Is MicroStrategy's Convertible Bond Strategy a viable strategy?

Ideg: MicroStrategy's Convertible Bond Strategy: Top Gambler in Bottom Crypto Community

Originally written by Ideg

Michael Saylor, the current CEO of NasDAQ-listed MicroStrategy, has become one of the crypto community's most prominent evangelists. In contrast to Elon Musk's capriciousness, Michael Saylor stands firm and does his best. To this end, he also gained a large number of fans in the crypto community.

Since May 1 alone, SpeakRJ has seen its Twitter followers rise 369,021, or nearly 50%, from 779,276 to 1,148,897.

We know that MicroStrategy is known for using large amounts of corporate cash and debt financing to buy bitcoin. With his big bet becoming the largest holder of a long Bitcoin position in the public market, it's not hard to understand why Michael Saylor himself is so keen to preach about Bitcoin.

Betting history

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

Overall, MicroStrategy spent $2.2 billion on 90,301 Bitcoins, with an average holding cost of $24,308. The fact that a single institution holds such a large bitcoin position is the highest among all disclosures. (Excluding GBTC's use of trust to help clients hold bitcoins)

Since MicroStrategy first disclosed its purchase of bitcoin, its shares have risen from $123.39 on August 20 to a high of $1,315.00 and are now trading at $484.67. The highest increase was 961 percent and the current increase was 293 percent. As you can see from the chart below, investing in Bitcoin has even turned MicroStrategy's stock into a very volatile asset similar to Bitcoin.

The convertible bond

We found that MicroStrategy used only $500 million of its own capital, while $1.7 billion in debt financing was 3.4 times its own capital. Its debt financing was done through a financial instrument called Unsecured Senior Convertible Notes. Its specific meaning is as follows:

The Unsecured bonds came to liquidation after the mortgage bonds, but before the preferred stock.

Senior bonds, which are liquidated after subprime mortgage-backed securities and ahead of subprime unsecured securities.

An investor can convert a bond into a company's stock at a certain rate, under certain conditions.

Notes: Short-term bonds maturing up to 10 years.

On December 7, 2020, MicroStrategy announced its first convertible bond plan. The bond is a 5-year bond with a coupon of 0.75% and a conversion price of $398, which is a 37% premium over the stock price of $289 at that time. The bond was originally intended to raise $400 million, but ended up overclosing by $650 million.

On February 15, 2021, MicroStrategy announced its second convertible bond program, which was a 6-year bond with a 0% coupon and a conversion price of $1,432, a 50% premium over the stock price of $955 at that time. The bond was ultimately intended to raise $600 million, but it overcompleted by $1.05 billion.

This convertible bond has three clauses, namely redemption, repurchase and conversion, respectively to protect and limit the interests of both parties. Since this bond is a form of private placement for institutional qualified investors without registration, the details are not disclosed, so this paper will not elaborate too much.

Structured financial instruments

Non-financiers may find it hard to understand how low the interest rate is, even at zero for the second issue. Zero-coupon bonds are actually quite common in the market, but most of them are issued at a discount. In this case, the bond is issued at par, mainly because the bondholder gets the right to convert.

From the perspective of financial engineering, convertible bonds can be dismantled into two parts: fixed coupon bonds and call options. A secondary convertible bond, for example, can be viewed as an investor buying a fixed coupon bond and then using all the interest income from the fixed coupon bond to buy a call option. An important component of the value of an option is its time value (that is, the longer the term, the higher the value), which is high relative to its price due to its six-year maturity.

According to CBonds data, the investors involved in the two issues include the following. As you can see, its investors are all convertible securities ETFs, including those of First Trust, Bloomberg and iShares. This could also explain why Bloomberg has been Posting a lot of good news about bitcoin recently.

Financial analysis

Nasdaq's disclosure only accounts for losses, not gains, in the digital currency asset class. Therefore, reading MicroStrategy's Q1 10Q report directly is extremely misleading. Based on the actual holdings of the company, the summary balance sheet at $39,100 per BTC is as follows.

According to the table above, MicroStrategy has about $3.53 billion in bitcoin exposure. Its net worth was $1.95 billion. Because its exposure to bitcoin is so large that its primary business has little impact, we can simply think of the company as a 1.81x leveraged hedge fund that is long bitcoin. For example, the price of Bitcoin dropped 55% to $17,500. The company will be insolvent.

At its current share price of $493, MicroStrategy has a market capitalization of $4.83 billion and a price-to-book ratio of 2.47 times, which is a steep premium for the fund. If you subtract out its $1.2 billion market capitalization before it announced it was buying bitcoin. The market capitalization gain from betting on bitcoin was $3.63 billion. The actual gain from his bet on bitcoin, at $39,100, was just $1.34 billion, making the stock similarly overvalued in relative terms.

Crazy gambler

Michael Saylor himself has a rather notorious history. An article written in June 2001 listed it as the biggest loser of the entire dotcom bubble. Michael Saylor made a name for himself when his company's stock price rose from $120 to more than $3,000 in a matter of months. But in the subsequent bust, it lost $13.52 billion, or more than 90% of its net worth. The SEC even launched a massive investigation into the company and charged it with making false statements about its health.

conclusion

In the crypto community, retail investors who are long bitcoin on the leveraged side of exchanges pay an annualized interest rate of about 36 percent. And the annualized interest rate for borrowing USDT over the counter by collateralizing bitcoin is generally more than 12 percent. And both of these leveraged instruments are at risk of bursting if the currency falls sharply.

It has to be said that MicroStrategy broke down the barriers between the crypto world and the traditional world through the financial instrument of convertible bonds, and obtained negligible funds from the traditional world to bet on "high risk" crypto assets. And because of its ingenious design, it theoretically avoids the risk of bursting warehouse. This is a very clever strategy indeed. But it may be precisely because of the safety of the strategy itself that the positions have risen to such exaggerated levels. This is in line with Michael Saylor, who has always been a big gambler. It is difficult to quantify its actual risk tolerance because details of the "forced repurchase" clauses in its convertible bonds are not available. We can only wait and see how it ends.

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