MicroStrategy, a business software company transformed into “the world's first Bitcoin financial company,” saw its stock price increase by 450 percent last year, giving the Virginia-based company a market cap of $80.9 billion. MicroStrategy's rising success is primarily driven by Bitcoin's rapid growth. The company is the world's largest holding company for Bitcoin, holding about 2 percent of all cryptocurrency on the market, which is worth about $40 billion. (US spot ETFs, eponymous Bitcoin founder Satoshi Nakamoto and cryptocurrency exchange Binance are the only entities holding more Bitcoin than MicroStrategy.)
Founded in 1989, MicroStrategy has been a software solutions company for most of its life. It's still a revenue generator, but that portion of the business has been steadily declining since 2014, giving the company an unusually low price-to-earnings ratio of -198.72 (as of Dec. 26). Fortunately, MicroStrategy founder and chairman Michael Saylor found a solution to save the company. Saylor, who founded the company at the age of 24 after graduating from MIT, served as the company's CEO until 2022 before taking over as executive chairman.
In August 2020, Saylor realized his company's poor prospects and began using the company's cash reserves to buy Bitcoin. He also began issuing convertible bonds—bonds that can be converted into a predetermined number of shares at a set price over time—to raise money to buy Bitcoin.
In an interview on Dec. 13 on CNBC, Saylor described MicroStrategy's role as “connecting” the traditional bond and equity markets to the “crypto economy.”
“What we've seen is our real strategic franchise is that we can acquire Bitcoin. I can issue fixed income securities, bonds, fixed income preferred stocks, or high volatility equity, and those are all products that the financial markets want,” Saylor explained in an episode of Dec. 5 of the Prof G Pod and Scott Galloway podcast.
How well is MicroStrategy's Bitcoin business doing?
Basically, MicroStrategy borrows money through convertible bonds at low interest rates to buy Bitcoin. Since MicroStrategy is a key buyer and the supply of Bitcoin is fixed, its move pushes up Bitcoin prices, which increases the value of Bitcoin holdings and the company's stock price, which further allows the company to borrow more money at lower interest rates. Over the past five years, MicroStrategy has issued $7.27 billion worth of convertible bonds, including a $3 billion stake last month at zero interest, with all proceeds going toward buying Bitcoin.
“In the Bitcoin bull market, it is the financial equivalent of a perpetual motion machine,” Citrini Research explained MicroStrategy's business model in a November 2021 blog post.
That's how the underperforming software company has gained 46 percent in market value since Donald Trump's election victory, which raised 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 debt equity over the next three years. MicroStrategy currently holds 423,650 Bitcoins, a third of which was acquired after election day.
However, even considering MicroStrategy's success with its Bitcoin bet, the stock price may not be strong. The company's market cap is currently double the value of Bitcoin Holdings.
Saylor says this valuation is justified by giving investors exposure to Bitcoin. “We're selling you this 2x Bitcoin equivalent and we're getting you 2x by selling bonds that strip the risk off the bottom of the capital structure,” he said on the Scott Galloway podcast.
However, “the ratio works both ways,” as Sherwood News' financial writer Jack Raines points out in his analysis of MicroStrategy, arguing that the company is not protected from the risks of Bitcoin's price falling too much.
Anyone who has followed Bitcoin even briefly knows that it does not last in a bull run. Since August 2010, Bitcoin has traded down for 74 out of 173 months—almost half the time. During a bear cycle, MicroStrategy's stock, which is closely linked to the price of Bitcoin, can fall below the convertible bond's conversion rate (the amount at which a bond investor can convert a loan into stock), meaning that the convertible bonds will not be converted into equity. by investors when they reach maturity, requiring MicroStrategy to repay the loan by selling Bitcoin.
Raines warned, “Conversion prices for its $4.2 billion bond between 2027 and 2032 range from $143.25 to $232.72, while the conversion price for the latest note is $672.40. While MicroStrategy stock is currently above all but the most recent price reversal, it was trading below $120 as recently as two months ago, and had not broken $200 until the most recent session.”
