Summary MicroStrategy recently made headlines when it was picked for inclusion in the NASDAQ-100 index. One of the factors that made the company eligible for inclusion was a market gap gain, driven by gains in Bitcoin, an asset that MicroStrategy holds in vast quantities. MicroStrategy is financing its Bitcoin buys with equity and debt. This creates risks for shareholders. Equity dilution becomes a major cost when the asset bought with share issuance proceeds declines in price. Debt servicing can become an issue when asset prices collapse enough. For these reasons, I consider MicroStrategy stock unsuitable for most investors. MicroStrategy ( MSTR ) made headlines Yesterday when it was picked for inclusion in the NASDAQ-100 index. The company’s index inclusion was spurred in no small part by a series of well-timed Bitcoin ( BTC-USD ) purchases, which took its market cap to a level where it was eligible to be added to the index. Although many investors were optimistic that MicroStrategy’s index inclusion would lift the stock, MSTR actually dipped in the days after the NASDAQ inclusion news was announced. It should be noted that MSTR’s actual index inclusion does not occur until December 23. The stock may yet experience a post-inclusion rally. However, investors who anticipate the inclusion may be making bets on the effect of index inclusion already. There is significant money to be made by front-running index fund buys, and MSTR will be in NASDAQ-100 index funds soon enough. Tuesday trading in MSTR seems to indicate that investors either don’t think that index inclusion will lift MSTR much, or think it will have a positive impact that will be outweighed by issues facing the company. Speaking of issues: MicroStrategy would face a large one if Bitcoin were to embark on a large, long-lasting drawdown–something BTC has, in fact, done many times in the past . The company is using a mix of debt and equity to finance its Bitcoin purchases, and these both come with problems in the event that the asset purchased goes down in price. Debt comes with interest expenses, which in MSTR’s case were already high as a percentage of the company’s revenue before the Bitcoin purchases. Equity issuance, on the other hand, reduces the percentage of the total enterprise that is owned by the pre-issuance shareholders. In other words, unless the asset purchased appreciates or pays income exceeding the amount of dilution, the dilution makes each share worth less. It’s certainly possible for MicroStrategy’s Bitcoin buying strategy to work out. Bitcoin has many advantages over other cryptocurrencies, including its supply cap, higher hash rate and greater decentralization . Cryptocurrency is useful for people who have one reason or another to be wary of their spending being tracked–a category that includes not just black market participants, but also political dissidents. As long as this use case remains, Bitcoin is likely to enjoy some measure of non-speculative demand. If that’s the case, then Bitcoin’s market value represents more than just a bubble, and its price could keep going up. With all that being said, Bitcoin’s historical volatility indicates that drawdowns far in excess of 50% are possible if not likely. Since its creation in 2009, Bitcoin has undergone at least five crashes greater than 50% , and three of those were greater than 80%. Therefore, it would be wise for those holding Bitcoin and its corporate proxy, MicroStrategy, to model for scenarios where the cryptocurrency declines by that much, to see whether their portfolios would survive it. As for Bitcoin itself: history teaches that it would likely recover from such a hypothetical crash. It has done so in the past, and it still has both its use case and its advantages over other cryptos. However, it’s not necessarily the case that Bitcoin holders would survive such an event. A retiree holding an asset at heavy weighting prior to it declining 80% in price would be in trouble, as would a person at any age holding the asset while being in debt. That latter category includes MicroStrategy. As of its most recent financial report, MSTR had 12% more debt than equity , and 343% more operating costs than revenue. The company cannot finance all of its obligations from operations alone. MicroStrategy does have more revenue than interest expense, with a ‘revenue interest coverage’ ratio of 6.4. That sounds reasonable but remember that that revenue has to pay interest along with operating expenses; the company’s deeply negative operating income cannot cover interest expenses. So, it looks like either Bitcoin sales, operating asset sales or debt refinancing will be needed to keep those interest payments at bay. For this reason, MicroStrategy is highly vulnerable to the price volatility inherent in Bitcoin, and is not a buy for risk-averse investors. Equity Raises Shortly after the release of its third quarter earnings, MicroStrategy announced a plan to buy $42 billion worth of Bitcoin, financed by 50% equity and 50% debt. Both the debt and the equity components of this plan have their risks. The risks of equity are the easiest to explain, so I’ll start with those. The risk of issuing equity is that doing so threatens to make shares that existed prior to the issuance, worth less than before. When equity is issued, the immediate effect is to replace a percentage of per-share ownership with an equivalent value in cash. Initially, the effect on shareholder wealth is zero, less a small impact from investment banking fees. However, as time goes on, the company has to invest the newly raised cash in lucrative opportunities, otherwise inflation and opportunity costs erode the value of the cash raised to the point where it reduces shareholder wealth in real terms. So, MicroStrategy’s equity raises present a risk to shareholders if the new Bitcoin purchases don’t work out. With MSTR continuing to buy Bitcoin at all-time highs, the possibility of said