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 excessive leverage is not a good thing, but for MSTR, this has become a low-cost and low-risk play. However, due to the limited development of the software business, the company actually has no excess cash flow. At present, the bond market seems to have difficulty in financing. It can only be used to finance rolling debts through allotment, which is equivalent to deeply binding the price of BTC. If BTC fails before the 2025 debt repayment period comes Rising sharply, MSTR’s game may not be up.
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)
Source: MSTR, TrendResearch
It can be seen that MSTR purchased at a faster rate before the first quarter of 2022, and 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 been increasing 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:
The 6.125% senior secured bonds due in 2028 (collateralized by 15,731 Bitcoins) have an issuance amount of US$500 million and an annual interest expense of approximately US$30.6 million. (Published June 2021)
0.75% Convertible Senior Notes due December 2025 in an amount of US$650 million and an annual interest expense of approximately US$4.9 million. (issued December 2020)
$1.05 billion of 0% Convertible Senior Notes due February 2027 with no annual interest expense. (issued February 2021)
2023~2024 MicroStrategy has no debt maturities. 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.
Source: MSTR, TrendResearch
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:
Issue Amount: The offering amount is $900 million, including an option for initial purchasers to purchase an additional $150 million of notes within a 13-day period.
Notes Nature: Unsecured Senior Debt, No Regular Interest, No Appreciation In Principal Amount. They will expire on February 15, 2027.
Redemption: MicroStrategy may redeem the Notes for cash at a redemption price equal to 100% of the principal amount of the Notes plus any accrued but unpaid special interest, subject to certain conditions, on or after February 20, 2024 .
Conversion: The 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 raised capital without directly incurring a large interest expense. 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:
- Stock upside potential: Convertible bonds can be converted into common stock 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.
- 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.
So the convertible bond is equivalent to holding the bond and the option to call MicroStrategy stock at the same time, but 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:
- In the third quarter of 2021, US$404 million will be raised through a rights issue plan, with an average issue price of US$728 per share
- Financing of US$596 million in the third quarter of 2021, with an average issue price of US$694 per share
- Financing of US$47 million in the fourth quarter of 2022, with an average issue price of US$213 per share
- Financing of US$341 million in the first quarter of 2023, with an average issue price of US$253 per share
- 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
Source: MSTR, TrendResearch
On August 1, 2023, with the announcement of the second quarterly report, MSTR announced the launch of a new US$750 million allotment plan, 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. .
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 of technology companies. Somewhat worrisome.
Chart: MSTR Annual Total Revenue (Annual)
Source: TrendResearch, SeekingAlpha
And since the first two quarters of this year, revenue has hardly changed, maintaining the level of 120 million US dollars.
Chart: MSTR Annual Total Revenue (Quarterly)
Figure: MSTR Net Profit (Annual)
Source: TrendResearch, SeekingAlpha
Although MicroStrategy recorded 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)
Source: TrendResearch, SeekingAlpha
Also, despite the $500 million in revenue, the company doesn’t really have excess cash flow. Although the average cost of debt is only 1.6%, the debt generates $36 million in interest payments each year, accounting 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 US dollars (2.346 billion US dollars are BTC) are actually underestimated. This is mainly because the calculation of the value of BTC only calculates the impairment of the comparison cost, even if the price rises back later. It will not be included in the statistics, so there is a non-permanent impairment loss of US$2.2 billion. Actually, at the current price of BTC close to US$30,000, MSTR’s total assets should be US$5.56 billion, corresponding to US$2.73 billion in debt.
Figure: MSTR Balance Sheet (Q2 2023)
Source: TrendResearch, SeekingAlpha
Although MSTR’s business model has tried its best to reduce the debt pressure, due to the poor performance of traditional businesses, the business prospects of the entire company have been deeply tied to the price of Bitcoin. If the price of Bitcoin cannot continue to rise at the current level , MSTR’s continuous fundraising may become difficult. For example, 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 arrival of BTC in 2025. rose sharply before.
