recently experienced a downturn, dropping around 20% from its peak above $109,000 two months ago. While fluctuations are common in the crypto landscape, the aggressive purchasing strategy employed by Saylor’s team has increased Strategy’s average acquisition cost to $66,000. This raises a pressing concern: could Strategy’s financial practices backfire if bitcoin prices continue to decline?
“It’s highly unlikely that it results in a scenario where [Strategy] has to liquidate a bunch of bitcoin because it gets margin called,” stated Quinn Thompson, founder of crypto hedge fund Lekker Capital, in a recent interview with CoinDesk. He emphasized that the debt could likely be refinanced for the convertible notes and mentioned that with the introduction of perpetual preferred stock, repayment is not an immediate concern.
Nevertheless, this does not imply a secure future for MSTR investors. Under various circumstances, Saylor may need to issue more equity than the market can absorb to maintain operations.
“If he’s not paying dividends with Strategy’s cash flow, he’s going to issue more shares and wreck the stock price. But it’s no different than what he’s doing already,” Thompson observed. The potential for further equity issuance could divert funds away from bitcoin purchases, leading to adverse consequences for the stock price.
Saylor’s Balancing Act
Strategy is navigating its capital requirements through three funding avenues: equity issuance, convertible notes, and preferred stocks.
Issuing equity involves creating new MSTR shares and utilizing the proceeds for bitcoin purchases. This can exert downward pressure on MSTR’s stock price. Conversely, convertible notes enable Strategy to raise funds swiftly without diluting its stock, appealing to investors who seek solid yields and benefits from potential stock surges.
On the other hand, preferred stocks offer lower volatility and stable returns through dividends. Currently, Strategy has two preferred offerings: STRK, offering an 8% annual return, and STRF, providing a 10% annualized return.
The rationale behind these diverse investment vehicles is to create a broad appeal that accommodates various risk tolerances among investors. As Jeffrey Park, head of Alpha Strategies at Bitwise, explained, “The convertible bond investors and the common equity investors were generally aligned in that they were both volatility-seeking structures. Preferred equities are different, favored by those minimizing volatility for reliable returns.”
“Strategy’s capital structure is analogous to a seesaw,” Park elaborated. “The weights shift as sentiment changes, redistributing perceived value across the company’s liabilities, while the overall enterprise value remains stable.”
Assessing the Risks
Presently, Strategy finds itself obligated to pay 8% dividends on its STRK and 10% on its STRF, in addition to a 0.4% interest on the convertible bonds. With limited cash flow from its software division, securing funds to cover these obligations might prove challenging.
It is likely that Strategy will have to continue issuing MSTR stock to meet its interest payments, which could exacerbate downward pressure on the stock price. In a worst-case scenario, the stock might trade at a discount relative to its bitcoin holdings if continuous share issuance becomes necessary.
Thompson cautions that shareholders could become vocal if this discount widens significantly, similar to the situation faced by Grayscale’s GBTC prior to its ETF conversion. “Right now, he’s adding shareholder value by selling stock at an elevated price and buying bitcoin, but the reverse may become true in the future,” he warns.
Another potential threat resides in the popularity and ongoing demand for the 2x long Strategy exchange-traded funds (ETFs) issued by T-Rex and Defiance. Despite recent stock declines, they have accumulated over $3 billion in MSTR exposure, fostering consistent buying pressure.
However, the landscape can shift unexpectedly. If these ETFs begin to offload their MSTR shares, the impact on stock prices could be dramatic.
“I don’t know where the endless capital comes from to buy the dip. These ETFs have taken significant hits,” Thompson stated. “This is not a sustainable demand relationship, yet it remains critical for bitcoin in the short term.”
