MicroStrategy, a business software firm converted into “the world’s first Bitcoin treasury company,” has seen its share price surge 450 percent in the past year, earning the Virginia company a market cap of $80.9 billion. MicroStrategy’s skyrocketing success is primarily driven by the fast rise of Bitcoin. The company is the world’s largest corporate holder of Bitcoin, owning approximately 2 percent of all of the cryptocurrency on the market, worth around $40 billion. (U.S. spot ETFs, anonymous Bitcoin founder Satoshi Nakamoto and the cryptocurrency exchange Binance are the only entities that own more Bitcoin than MicroStrategy.)
Founded in 1989, MicroStrategy has been a software solutions company for most of its life. It’s still how it generates revenue, but that business segment has been steadily declining since 2014, giving the company an unusually low price-to-earnings ratio of -198.72 (as of Dec. 26). Luckily, MicroStrategy founder and chairman Michael Saylor has found a solution to save the company. Saylor, who founded the company at the age 24 after graduating from MIT, served as the company’s CEO until 2022 before taking the role of executive chairman.
In August 2020, Saylor realized his company’s poor prospects and started using the company’s cash reserve to buy Bitcoin. He also began issuing convertible bonds—bonds that can be converted to a pre-determined number of shares at a set price at a later time—to raise cash to buy Bitcoin.
In a Dec. 13 interview on CNBC, Saylor described MicroStrategy’s role as “plugging” the traditional capital markets that want bonds and equity “into the crypto economy.”
“What we realized is that our real great strategic franchise is that we can securitize Bitcoin. I can issue fixed-income securities, bonds, fixed-income preferred stocks, or high-volatility equity, and those are all products the capital markets want,” Saylor explained on the Dec. 5 episode of the Prof G Pod with Scott Galloway podcast.
How does MicroStrategy’s Bitcoin business work exactly?
Essentially, MicroStrategy is borrowing money through convertible bonds at low interest rates to buy Bitcoin. Since MicroStrategy is a significant buyer and Bitcoin’s supply is fixed, its move pushes Bitcoin prices higher, which increases the value of its Bitcoin holdings and the company’s stock price, which further allows the company to borrow more money at low interest rates. Over the last five years, MicroStrategy has issued $7.27 billion worth of convertible bonds, including a $3 billion stake last month at a zero interest rate, with all the cash going towards buying Bitcoin.
“In a Bitcoin bull market, it is the financial equivalent of a perpetual motion machine,” Citrini Research described MicroStrategy’s business model in a November 2021 blog post.
That’s how a poorly performing software company has gained 46 percent in market value since Donald Trump’s election win, which fueled hopes for crypto-friendly policies under the incoming administration.
Saylor is betting big on Trump. In its third-quarter earnings report released in October, MicroStrategy announced its intention to raise $42 billion in equity and debt over the next three years. MicroStrategy currently holds 423,650 Bitcoins, a third of which were acquired after election day.
However, even considering MicroStrategy’s success with its Bitcoin bets, its stock price may not be sustainable. The company’s market cap is currently twice the value of its Bitcoin holdings.
Saylor argues this valuation is justified by offering investors leveraged exposure to Bitcoin. “We sell you this equity that is 2x Bitcoin and we get you 2x by selling bonds that strip the risk off the bottom of the capital structure,” he said on the Scott Galloway podcast.
However, “leverage works both ways,” as Sherwood News’ financial writer Jack Raines points out in his analysis of MicroStrategy, arguing that the company is not shielded from the risks of Bitcoin price falling dramatically.
Anyone who has followed Bitcoin even briefly knows it is not always in a bull run. Since August 2010, Bitcoin has traded downward during 74 of the 173 months—around half the time. During a bear cycle, MicroStrategy stock, which is highly correlated with Bitcoin’s price, can fall under the convertible bond conversion price (the price at which the bond investor can convert their loan into stock), meaning that convertible bonds will not be converted into equity by the investors when they reach maturity, requiring MicroStrategy to pay back the loan by selling Bitcoin.
Raines warned, “The conversion prices for its collective $4.2 billion due between 2027 and 2032 range from $143.25 to $232.72, and the conversion price for the most recent note is $672.40. While MicroStrategy’s stock is currently well above all but the most recent conversion price, it was trading below $120 as recently as two months ago, and it hadn’t broken $200 until the recent rally.”
