Abstract: This article will focus on the structure of MicroStrategy's convertible bonds and analyze whether MicroStrategy may be forced to sell BTC to repay bondholders in the event that bondholders demand cash redemption. Based on the current debt structure, we believe the likelihood of a forced liquidation is extremely low. However, given the violent fluctuations in BTC prices, anything is possible.
MicroStrategy holds over 250,000 BTC, and its stock price trades at a significant premium to its net asset value (NAV). This inevitably reminds people of the similar high premium phenomenon that occurred with the Grayscale BTC Trust (GBTC) before its conversion to an ETF, which attracted a large influx of funds. However, we are at a loss to explain why these two investment vehicles can trade at such high premiums, and we cannot provide a reasonable explanation. Even more puzzling is that MicroStrategy can even issue a large number of shares at a premium valuation to buy more BTC, thereby pushing up the book value per share. This seemingly "unlimited capital" circular operation is puzzling. Since launching its BTC strategy, MicroStrategy has announced five equity issuances, raising a total of $4.4 billion.
MSTR Outstanding Shares (million)
History seems to be repeating itself. MicroStrategy's CEO Michael Saylor has been seen by many as a "villain" in the BTC space due to some rather controversial positions, including his apparent hostility towards supporting BTC developers, his opposition to privacy technologies, and his brief but outspoken opposition to self-custody. Similarly, Mr. Barry Silbert, who controls Grayscale, has been controversial for being a key organizer of the "New York Agreement" in 2017, which proposed a doomed proposal for the industry to abandon BTC in favor of the flawed and buggy "SegWit2x" altcoin.
As MicroStrategy has accumulated a large amount of BTC, with a market capitalization approaching $50 billion, people have started to worry. In particular, some have asked whether MicroStrategy's debt will force it to sell BTC to the market, triggering a downward price spiral? Unfortunately, due to the complexity of the debt structure, there is no simple "yes" or "no" answer to this question. Nevertheless, we have reviewed the relevant documents and will do our best to address this question in this article.
Disclaimer
We want to state that we are not bond traders, bond market experts, or lawyers, adding this disclaimer to the article. The corporate debt market may be highly complex, and non-professionals may find it difficult to navigate. This article is likely to contain many errors. Furthermore, the article oversimplifies the products and does not comment on many conditions and complexities. Please do not rely on any information in this article, and if there are any errors, please feel free to point them out.
MicroStrategy's Bonds
To our knowledge, since announcing its BTC strategy, MicroStrategy has issued seven rounds of publicly traded convertible bonds, as shown below.
First, it should be noted that two of these bonds have been fully redeemed and are therefore not related to the outstanding debt. Therefore, MicroStrategy has five outstanding bonds, with a principal value of $4.25 billion. We will therefore review these five bonds.
Redemption and Conversion Options
The bond structure is relatively complex, and to our knowledge, there are four different types of conversion options before maturity. The following diagram summarizes these conversion options for the latest instrument (the 2028 bond).
MicroStrategy 0.625% 2028 Bond Timeline:
Unpacking the Convertible Bond Options:
To our knowledge, except for the zero-coupon bond issued by MicroStrategy in September 2021, the mechanisms of the other four convertible bonds are essentially the same, with only the pricing and dates differing. The holders of the zero-coupon bond have no right to redeem cash before maturity, unless there is a "fundamental change" in the business. This could be crucial if BTC prices fall.
The following table lists the key dates related to the cash conversion options for the five bonds:
Source: Bond Offering Documents
Note: *The stock must trade at a price greater than 130% of the conversion price for at least 20 days (consecutive or non-consecutive) within any 30-trading day window
MicroStrategy's Conversion Rights
It is worth noting that for the zero-coupon bond, MicroStrategy's cash option date in February 2024 has already passed. The conversion price is $143.25, and a 30% premium on this would be $186.23. Currently, the MSTR stock price is $214, well above this price. However, it has only been above this price for 11 days out of the past 30 trading days. Therefore, this option is about to become effective, but is not yet exercisable. Exercising this option would create value for MSTR shareholders, but bondholders are likely to be able to prevent this by exercising their conversion rights.
These complex factors make bond valuation quite difficult, as convertible bonds have multiple potential outcomes. However, many bondholders are likely to be experienced professional bond investors with models to perform these calculations.
Bond Interest Payments
Of the five outstanding bonds, four carry interest payments. These coupon payments are cash liabilities, theoretically forcing MicroStrategy to sell BTC to fulfill the payment obligations. However, given the relatively low interest rates, and the fact that its traditional software business generates ample free cash flow to cover the interest costs, even a BTC price crash would not be enough to force the company to sell BTC to pay the bond interest. In summary, we do not believe the interest costs will force MicroStrategy to sell BTC.
Conclusion
MicroStrategy's debt stands at $4.25 billion in principal, while the company's current market capitalization is $43 billion, and the value of its BTC holdings is $17 billion. This suggests that the bonds do not make up a large portion of MicroStrategy's capital structure.
However, if BTC prices were to crash significantly, say to around $15,000 per coin, and MicroStrategy is unable to take on further debt, analysts may need to consider the "forced liquidation" of BTC as a possibility. However, these potential forced liquidation points would be concentrated around the maturity dates and option exercise dates mentioned in the article, which are spread out between 2027 and 2031 and are quite specific. Therefore, even if BTC were to drop to around $15,000, we believe the likelihood of MicroStrategy being forced to sell BTC to repay its bonds is still relatively low.
While it is unlikely that MicroStrategy will be forced to sell BTC, we believe a more likely scenario is that MicroStrategy will proactively sell BTC out of consideration for shareholder value maximization. Currently, MicroStrategy's stock price trades at a significant premium to its net asset value. Once this premium disappears or even turns into a discount (which is almost inevitable), and the bonds are approaching maturity, selling BTC to raise funds to repay the debt will become the best choice to serve shareholder interests. However, as long as the stock price maintains a premium, MicroStrategy can continue to leverage this to keep up its "revolving loan" operations, and there would be no reason to sell BTC. Of course, this massive premium state cannot last forever.
In addition, it is also worth noting that if the stock price of Microstrategy can continue to maintain a premium, and the market demand for MSTR bonds remains strong, the company may issue more debt. This will lead to an increase in its debt risk and increase the possibility of being forced to sell when the price of BTC plunges. But for the time being, Microstrategy's leverage is relatively low, and the liquidation risk is also at a relatively low level.
