What is the operating principle behind MicroStrategy's issuance of convertible bonds while aggressively buying Bitcoin?

Author: Chain News Florence

Source: https://abmedia.io/microstrategy-convertible-note-financial-leverage

The software development company MicroStrategy (MSTR), which is based on Bitcoin, has issued convertible bonds again after three years. The conversion price has a premium of up to 20% compared to the current stock price. What are the incentives for investors to subscribe to this six-year convertible bond with a coupon rate of only 0.625%? And what are MicroStrategy's operational strategies?

MicroStrategy Issues Convertible Bonds Again After Three Years

MicroStrategy announced that it will issue $700 million in principal amount of convertible senior notes due in 2030, privately placed to qualified institutional buyers. The issuance conditions are as follows:

● Maturity Date: March 15, 2030

● Coupon Rate: 0.625%

● Interest Payment Date: Interest is paid semi-annually (on March 15 and September 15 each year)

● Conversion Price: $1,498

● Conversion Period: July 1, 2024 ~ March 13, 2030

● Put Option: Can sell back the notes at par (100) after September 15, 2028

The so-called convertible bonds have an additional clause that allows the bond to be converted into stock at an agreed price when the stock price exceeds a certain level. The pricing principle is essentially a corporate bond plus a call option to buy stock.

With MicroStrategy's stock price at $1,246 on the pricing date, the conversion price of $1,498 represents a premium of up to 20%. The coupon rate of only 0.625% is almost negligible compared to the current risk-free yield of 4.1% on the U.S. ten-year Treasury bond. Why would any investor be willing to purchase this?

Timing of MicroStrategy's Convertible Bond Issuance

Let’s first review the three convertible bonds currently issued by MicroStrategy, all of which have extremely low or even zero coupon rates, and conversion prices that have premiums of over 20% compared to the pricing date. The summary is as follows:

MicroStrategy began purchasing Bitcoin in September 2020. Based on this initial period, we compare MicroStrategy's stock price with Bitcoin prices (orange line) in the table below. The three purple arrows indicate the times when MicroStrategy issued convertible bonds, revealing that these issuances occurred when MicroStrategy's stock price was significantly higher than Bitcoin's price. We can infer:

By pricing options at high stock prices, the conversion price can be set at a relatively high point. In a buoyant market, the price of options also rises, allowing funds to be obtained at almost zero cost.

Considerations for Investors Buying Convertible Bonds

So why would investors spend money on a product that yields no interest and has a conversion price 20% higher than the current price? If they are so optimistic about MicroStrategy, wouldn’t it be better to buy at the current price? We analyze the reasons as follows:

● Low risk; even if not converted after six years, the principal can still be retrieved (unless MicroStrategy goes bankrupt)

● The option to convert within six years; if MicroStrategy's stock price rises above $1,498, conversion can be executed, which is very cheap from the perspective of option pricing

● There is an early redemption mechanism: the bond can be sold back at par (100) after September 15, 2028 (this is a unique redemption mechanism for this convertible bond)

Investors who buy MicroStrategy's convertible bonds are likely very optimistic about MicroStrategy's stock price but do not want to take on too much risk, so they choose to invest in this way.

Although the liquidity of these convertible bonds is uncertain, according to Bloomberg's current quote, the new convertible bond is priced at $109, still at a premium! The previous convertible bond with a conversion price of $398 due in 2025 has even soared to $258, demonstrating MicroStrategy's clever fundraising strategies.