Pioneering Corporate Finance of the Future

On August 11 2020 MicroStrategy purchased $250mn worth of bitcoin. Bitcoin on the balance sheet of a listed equity was a monumental event but little did we know that MicroStrategy would go on to amass more than 1% of bitcoin supply for around $6.9bn, changing the face of financial markets. Given the immense power of decentralised digital scarcity bitcoin unleashed onto the world this impact shouldn't come as a surprise but nevertheless, it is incredible to witness these events unfold in front of our eyes. In this piece, we will detail how MicroStrategy (MSTR) absorbing bond markets into bitcoin’s black hole and why MSTR’s optically risky strategy is the logical conclusion to today’s monetary conditions.

Conclusions:

MSTR’s convertible notes are some of the best performing in its class
MSTR is pulling traditional financial markets into bitcoin
MSTR rivals Nvidia performance since early 2020 without strategic barriers to entry
Short fiat currency, long bitcoin is the logical conclusion over long enough time horizons
US government Treasury issuance back to covid crisis levels

First, a few notes on current market conditions.

Major BTC outperformance vs ETH in March as the market called into the question the probability the SEC will approve an ETH ETF in May 2024

It was a strong month for gold, as the market favours store of value assets, but gold gains are still dwarfed by bitcoin over almost all time horizons
Equities continued to grind higher
Yields have started to drop but are still much higher than a year ago
Bitcoin has reached new all-time highs despite significantly higher yields because the market is forward-looking and because the US government (like many other governments) is still racking up incredible amounts of debt.
Bitcoin holders are in the green over almost all time horizons (volatility does not matter if you have a long enough time horizon)
Profit-taking is underway at new ATHs, restraining price short-term. Weakness possible towards mid $50Ks
Fundamentals are still constructive & ETF flows strong
The outlook remains constructive for the coming 3-6 months

Bitcoin is a Superior Treasury Reserve Asset

MicroStrategy's primary business functions revolve around providing business intelligence (BI), mobile software, and cloud-based services. The only component of this history that is particularly relevant is Microstrategy's cash-producing qualities. They had cash on the balance sheet in 2020 that needed to be put to work in the face of the increasingly extreme monetary inflation governments of the world engaged with since covid.

Facing excess cash, many companies would have engaged in stock buy backs which tend to boost share prices, but don't add any further strategic value and don't provide the optionality afforded by cash. CEO Michael Saylor investigated the possibility of holding property, gold and other assets that tend to preserve value over longer periods of time but settled on bitcoin as a treasury reserve. The historical affirmation for this decision is compelling. Even if you bought bitcoin at its monthly peak price in October 2021, you would have outperformed most asset class peers. Over almost any other time horizon BTC outperforms comfortably (see table above).

Saylors' rationale for buying Bitcoin centres around its qualities as a store of value and a hedge against inflation. Saylor has described Bitcoin as “a dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash.” He has emphasized its unique attributes, stating, “Bitcoin is digital gold – harder, stronger, faster, and smarter than any money that has preceded it.”

Significant Outperformance without Barriers to Entry

After a sharp blow-off during the dotcom bubble, MSTR's share price had been largely flat for years, until CEO Michael Saylor began his impressive acquisition strategy in 2020. The core business continues to run exactly as before yet MSTR returns have rivaled Nvidia since 2020. Let that sink in for a moment... Any cash flow generating company could feasibly execute upon Microstrategy's treasury policy. Unlike chips, semiconductors and tech IP, there isn't a barrier to entry (apart from Michael Saylor's sheer guts and appetite to stomach volatility).

Leveraging Corporate Bond Markets

Not only is Microstrategy buying bitcoin, but from December 2020 they made these purchases with debt. I.E. MSTR is a leveraged bitcoin instrument, and the market prices it as such. The share price was heavily discounted during the 2022 bear market, but now trades at a large premium to the Net Asset Value (NAV) of its underlying bitcoin. The premium, which is where we find ourselves today, encourages Microstrategy to issue equity, dilute existing shareholders and purchase more bitcoin.

Understandably, many would regard this strategy as an incredibly risky ploy. However, Microstrategy can service the debt with cash flows from its primary business and the time horizon that corporate bond markets offer on the loans allows MSTR to shoulder bitcoin's incredible volatility. Bear in mind that bitcoin has never returned less than 27% annualised over any 4 year rolling period.

Clearly Microstrategy's treasury management process needs to be prudent, but if they ensure that they have the cash flow to service the loans and maintain 5 year+ loan durations they should be on a reasonable sound trajectory.

Absorbing Bond Markets into Bitcoin's Black Hole

Convertible bonds are the instrument favoured by Microstrategy, allowing the bond holder to convert into equity under certain conditions. In other words, the bonds have an embedded call option on the MSTR share price. So, not only do equity investors have numerous avenues through which to access bitcoin through MSTR and ETFs, but bond investors have been included in the opportunity too.

The first convertible notes issued in December 2020 are due in 2025 have returned approximately 382% thus far. By contrast the i-shares convertible bond ETF has returned -14.2%. Due to its strong performance this MSTR bond now accounts for 1.33% of the -shares convertible bond ETF.

We will have to wait and see how this all turns out but I think its pretty powerful that corporate bond investors are being forced to take notice of MSTR and thus bitcoin. This is no longer merely an alternative monetary tech that aficionados are trading on unregulated exchanges. This is an asset that through Microstrategy features within corporate bond ETFs. Sluggish corporate bond investors that are underweight MSTR converts will underperform peers. I think it is particularly interesting that a pseudo bitcoin proxy is available in corporate bond markets because bonds (through their strong interest rate linkage) are arguably more prone to disruption than equities.

It is worth noting that BlackRock is in the process of including IBIT (its bitcoin ETF) into a number of its diversified asset allocation funds. Moreover, Microstrategy now meets the market cap threshold for inclusion into the S&P500 index. I am unsure how long this process takes but the reality is that bitcoin will be included within most global indices over the coming years.

The Logical Conclusion

MicroStrategy would not phrase it in these terms but at its essence, taking a long bitcoin position funded in fiat currency is the logical arbitrage given the conditions presented by global monetary and financial policies. Governments continue to generate excessive debt and deficits with ultra low real interest rates. Currency cannot hold value vs real assets under these conditions. Scarce, portable, liquid, digital assets fare well under these conditions, and there aren't any of them with the same track record as bitcoin. If the market will offer cheap financing, why not arbitrage the miss-pricing? Looking far enough into the future, interest rates are still too low, bitcoin is too cheap and all fiat currencies are overvalued. So, hold bitcoin, maintain fiat currency liabilities and wait.