MicroStrategy’s convertible bond strategy: Uncovering the crypto community’s top gambler

According to Speakrj statistics, from May 1 to date alone, his Twitter followers have increased from 779,276 to 1,148,897, a cumulative increase of 369,021, or nearly 50%.

We know that MicroStrategy is famous for using a large amount of company cash and debt financing to buy Bitcoin. Its bets have become the largest Bitcoin long position holder in the public market, so it is not difficult to understand why Michael Saylor himself is so enthusiastic about preaching Bitcoin.

Betting History

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

In summary, MicroStrategy used a total of $2.2 billion to purchase 90,301 bitcoins, with an average holding cost of $24,308. A single institution holds such a high bitcoin position, ranking first among all institutions that disclose relevant information. (Excluding GBTC, which helps clients hold bitcoins through trusts)

Since MicroStrategy first disclosed its purchase of Bitcoin, its stock price has risen from $123.39 on August 20 to a high of $1,315.00, and has now fallen to $484.67. The highest increase was 961%, and the current increase is 293%. From the figure below, we can see that investing in Bitcoin has even turned MicroStrategy's stock into an extremely volatile asset similar to Bitcoin.

Convertible Bonds

We found that MicroStrategy used only $500 million of its own funds, while debt financing was $1.7 billion, 3.4 times its own funds. Its debt financing was completed through a financial instrument called convertible bonds, the full name of which is Unsecured Senior Convertible Notes. Its specific meaning is as follows:

• Unsecured: Unsecured bonds rank after secured bonds and before preferred stocks in liquidation.

• Senior: Senior bonds rank after junior mortgage bonds and before junior unsecured bonds in liquidation.

• Convertible: Convertible. Under certain conditions, investors can exchange bonds for company stocks at a certain ratio.

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

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

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

The convertible bond has three terms: redemption, repurchase and conversion, which respectively protect and restrict the interests of both parties. Since the bond is a private placement that does not require registration and is aimed at qualified institutional investors, the details are not disclosed and this article will not elaborate on them.

Structured financial instruments

Non-financial people may find it difficult to understand why the interest rate is so low, or even 0% for the second issue. Zero coupon bonds are actually very common in the market, but most zero coupon bonds are issued at a discount. The bonds in this case are issued at par, mainly because bondholders will get conversion rights.

From the perspective of financial engineering, convertible bonds can be broken down into two parts: fixed-rate bonds and call options. Taking the secondary issuance of convertible bonds as an example, the bond can be regarded as an investor first buying a fixed-rate bond, and then using all the interest income from the fixed-rate bond to buy a call option. An important component of the value of an option is the time value (i.e. the longer the term, the higher the value). Since the option is for 6 years, the relative price is relatively high.

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

Financial Analysis

The report disclosed by Nasdaq only provides for losses in the "digital currency" asset category, but not for floating profits. Therefore, directly reading MicroStrategy's 10Q report for the first quarter will cause great misunderstanding. Based on the company's actual holdings, the author converted the price of each BTC at $39,100, and its simplified balance sheet is as follows.

From the table above, we can see that MicroStrategy's Bitcoin exposure is about $3.53 billion. Its net assets are $1.95 billion. Due to the huge Bitcoin exposure, its original main business has little impact. We can simply understand the company as a hedge fund that is long Bitcoin with a leverage of 1.81 times. If the price of Bitcoin falls by 55% to $17,500, the company will be insolvent.

Based on the current share price of $493, ​​MicroStrategy's market value is $4.83 billion, with a price-to-book ratio of 2.47 times, which is too high as a fund premium. If the $1.2 billion market value before its announcement of the purchase of Bitcoin is deducted, the market value increase brought by betting on Bitcoin is $3.63 billion. The actual profit brought by its bet on Bitcoin is only $1.34 billion, calculated at the price of $39,100. Relatively speaking, the stock price is also overvalued.

Crazy Gambler

Michael Saylor himself has a notorious history. An article written in June 2001 listed him as the biggest loser of the entire Internet bubble. At that time, MicroStrategy's stock price rose from $120 to more than $3,000 in just a few months, and Michael Saylor became famous because of this. But in the subsequent bubble burst, his losses reached $13.52 billion, accounting for more than 90% of his net worth. The SEC even launched a large-scale investigation and accused him of misrepresenting the company's conditions.

Summarize

In the crypto community, retail investors who go long on Bitcoin in the leveraged area of ​​the exchange need to pay an annualized interest rate of about 36%. The annualized interest rate for borrowing USDT by mortgaging Bitcoin in the OTC market is also generally above 12%. Moreover, both of these leverage tools will generate the risk of liquidation when the price of the currency plummets.

It has to be said that MicroStrategy has broken through the barriers between the crypto world and the traditional world through convertible bonds, and obtained negligible funds from the traditional world to bet on "high-risk" crypto assets. And due to its clever design, it theoretically avoids the risk of liquidation. This is indeed a very smart strategy. However, it may be because of the security of the strategy itself that its position has risen to such an exaggerated level. This is also in line with Michael Saylor's consistent strong gambling nature. Since we cannot obtain detailed information on the "forced repurchase" clause in its convertible bonds, it is difficult to quantify its actual risk tolerance. We can only wait and see its final outcome.