purchases not working out is real. With that being said, the risks with the equity raises are not existential ones. It’s a different story with debt. Debt The debt that MicroStrategy is taking out to finance its Bitcoin purchases is an existential threat in a scenario where Bitcoin declines precipitously in price. The reason is simple: debt creates interest expenses, and MicroStrategy does not generate enough operating income to cover those expenses. Therefore, the company will need to either sell Bitcoin or refinance its debt to keep covering its interest expenses. In the event that Bitcoin crashes, that becomes hard to do. How steep a fall in the price of Bitcoin would be required in order for MSTR to experience solvency issues? We can get at that by reviewing some facts: MicroStrategy had $4.21 billion worth of debt, bearing $18 million in quarterly interest expenses at the end of the third quarter. The future amount of interest is higher because the company issued a $1 billion interest-bearing bond right before the quarter ended (on September 20 ). The yield on the $1 billion note was 0.625%, meaning it adds $6.25 million in annual interest expenses. It’s likely that none of this showed up in the third quarter income statement because the new bond does not make its first payment until March 15, 2025. Therefore, forward annual interest expense is likely $78.25 million ($6.25 million plus $72 million from the previously mentioned $18 million quarterly payments). The company issued $3 billion in convertible debt since the end of the third quarter (with no interest attached to it). That brings the total debt to $7.21 billion. It has $2.05 billion in maturities coming up in the next five years. MSTR’s Bitcoin was worth $44.5 billion at the time of this writing. Given the above facts, what level of Bitcoin price decline would cause serious problems for MSTR? One thing we know is that, at an 84% price decline, MicroStrategy’s Bitcoin value would drop below the value of its debt. Such a decline would take the company’s Bitcoin to $7.12 billion. That’s not such an immediate threat in itself because the company’s debt carries very little interest. However, it could be a threat over time: $78.25 million in interest is a little over 1% of $7.12 billion, so MicroStrategy having to sell Bitcoin at such a level would gradually chip away at the value of the BTC holdings. Also, MicroStrategy has two maturities totaling $2.05 billion coming up in 2027 and 2028, which would eat up 28.8% of the company’s Bitcoin in a scenario where BTC were down 84% from today’s level. Last but not least, MicroStrategy had about $398 million more operating costs than revenue last quarter, which works out to $1.59 billion per year, and that also has to be covered somehow. Unless the operating business were sold off, these expenses would eat up all of MicroStrategy’s Bitcoin in 4.47 years, in a scenario where BTC had declined 84% in price. Considering the maturities, interest expenses and operating expenses all together, the costs would burn through all of MSTR’s Bitcoin in about three years–again assuming it’s down 84%. That would be a real solvency risk for MicroStrategy. Now, of course, the above assumes that MicroStrategy doesn’t refinance its debt or sell its operating business. Selling the operating business is an option, although it only kicks the can down the road a few years. Refinancing debt creates issues because, if Bitcoin were down 84%, then MicroStrategy’s stock would likely be down too, meaning there’d be little appetite for convertible bonds and the company would probably have to issue at very high interest rates to get any takers. For these reasons, I believe that MicroStrategy would be existentially threatened in a situation where Bitcoin declined 84% in price. Valuation An additional concern for anybody considering going long MicroStrategy today is that the company is arguably overvalued, even in a scenario where Bitcoin trades flat or goes up slightly. The company currently trades at 21.94 times last quarter’s book value . It also trades at 162 times sales. The “actual” price/book ratio is likely somewhat lower now because of the gains Bitcoin has made, but is still probably greater than one. This begs the question: why pay a premium for a stock that has become essentially a bet on another asset? MicroStrategy’s operations are nowhere near profitable; if the company has anything going for it, it’s the Bitcoin horde. However, it trades at very high multiples to said horde, and its heavy amount of leverage creates severe problems in a scenario where Bitcoin declines precipitously in price. MicroStrategy multiples (Seeking Alpha Quant) A Concluding Note Before concluding, I should address one critique that could be made of the argument I outlined in this article: that the scenario I modelled (a -84% BTC price change) is very extreme. It is extreme, but not unprecedented: as I showed at the start of the article, BTC has declined more than 80% in price at least three times. It’s plausible to think it will do so again. Additionally, sometimes extreme scenarios can illustrate general principles. Although MicroStrategy would not become insolvent with Bitcoin down 40%, 50% or 60%, the issues that appear in my -84% scenario appear in milder forms in smaller BTC price crashes. Does MicroStrategy cease existing because of a 50% Bitcoin price dip? No, but the general problem that my model uncovered–the problem of having to sell off Bitcoin at unfavorable prices to cover operating expenses and interest–definitely starts rearing its ugly head in such a scenario. For this reason, I think that MicroStrategy faces too much tail risk to be investable. Sure, the company will thrive if Bitcoin keeps rising, but it isn’t prudent to just assume that a raging bull market will continue forever. It’s in the nature of volatile assets to come down in price sometimes, and Bitcoin is nothing if not volatile.
