Written by: 100y
Compiled by: Luffy, Foresight News
If you can live until tomorrow, it may mean: a) you are more likely to live forever, or b) you are closer to death.
—From Nassim Nicholas Taleb's "The Black Swan"
It has been two years since FTX filed for bankruptcy in November 2022. The market seems to have forgotten the collapses of FTX and Terra, and has quickly recovered, with Bitcoin reaching the $10,000 mark.
While the steady rise of the market is exciting, as an investor who entered the crypto market in 2020, I have witnessed too many collapse events, and I can't help but worry about what the next black swan event will be.
The failures of FTX and Terra had different causes, processes, and results, but they have one obvious similarity: the virtuous cycle and the vicious cycle. The structure of both was able to achieve explosive growth under favorable market conditions, but when things went wrong, they also fell into an endless death spiral.
Currently, similar characteristics are also reflected in another entity, MicroStrategy. Personally, I believe the risks of MicroStrategy are smaller than those of FTX and Terra, but its practice of using debt to purchase Bitcoin is not without danger. I want to discuss this briefly.
1. Current Situation
1.1 Company Profile
MicroStrategy was originally founded by Michael Saylor in 1989 and is a business intelligence company. In the early days, the company focused on analytical software, and eventually expanded to mobile applications and cloud services as technology progressed.
Source: companiesmarketcap.com
The company went public in 1998, with an initial valuation of around $1 billion. Aside from a brief spike during the internet bubble, MicroStrategy's market capitalization has hovered around $1 billion until 2020, remaining a relatively unremarkable stock. However, everything changed on August 11, 2020, when MicroStrategy, as a publicly traded company, announced its first purchase of Bitcoin. Since then, it has been continuously increasing its BTC holdings, driving its own market value to grow exponentially, currently around $9 billion.
1.2 Where does the funding come from?
Source: SaylorCharts
MicroStrategy has purchased a total of 402,100 BTC at an average price of $58,263, which is an astonishing figure, accounting for 1.9% of the total Bitcoin supply of 21 million. The company has primarily funded its Bitcoin purchases through three methods:
1.2.1 Cash Reserves
Source: SEC
As a software company, MicroStrategy generates revenue through product licensing, subscription services, and product support. According to its 10-K report, the company's core business generated approximately $499 million in revenue in 2022 and approximately $496 million in revenue in 2023.
After deducting costs and operating expenses (excluding cryptocurrency price fluctuations), MicroStrategy had a surplus of $105 million in 2022 and $8 million in 2023. These funds can be used to purchase BTC or pay interest on existing debt.
1.2.2 Convertible Preferred Notes and Stock Issuance
Source: MicroStrategy Q3 2024 Report
MicroStrategy's primary method of raising funds is through the issuance of convertible preferred notes. As of Q3 2024 financial performance, the company has accumulated approximately $4.26 billion in debt through such notes, with an average annual interest rate of 0.811%, resulting in an annual interest expense of $346 million.
Recently, on November 21, 2024, MicroStrategy issued another $3 billion in convertible preferred notes. This brings its total debt to over $7 billion. Notably, the new $3 billion notes have a 0% coupon rate, meaning there will be no interest expense. In return, investors can convert these notes into equity at a 55% premium in the future.
In addition to convertible notes, MicroStrategy has also conducted stock issuances. In Q3 2024, the company issued $1.1 billion worth of Class A common stock.
MicroStrategy has announced plans to raise a total of $42 billion in funding over the next three years (2025 to 2027). Of this, $21 billion will come from stock issuances, and the remaining $21 billion will be raised through fixed-income issuances. The specific timeline is: $5 billion from each source in 2025, $7 billion in 2026, and $9 billion in 2027.
1.3 Some Interesting Statistics
Here are some interesting data and facts about MicroStrategy:
Source: SaylorCharts
MicroStrategy's average purchase price for Bitcoin is $58,263, and the total market value of its Bitcoin holdings is $38.5 billion, with a book value of $23.4 billion, resulting in an unrealized gain of approximately $15 billion.
Source: MSTR-tracker
MicroStrategy's market valuation is approximately 2.2 times the value of its Bitcoin holdings. This valuation difference is the reason why funds like Hindenburg are short-selling MSTR stock.
Source: MSTR-tracker
Despite the increase in the number of shares due to stock issuances, the BTC price per basic share has actually increased. This is because MicroStrategy's pace of Bitcoin purchases has outpaced the dilutive effect of the additional stock issuances.
2. Is MicroStrategy the Next FTX?
While structural issues played a role in the downfall of FTX and Terra, the moral hazard of their founders was also an important factor. By definition, black swan events are inherently unpredictable, so it is impossible to assess based on public information whether there are moral risks within MicroStrategy. Therefore, the focus here will be on analyzing the structural risks.
