Infinite "bullets"? Talk about the hidden worries of MSTR, the largest BTC listed company

On August 1, MicroStrategy (MSTR), a Nasdaq-listed company, released its report for the second quarter of 2023, and increased its holdings by 12,800 BTC. The market is generally concerned about the leveraged purchase of Bitcoin. The company has spent 4.53 billion US dollars to buy Bitcoin, and more than 4 billion US dollars have been raised through the issuance of bonds or stocks. Usually too much leverage is not a good thing, but for MSTR, this has become a low-cost and low-risk game. However, due to the limited development of the software business, the ** company actually has no excess cash flow. It seems that there is difficulty in financing in the bond market at present. It can only roll debts through allotment financing, which is equivalent to deeply binding the price of BTC. ** BTC will come in 2025 when the debt repayment period comes If it cannot rise sharply before, MSTR may not be able to play the game.

Bitcoin holdings:

As the largest publicly traded holder of bitcoin, MicroStrategy acquired bitcoin initially as a defensive strategy to protect their balance sheet, but has now become their second core strategy. MicroStrategy has two corporate strategies: acquiring and holding bitcoin, and growing its enterprise analytics software business. They believe these two strategies differentiate their business and provide long-term value.

The company earlier stated that the company’s excess capital of more than $50 million would be invested in Bitcoin, but a subsequent statement stated that it will continue to monitor market conditions to determine whether to conduct additional financing to purchase more Bitcoin.

MicroStrategy began investing in Bitcoin in August 2020, shortly after the COVID-19 outbreak. As of July 31, 2023, the company held 152,800 bitcoins at a total cost of $4.53 billion, or $29,672 per bitcoin, nearly equal to the current market price ($29,218 on August 1). Of these, 90% of the bitcoins were unsecured, meaning they were not used as collateral for any loans or debts.

Figure Microstrategy’s BTC position changes (MacroStrategy is a subsidiary of Microstrategy)

It can be seen that MSTR purchased at a faster rate before the first quarter of 2022, and then in the next three quarters, as the market fell sharply, it almost stood still, and then in 2023, as the market rebounded, the pace of purchases accelerated.

Financing Structure:

The way they expand their balance sheets mainly includes equity, debt and convertible bond issuance.

Bond Issuance

Although MSTR has increased its holdings of Bitcoin every quarter, and the price of Bitcoin has plummeted since the end of 2021, the company’s debt structure is relatively stable, with a total of about 2.2 billion US dollars in debt, an average annual fixed interest rate of 1.6%, and annual fixed interest expenses of about It was $36 million, mainly because the company used convertible notes (Convertible Notes) to finance.

As of the latest financial report for the second quarter of 2023, the company’s main debts include:

• 6.125% senior secured bonds due in 2028 (collateralized by 15,731 bitcoins), with an issuance amount of US$500 million and an annual interest expense of approximately US$30.6 million. (issued in June 2021)
• $650 million of 0.75% senior convertible notes due December 2025, with an annual interest expense of approximately $4.9 million. (issued in December 2020)
• $1.05 billion of 0% convertible senior notes due February 2027 with no annual interest expense. (issued in February 2021)

MicroStrategy does not have any debt maturities in 2023-2024. Its debt maturities start in 2025 and run until 2028 at the latest. In other words, MicroStrategy can at least survive the Bitcoin halving in 2024 smoothly.

Among them, convertible bonds are a hybrid financial instrument that has both the nature of bonds and the nature of stocks. Take the US$1.05 billion convertible bonds issued in 2021 as an example:

**Offer Amount:**The offering amount is US$900 million, including the initial purchaser’s right to purchase an additional US$150 million of notes within a 13-day period.

Nature of note: Unsecured senior debt with no regular interest and no appreciation of the principal amount. They will expire on February 15, 2027.

Redemption: MicroStrategy may, subject to certain conditions, redeem the Notes for cash at a redemption price equal to 100% of the principal amount of the Notes plus any special interest paid.

Conversion: Notes may be converted into cash, MicroStrategy Class A common stock, or a combination of both. The notes are convertible into 0.6981 shares per $1,000 of principal at the initial conversion rate, which equates to an initial conversion price of approximately $1,432.46 per share. This represents a premium of approximately 50% to the last reported selling price of $955.00 per share of MicroStrategy’s Class A common stock on Nasdaq on February 16, 2021. Noteholders can also convert their notes before maturity, provided the shares are trading at 130% of the strike price of 1400.

By issuing convertible bonds, MicroStrategy has raised capital without having to directly bear huge interest payments. At the same time, the immediate equity dilution effect is also controlled.

Why are investors willing to choose to invest in zero-coupon convertible bonds? The main reasons include two points:

1. **Stock upside potential: **Convertible bonds can be converted into common shares of the company under certain conditions. If the company’s stock price rises more than the target price, investors can choose to convert the bonds into stocks, thereby enjoying the benefits of rising stock prices. This is one of the main motivations for investors to choose zero-coupon convertible bonds.
2. **Capital Protection: **Convertible bonds provide better capital protection than buying stocks outright. Even if the company’s stock price falls, investors can still redeem the face value of the bond, and the bond has priority recourse to the stock. This provides investors with a way to reduce investment risk while enjoying the upside potential of the stock.

