MicroStrategy: Not much strategy after all

We were pleased to be featured extensively in a Forbes article earlier this week regarding our short position in MicroStrategy (MSTR). Despite having plummeted along with the rest of the cryptocurrency ecosystem we believe it still has much further to fall.

In February 2021, we published an investor letter entitled Part II: Anatomy of a Bubble, bemoaning the frothy speculation rampant at the time. We described how investors, in search of fortune, had reached higher and higher up the levels of the speculative pyramid, each level more rickety than the last. Near the top of the pyramid, we identified the “pretenders,” companies “devoid of solid business models [which] absorb the zeitgeist and learn the relevant buzzwords – electric vehicles, blockchain, disruption – and spend more energy marketing their stock than building a business.”

MicroStrategy was one of the pretenders we identified. They claimed to have a grand cryptocurrency strategy, but their “strategy” merely consisted of turning their mildly successful $700m enterprise value SaaS business into a gigantic levered bet on bitcoin.

For a while, this paid off.

As we wrote at the time:

MSTR has made a ~$3b windfall on its bitcoin purchases. However, its market cap has increased by roughly $9b. While nonsensical, this massive premium is unsurprising, given the froth in the cryptocurrency market and the paucity of publicly listed vehicles for bitcoin speculation… We calculate the fair value of MSTR shares to be $450 at current bitcoin prices. It trades at nearly $1000.

However, pivoting the business into a massive levered bet on a no-yield, infinite-duration, purely speculative asset at the very peak of speculative mania turned out to be not such a great idea.

Over the past two years, MicroStrategy has spent just under $4b on bitcoin and incurred $2.4b worth of debt to do so. At current prices, that bitcoin is now worth $2.7b – a $1.3b loss. The stock has suffered from both a falling bitcoin price as well as a falling premium over NAV as the meme stock craze fades. On a closing basis, MicroStrategy has plummeted as much as 88% from the all-time highs it reached just two weeks before we published Part II back in February of 2021.

The interest payments on MicroStrategy’s new and enormous debt load are about $45m annually. Over the last twelve months, MicroStrategy’s operating business did $35m in operating income and $47m in EBITDA. (We believe it unlikely those figures will grow substantially; MicroStrategy’s sales and operating income are roughly flat since 2020 despite the enormous profits other SaaS businesses made during the pandemic.) So it seems that, barring a fall in profitability, they will be able to pay the interest on the debt using substantially all the cash flow from the business without any asset sales.

With the operating business and the interest payments roughly canceling each other out, we view the fair price of MicroStrategy as the $2.7b value of their bitcoin hoard minus their total debt of $2.4b. Thus, at current bitcoin prices, the company is worth $330m, or $29 per share. The current market cap is $1.8b and the shares trade at $161.

No debt matures until 2025, so any insolvency risk remains far in the future. There are downside risks in the meantime, however. The first risk is that the business fails to generate sufficient cash to make the interest payments, necessitating bitcoin sales and further depressing the value of the rest of their stockpile.

The second risk is that it is a virtual certainty that between now and 2025 there will be numerous shareholder lawsuits and/or SEC investigations into whether levering up the company to buy bitcoin was a breach of fiduciary duty. In fact, insurers appear to be extremely concerned about this very thing; MicroStrategy was unable to obtain the customary directors and officers liability insurance at commercially reasonable terms, and has paid its CEO Michael Saylor more than $1.5m over the past year to personally indemnify the company.

The third risk is that MicroStrategy has a $205m secured loan collateralized by some of their bitcoin. As the price of bitcoin falls, they will be required to post additional collateral or the loan will be in default. Their first margin call is around current prices of $21,000, which has been widely discussed in the press, including in the article we’re featured in. MicroStrategy can easily post more collateral to meet this first margin call as 74% of its bitcoin remains unencumbered. However, in the event bitcoin falls to around the $5,000 level, they will run out of bitcoin to post, necessitating asset sales or some other intervention. Though bitcoin at $5,000 may seem far-fetched, we would point out that bitcoin traded under $5,000 as recently as 2020.

As MicroStrategy’s margin call loomed this week, Saylor did an interview on CNBC to defend his company’s bitcoin purchases. He justified his decision by saying: “We backtested our strategy against every other alternative… over any time frame, bitcoin is the best performing asset.”

His answer seems to be roughly “we incurred as much leverage as possible to load up on whichever asset happened to have the best performance over the past decade.” We fail to see how that is any justification whatsoever for a public company’s capital allocation strategy.

In a bit of nominative determinism, it seems that MicroStrategy didn’t actually have very much strategy at all.

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