Although this discussion topic may sound grandiose, the structural risks involved in MicroStrategy are actually quite simple: leveraged investment in Bitcoin. If the company only invested its own equity in Bitcoin, the impact of a price crash would be relatively small.
Source: MicroStrategy
However, as emphasized in the Q3 2024 report, MicroStrategy's goal is to acquire as much BTC as possible using prudent leverage to increase shareholder value and outperform Bitcoin itself.
It is well known that leverage is a double-edged sword, as it comes with the cost of debt interest, and if the BTC purchased with leverage declines in value, the company may be forced to sell its assets to repay the debt.
Michael Saylor has repeatedly stated in the media that he has no intention of selling BTC, which means that any forced liquidation could severely impact the company's value. This could lead to a drop in the MSTR stock price and difficulty in future financing. The collapse of the leverage strategy could also have a significant cascading effect on the market.
To assess whether MicroStrategy's leverage strategy is sustainable, I will examine two key aspects:
- Interest costs
- Sustainable volatility
2.1 Can MicroStrategy Control Interest Costs?
First, let's consider the interest costs. With the recent issuance of $3 billion in convertible preferred notes at a 0% coupon rate, MicroStrategy's total debt is now around $7.3 billion, with an average interest rate of 0.476%, resulting in an annual interest expense of $346 million. The key question is: Can MicroStrategy continue to pay these interest costs?
Source: SECAccording to the company's 2023 10-K filing, in addition to digital assets, MicroStrategy holds approximately $1.13 billion in other assets. This is significantly higher than the $34.6 million in annual interest expense, indicating that MicroStrategy does not have an immediate interest payment problem. Furthermore, MicroStrategy generates substantial revenue from its core business intelligence software. However, the concern is that the remaining profit after deducting revenue and operating expenses is relatively small and has been declining. The future debt size is also not to be ignored. As mentioned earlier, MicroStrategy plans to issue an additional $21 billion in convertible preferred notes over the next three years. This will increase its total debt to $28.3 billion. Calculated at the current average interest rate of 0.476%, the annual interest expense could rise to $134.7 million, which may be unsustainable in the long run. While MicroStrategy has recently alleviated its interest burden by issuing 0% coupon bonds, it remains uncertain whether the company can continue to obtain such low-interest debt. The next section will further explore this issue.
2.2 Is Future Fundraising Sustainable?
2.2.1 Will Investors Continue to Provide Funding?
Source: MicroStrategyThe primary issue is the sustainability of financing. While the current positive sentiment in the cryptocurrency market has made it easy to obtain financing, historical data shows that MicroStrategy did not issue any convertible preferred notes from February 2021 to March 2024. This period coincides with the Bitcoin crash in 2021 and the recent market recovery.
Source: BitboWhile there is no conclusive evidence, Bitcoin's price cycles have historically been consistent with its 4-year halving cycles. This suggests a high likelihood of a bear market around 2026-2027, with the long-term power law model indicating a potential price bottom of $53,000-$70,000 during this period. Considering MicroStrategy's average Bitcoin purchase price of $58,000, a bear market could make financing more difficult.
2.2.2 Volatility is Crucial
Source: MicroStrategyIn addition to Bitcoin's price, volatility also plays a crucial role in the sustainability of convertible preferred note financing. Some readers may wonder: Why is the trading price of MSTR stock more than twice its net asset value (NAV)? Why are investors participating in the recent $3 billion convertible preferred note issuance with a 0% coupon?
Source: MicroStrategyThe key to these questions lies in volatility. Compared to other assets, Bitcoin and MSTR exhibit significantly higher volatility, which is attractive to investors. MicroStrategy even highlighted the volatility of its stock in its Q3 2024 IR report. High volatility enables various trading strategies, such as Delta hedging, Gamma trading, and volatility arbitrage. Delta measures the sensitivity of an option's price to changes in the underlying asset's price. Gamma measures the rate of change of Delta with respect to changes in the underlying asset's price. Gamma trading profits from these changes in market volatility.
Source: MSTR-trackerDue to Bitcoin's higher volatility compared to traditional stocks, and MSTR's leveraged Bitcoin purchases amplifying this volatility, MSTR stock and its convertible preferred notes have attracted significant interest from hedge funds. These notes are not only a debt instrument but also a call option, allowing holders to convert them into shares at a specific price, further increasing their appeal.
Source: BitboFor MicroStrategy to maintain stable financing, the volatility of BTC and MSTR must persist. However, with the approval of Bitcoin ETFs and the continued influx of institutional investors, the market is becoming more stable, and volatility is gradually declining. If Bitcoin's volatility decreases, MSTR's net asset value premium may shrink, affecting its stock price and reducing the financing appeal of its convertible preferred notes.