Therefore, the convertible bond is equivalent to holding the bond and the option to call MicroStrategy stock at the same time. However, considering that the current stock price of MSTR is only 434 US dollars, the stock price needs to rise by more than 3.3 times by February 2027 to make investors profitable. Therefore, once the stock of MSTR, or strictly speaking, the price of Bitcoin cannot rise more than 3 times from now on, MSTR is equivalent to using the money for free for 6 years.

Stock Issue

MicroStrategy issued a total of $1.723 billion of Class A common stock in 2021, 2022, and 2023 at an average selling price of $424 per share. The primary use of these equity issuances is to purchase Bitcoin in all equity issuance quarters and to repay debt in Q1 2023.

The issuance dates of these shares are:

1. In the third quarter of 2021, US$404 million will be raised through the rights issue plan, with an average issue price of US$728 per share
2. Financing of US$596 million in the third quarter of 2021, with an average issue price of US$694 per share
3. Financing of US$47 million in the fourth quarter of 2022, with an average issue price of US$213 per share
4. Financing of USD 341 million in the first quarter of 2023, with an average issue price of USD 253 per share
5. Financing of USD 335 million in the second quarter of 2023, with an average issue price of RMB 310 per share

Figure: MSTR 2021-to-date stock issuance price and scale

On August 1, 2023, with the announcement of the second quarterly report, **MSTR announced the launch of a new US$750 million allotment plan, which is the largest financing scale in history, and the purpose is still to continue to support the company’s large-scale purchase and holding of Bitcoin strategy. **

Financial Health Analysis

MicroStrategy’s annual revenue has been relatively stable in the past few years, reaching $499 million in 2022, but it has remained basically flat at $500 million since 2013. **As a software company, software sales revenue cannot expand at all during the boom period of technology companies This is actually somewhat worrying. **

Graph: MSTR Annual Total Income (Annual)

And since the first two quarters of this year, revenue has hardly changed, maintaining the level of 120 million US dollars.

Graph: MSTR Annual Total Revenue (Quarterly)

Graph: MSTR Net Profit (Annual)

Although MicroStrategy reported a net profit of US$483 million in the first half of this year, the operation of its software business was still unprofitable, with an operating loss of US$30 million in the first half of the year. The net profit was mainly because it recorded an income tax benefit of $513.5 million.

These earnings are not equal to the actual cash received by the company, but various tax benefits and credits that the company can deduct from the total income when calculating the pre-tax profit, mainly due to the previous impairment of Bitcoin. In terms of accounting treatment, a company’s asset impairment, business losses, etc., may generate income tax benefits, because it can use these losses to offset future taxes.

Figure: MSTR net profit (quarterly)

Additionally, despite the $500 million in revenue,** the company has no excess cash flow**. Although the average cost of debt is only 1.6%, the annual interest expense of $36 million in debt accounts for more than half of the company’s cash reserves, forcing the company to continue to issue new bonds or issue new shares to raise interest. If the cash reserve bottoms out, it may endanger the investment in the software business and further affect the operating income.

Chart: MSTR Cash and Equivalent Reserves (Quarterly)

Judging from the current balance sheet of MSTR, the total assets of 3.363 billion U.S. dollars (2.346 billion U.S. dollars are BTC)** are actually undervalued**, mainly because the calculation of the value of BTC only calculates the depreciation of the comparison cost, even if the subsequent The price increase will not be included in the statistics, so there is a non-permanent impairment loss of 2.2 billion U.S. dollars. Actually, according to the current price of BTC close to 30,000 U.S. dollars, the total assets of MSTR should be 5.56 billion U.S. dollars, corresponding to 2.73 billion U.S. dollars debt.

Figure: MSTR Balance Sheet (Q2 2023)! Infinite “bullets”? Talk about the hidden worries of MSTR, the largest BTC listed company

Although MSTR’s business model has tried its best to reduce the debt pressure, due to the poor performance of traditional businesses in general, the business prospects of the entire company and the price of Bitcoin have been deeply tied. If the price of Bitcoin cannot continue to rise at the current level , MSTR’s continuous fundraising may become difficult. For example, in this quarter, MSTR announced the launch of the largest US$750 million allotment plan in history. It is not clear how it will be implemented, but the company’s stock fell 6.4% the next day after the news was announced.

From the specific situation of MicroStrategy, the cost of direct issuance of new shares is lower than that of conventional bonds, while the difficulty of issuing convertible bonds is slightly higher, requiring careful design of terms to attract investors, which is obviously not easy in today’s digital currency bear market.

It can be seen that MSTR’s three major bonds were issued during the peak period of the last round of BTC bull market (December 2020~June 2021), and after the third quarter of 2021, it will be dominated by allotment financing, which also reflects MSTR’s strong position in the bond market. Financing may be difficult, or it may be difficult to afford high interest rates. After all, the yield benchmark of American junk bonds is 8%+. It is unsustainable to roll existing debts at this cost. We can only bet on the coming of BTC in 2025. rose sharply before.