Uncovering the number one "gambler" in the crypto world: Is MicroStrategy's convertible bond strategy reliable?

This article is from Crypto Valley Live, original title: "IDEG | MicroStrategy's Convertible Bond Strategy: Uncovering the Number One Gambler in the Crypto Community," author: IDEG.

The current CEO of Nasdaq-listed MicroStrategy, Michael Saylor, has become one of the most well-known evangelists in the crypto community. Compared to Elon Musk's unpredictability, Michael Saylor's stance is firm and unwavering. As a result, he has garnered a large following within the crypto community.

According to Speakrj statistics, from May 1 to now, his Twitter followers have increased from 779,276 to 1,148,897, a total increase of 369,021, nearly a 50% rise.

We know that MicroStrategy has gained fame for using a large amount of company cash and debt financing to purchase Bitcoin. Its heavy bets have made it the largest holder of Bitcoin long positions in the public market, so it is not difficult to understand why Michael Saylor is so passionate about evangelizing Bitcoin.

Betting History

MicroStrategy first disclosed on August 11 last year that it was using its own cash to purchase and hold Bitcoin. Since then, it has made four additional investments, using a total of $500 million of its own funds to buy 41,433 Bitcoins, with an average acquisition cost of $11,947. Subsequently, on December 20 last year and February 24 this year, it issued convertible bonds to raise a total of $1.7 billion, purchasing 48,868 Bitcoins at an average acquisition cost of $34,788.

In total, MicroStrategy has used $2.2 billion to purchase 90,301 Bitcoins, with an average acquisition cost of $24,308. A single institution holding such a large Bitcoin position ranks first among all institutions that have disclosed related information. (Excluding cases like GBTC, which helps clients hold Bitcoin through trusts.)

Since MicroStrategy first disclosed its Bitcoin purchases, its stock price has risen from $123.39 on August 20 to a peak of $1,315.00, currently down to $484.67. The highest increase was 961%, and the current increase is 293%. As seen in the chart below, investing in Bitcoin has even turned MicroStrategy's stock into a highly volatile asset similar to Bitcoin.

Convertible Bonds

We find that MicroStrategy used only $500 million of its own funds, while debt financing amounted to $1.7 billion, which is 3.4 times its own funds. This debt financing was completed through a financial instrument called convertible bonds, formally known as Unsecured Senior Convertible Notes. Its specific meanings are as follows:

• Unsecured: Unsecured bonds, which rank after secured bonds and before preferred stock in liquidation.

• Senior: Senior bonds, which rank after subordinated secured bonds and before subordinated unsecured bonds in liquidation.

• Convertible: Convertible, allowing investors to exchange the bonds for company stock at a certain ratio under certain conditions.

• Notes: Short-term bonds with a maturity of less than 10 years.

On December 7, 2020, MicroStrategy announced its first convertible bond plan, which was a 5-year bond with a coupon rate of 0.75% and a conversion price of $398, a 37% premium over the then stock price of $289. The bond was initially planned to raise $400 million but ultimately oversubscribed to $650 million.

On February 15, 2021, MicroStrategy announced its second convertible bond plan, which was a 6-year bond with a coupon rate of 0% and a conversion price of $1,432, a 50% premium over the then stock price of $955. The bond was ultimately planned to raise $600 million but oversubscribed to $1.05 billion.

The convertible bonds have three clauses: redemption, repurchase, and conversion, which protect and limit the interests of both parties. Since these bonds are issued in a private placement format without registration and targeted at institutional qualified investors, details are not disclosed, and this article will not elaborate further.

Structured Financial Instruments

Non-financial individuals may find it difficult to understand why the interest rates are so low, with the second issuance even having a 0% rate. Zero-coupon bonds are actually quite common in the market, but most zero-coupon bonds are issued at a discount. The bonds in this case are issued at par value, mainly because bondholders will receive conversion rights.

From a financial engineering perspective, convertible bonds can be decomposed into two parts: fixed-income bonds and call options. Taking the second issuance of convertible bonds as an example, this bond can be viewed as investors first purchasing fixed-income bonds and then using all interest income from the fixed-income bonds to buy a call option. An important component of the option's value is time value (i.e., the longer the term, the higher the value), and since this option has a 6-year term, its relative price is higher.

According to data disclosed by cbonds, the investors in the two bond issuances include the following. It can be seen that all of its investors are convertible securities ETFs, including related ETFs from First Trust, Bloomberg, and iShares. This also explains why Bloomberg has recently frequently released positive news related to Bitcoin.

Financial Analysis

The reports disclosed by Nasdaq only recognize losses for the "digital currency" asset class and do not recognize unrealized gains. Therefore, directly reading MicroStrategy's Q1 10Q report can lead to significant misunderstandings. Based on the company's actual holdings, calculated at a price of $39,100 per BTC, its simplified balance sheet is as follows.

From the table above, it can be seen that MicroStrategy's Bitcoin exposure is approximately $3.53 billion. Its net assets are $1.95 billion. Due to the enormous Bitcoin exposure, the impact on its original main business is minimal, and we can simply understand the company as a hedge fund with 1.81 times leverage long on Bitcoin. If the price of Bitcoin drops 55% to $17,500, the company will be insolvent.

Calculating at the current stock price of $493, MicroStrategy's market capitalization is $4.83 billion, with a price-to-book ratio of 2.47 times, which is excessively high for a fund. If we deduct the $1.2 billion market value before it announced the purchase of Bitcoin, the market value growth brought by betting on Bitcoin is $3.63 billion. However, the actual profit brought by its bet on Bitcoin, calculated at a coin price of $39,100, is only $1.34 billion, which indicates that the stock price is also overvalued.

The Crazy Gambler

Michael Saylor himself has a notorious history. An article written in June 2001 listed him as the biggest loser during the entire internet bubble period. At that time, MicroStrategy's stock price soared from $120 to over $3,000 in just a few months, and Michael Saylor gained fame as a result. However, in the subsequent bubble burst, he suffered a loss of $13.52 billion, accounting for over 90% of his net assets. The SEC even launched a large-scale investigation against him and charged him with false statements about the company's condition.

Conclusion

In the crypto community, retail investors who go long on Bitcoin in leveraged trading on exchanges need to pay an interest rate of about 36% annually. Meanwhile, borrowing USDT against Bitcoin in the over-the-counter market generally incurs an annual interest rate of over 12%. Both of these leveraged tools carry the risk of liquidation when the coin price plummets.

It must be said that MicroStrategy, through the financial instrument of convertible bonds, has bridged the gap between the crypto world and the traditional world, obtaining funds at a cost so low that it can be ignored to bet on "high-risk" crypto assets. Moreover, due to its clever design, it theoretically avoids the risk of liquidation. This is indeed a very smart strategy. However, perhaps because of the safety of the strategy itself, its position has risen to such an exaggerated level. This also aligns with Michael Saylor's consistently strong gambling nature. Since we cannot obtain detailed information about the "mandatory repurchase" clause in its convertible bonds, it is difficult to quantify its actual risk tolerance. We can only wait and see its final outcome.