My interest in Bitcoin (BTC-USD) proxies continues with an overview of MicroStrategy (NASDAQ:MSTR). MSTR, unlike the past reviews on the BTC miners, embarks on a differentiated strategy to become a quasi-spot ETF with a slow-growth software enterprise. Under the tutelage of its founder, Michael Saylor, they have leveraged the balance sheet to acquire a copious amount of BTC over the past few years. My review of the equity’s prospects will focus on the MacroStrategy holding company, where the bulk of the BTC is held, along with a general overview of the path of BTC and upcoming debt maturities.

Upcoming catalysts for Bitcoin

By levering up its balance sheet, MSTR is intrinsically linked to the price of BTC as it makes up much of the equity. For MSTR to move higher, BTC must be advancing.

The price of BTC has caught fire since October as the regulatory win by Greyscale over the SEC has opened the door for the possibility of multiple Spot ETFs to enter the marketplace. BTC was trading in the mid $20k range only to push above $30k in short order and is now in the range of $35-37k. The change in sentiment is refreshing, thus heightening the dormant bull’s expectations that higher prices are in the near future. From a technical perspective, the area around $40k offers round number resistance with an interesting historical caveat. The $40k number serves as a major line of resistance, marking the area BTC was trading at before the true effects of the catastrophic Terra Luna blow-up that eventually took out Three Arrows Capital and Sam Bankman-Fried’s FTX exchange.

SBF was found guilty of fraud and is expected to face a hefty prison term, thus helping to clean up some of the greatest sources of fraud that plague the industry. Not to be outdone, Changpeng Zhao (affectionately known as CZ), the head of the offshore exchange Binance, pleaded guilty to money laundering charges and paid a $50 million dollar fine.

Binance itself paid a whopping fine of $4.3 billion and pleaded guilty as well. Why do I find these events so particularly important? In my opinion, it underscores the massive clean-up of the less-than-reputable players ahead of the legitimization of Bitcoin as an asset class via a spot ETF vehicle. The next domino to fall may be Alex Mashinsky of Celsius, who has already been arrested and charged with fraud.

Not to be overshadowed by regulatory events, the BTC network will undergo a halving where the block reward for successfully “mining” a block will be reduced from 6.25 BTC to 3.125 BTC. In the past three cycles, the halving event has created a positive feedback loop where the reduction of new supply has caused a surge in the price of BTC. BTC has neatly followed the classic boom-bust commodity cycle and, in my opinion, should be viewed through the lens of a commodity, not a currency alternative.

MacroStrategy

Saylor has created a unique corporate structure where the cash flow of the legacy software business is used to pay the interest on the copious debt used to purchase the BTC, which is held predominantly by the MacroStrategy holding company.

As of Oct 31, 2023, MSTR owns 158,400 BTC, with 142,514 held by MacroStrategy and the rest by MSTR. Part of the reason for this move is the current accounting rules on how BTC is treated on a corporation’s balance sheet. MSTR has spent $4.7 billion acquiring its horde of BTC, yet it is being carried on the books at a value of $2.5 billion. The $2.2 billion in cumulative impairment charges has caused MSTR to take the massive non-cash loss on earnings that, in my view, causes the majority of CFOs to pause on adding BTC to the corporation’s balance sheet. The FASB is expected to issue new rules on the treatment of digital assets that may pave the way for wider corporate adoption.

MSTR’s average purchase price of BTC is $29,586, offering investors a unique way to ride the price of BTC higher. The equity price of MSTR has caught fire recently with a move from the $330 range up past $500 per share in the past six weeks. The move in MSTR share price over the past 1-month, 3-month, and 6-month periods outstrips the percentage move in BTC.

Risk Factors

A thorough review of the debt maturities held by MSTR is required to give investors a comprehensive overview of the unique risks of an investment in MSTR. The legacy software company held in the MicroStrategy shell is not growing with negative revenue growth the past decade. In my view, part of the reason MSTR embarked on its BTC crusade was to diversify its holdings, as the business generates a ton of cash, and bonds or cash seemed a worthy investment to beat inflation over time. Saylor is using the cash flow from MSTR legacy software to fund the interest payments on some of its outstanding debt. The move seems prescient at $38k BTC and foolish at $20k BTC.

The second risk is the convertible debt held on the books. The debt issuance is a masterstroke in my view, with an interest rate of 0.75% on one tranche and zero on the second tranche. The first tranche is for $650 million and comes due in December 2025, well after the halving cycle and well into the expected run-up due to a shortage of new BTC. There are no guarantees that BTC will run up in a manner similar to past historical patterns or that MSTR will be able to refinance the debt at an attractive rate.

MSTR may be forced to issue additional equity, which would dilute existing shareholders. The conversion rate for the notes is initially 2.5126 shares of MSTR stock per $1,000 principal amount of notes, with an initial conversion price of approximately $397.99 per share. The only positive is that MSTR can redeem for cash, shares, or a combination of both at their discretion.

A similar cycle may play out with the second tranche due February 2027 with an effective interest rate of zero. The bonds are convertible into 0.6981 shares of MSTR at a conversion price of $1432.36 per share. A conversion seems less likely currently, yet a big BTC price run may change those dynamics. A conversion into shares based on current US interest rates seems more likely as cheap financing is unavailable until the Fed cuts rates.

In my view, I am bullish on the current prospects of MSTR well into the end of 2024 based on past BTC pricing dynamics. To add some context, a move up to old Bitcoin highs (using $70k as a target), the BTC holdings of MSTR would be worth roughly $11 billion, far greater than MSTR’s current market cap in the $7 billion dollar range. Currently, MSTR BTC holdings are worth less than $4 billion, with, in my view, a fair value on the enterprise business of 6 times revenue or $3 billion.

MSTR stock is overvalued from a sum of the parts model if you are using a static model for BTC. My bullishness stems from the equity now serving as a quasi-spot ETF (due to the BTC held on the balance sheet) with BTC entering into a historically bullish period of time. I am more inclined to fade the equity into 2025 unless additional clarity is gained on the path of how the two convertible bonds will play out. Call me a bull for now. Good luck to all!!!!