Microstrategy's $1.5 billion "new bullet" has become a reality Bitcoin ETF, but there are two major risks

1.15 billion US dollars to buy coins, the stock price rose against the market trend

On June 14, Microstrategy released an announcement(1) stating that it had completed the issuance of $500 million worth of junk bonds (also known as high-interest bonds) and would use the proceeds to purchase more Bitcoin. The annual interest rate of the junk bonds was 6.125%. The issuance was enthusiastically sought after by the market as it received a purchase demand of up to $1.6 billion.

Such enthusiasm has boosted Microstrategy’s confidence in buying more Bitcoin. In the [S3 application](2) it submitted to the SEC on June 14, it stated that it would continue to sell Class A shares worth US$1 billion, and the proceeds would be used to maintain the company’s continued operations and purchase more Bitcoin.

The market responded positively to MicroStrategy's move. MicroStrategy's performance was outstanding among some Bitcoin concept stocks. On June 15, after the application was submitted, Tesla's stock price fell 2.97%, Coinbase fell 2.88%, and Square fell 1.39%. Under such circumstances, MicroStrategy's stock price rose 5.36%, which can be said to be a rise against the trend among these large companies holding coins.

2 Becoming a de facto Bitcoin ETF

Today, MicroStrategy's market value is $6.14 billion, and the 92,079 bitcoins it holds are worth $3.69 billion, which means that one dollar of MSTR stock contains $0.6 worth of bitcoins.

Since the United States has long lacked Bitcoin ETF products, institutional funds can only be solved by purchasing GBTC, but GBTC is only available to institutional investors in the over-the-counter market, while MSTR, as a stock, can be bought by ordinary investors. In this sense, compared with GBTC, MSTR is a Bitcoin-related stock that is easier for ordinary investors to buy. Other Bitcoin concept stocks, whether Tesla, Square or Coinbase, hold much less Bitcoin than MSTR, so MicroStrategy has become a de facto Bitcoin ETF.

By selling stocks and continuing to buy Bitcoin, the share of Bitcoin in MSTR's market value will be higher in the future, and it will evolve into a purer Bitcoin ETF. With the approval of the Bitcoin ETF in the United States nowhere in sight, MicroStrategy can be said to have seized the market opportunity.

3 The risks facing MicroStrategy

For MicroStrategy, such a crazy move is by no means without risks, and its risks mainly come from the following two aspects.

1. The cost of holding currency.

MicroStrategy's holding of coins is not without cost, and the cost is quite high. The interest cost of the latest $500 million junk bond is 6.125% per year, which is $30.625 million per year.

MicroStrategy's current business is divided into two major parts: holding Bitcoin and selling business software. The former does not generate cash income, and the latter's income is not enough to cover MicroStrategy's interest costs. According to MSTR's annual report, its net profit in 2018 was US$23 million, and its net profit in 2019 was US$34 million. In 2020, because the profits have begun to be used to buy Bitcoin, the net loss for the year was US$8 million. In the first quarter of 2021, due to the continued purchase of Bitcoin, the net loss was US$110 million. Due to the decline in Bitcoin prices in the second quarter, the book loss is expected to be as high as US$285 million.

This junk bond will last until 2028, so MicroStrategy will have to pay more than US$210 million in interest costs for this part in the next seven years. When the income is not enough to cover this part, it can only be covered by selling stocks.

2. Risk of principal repayment of convertible bonds

MicroStrategy issued convertible bonds twice in December last year and February this year. On December 9, 2020, MicroStrategy issued $550 million in convertible bonds, with an expiration date of December 2025 and a conversion price of $397.99; in February 2021, MicroStrategy issued $1.05 billion in convertible bonds with a conversion price of $1,432.46 and an expiration date of February 2027.

The interest rate of convertible bonds is very low and can be ignored, but due to the dual nature of convertible bonds as both debt and equity, if MSTR's stock price cannot reach above the conversion price before the maturity date, MicroStrategy will face huge pressure to repay the principal due to holders' unwillingness to convert their bonds.

The current MSTR share price is $630. If MicroStraegy continues to maintain this share price in the future, there will naturally be no pressure to repay the principal for investors who purchased convertible bonds at a conversion price of $397.99. However, for investors who purchased at a conversion price of $1,432.46, they will need to repay $1.05 billion.

The stock price of MSTR has been volatile. On May 19, it had fallen to US$411.58, just one step away from falling below US$397.99. Although both convertible bonds are still a few years away from maturity, if the stock market enters a recession, no one can guarantee that MSTR's stock price will continue to rise.

Once MSTR's stock price goes down, for example, to below $397.99, the pressure it faces will be enormous, not only because of the pressure of interest and principal repayment, but also means that it may no longer be able to raise a large amount of funds by selling stocks. In this case, it will only be able to alleviate the financial pressure by selling Bitcoin, which will cause its stock price to fall further.

In any case, it is no exaggeration to say that MicroStrategy has staked its life on Bitcoin's "eternal bull market."