As the world suffered from Covid, governments around the world drove interest rates to zero and pumped money into the economy. Assets of all kinds have started to rise. Michael Saylor, CEO of a marginally profitable software company called MicroStrategy (NASDAQ: MSTR) had an idea: why not invest the company’s reserve money in Bitcoin? It worked well, so Saylor doubled and tripled, issuing convertible bonds, debt and equities to fund additional purchases worth billions of dollars. For a while it seemed like a smart bet like Bitcoin rose above $ 60,000 in 2021 from a pre-pandemic of just $ 7,000. MSTR actions followed suit, going from $ 140 to over $ 1,200.
This year, it doesn’t look so good as Bitcoin’s price has halved, below the company’s average purchase price. MicroStrategy has effectively become a leveraged game on Bitcoin, with the bulls believing the company will be claimed in the long run, while the bears find it a convenient way to short Bitcoin. I decided to see what the company’s reported results say about its business and valuation.
The company’s value comes from its operations and its holdings in Bitcoin. I thought it would be a useful exercise to build an interactive model, connect the data, and see the resulting real-time valuation based on Bitcoin’s current price.
I had a number of questions that I was curious about and wanted to answer as I set out. Among them were the following:
- What is a fair value for MSTR shares at the current Bitcoin price? What is the positive / negative side?
- How much of the company’s intrinsic value comes from its Bitcoin holdings?
- What price should Bitcoin be at to justify the company’s current share price of $ 313?
- How much does a $ 1,000 change in Bitcoin’s price affect MSTR’s per share value?
- At what Bitcoin price does the company’s equity value go to zero and bankruptcy becomes a possibility?
Scroll down for the answers! I am also making my model publicly available for anyone to see the assumptions and details.
Where is Bitcoin headed?
When interest rates are zero, people will take a flyer on just about anything. While I believe there is a future for blockchain technologies, it’s not clear to me if they will require a particular cryptocurrency. There has been no legal use case for any cryptocurrency so far, and there appear to be few barriers to entry to create new ones. There will always be a market for Bitcoin, as there will always be a certain amount of excess money in the world trying to find a home in the oldest and most established cryptocurrency. There will also be some demand from criminals, those looking to diversify into alternative resources, and people wary of fiat currencies. However, from an opportunity cost perspective, it becomes increasingly expensive to maintain as interest rates rise. At a short-term zero rate, you don’t give up anything by holding a cryptocurrency. At 3%, this is a significant cost. Many retail investors buy assets because they are rising. The initial shock of seeing it go down pushes them to buy more at a low average cost. But a sustained downward current is likely to cause them to throw in the towel and find something else to do. Hence, the environment for Bitcoin’s future is likely to be questioned, until we reach a period where interest rates start to fall.
However, I am attempting here to value MSTR shares on Bitcoin’s current price without having a strong view of where it is headed.
What do others think of MicroStrategy? The company’s SA rating is 1.1, which equates to a strong sale. Looking at its factorial degrees, it gets a D for everything. It’s not a good picture, but Wall Street analysts seem to be mostly positive about the company. They have a composite rating of 4 on it, with three rating it as a strong buy and one as a strong sell.
Answers to previous questions (based on linked model)
Here is the model based on the second quarter 2022 results recently disclosed by the company. I believe this is the first and only publicly available model that allows for a transparent look at MicroStrategy’s evaluation. And the answers to my questions are:
- At the current price of $ 23,000 in Bitcoin, the fair value of the MSTR stock is $ 150, down by 50%.
- 75% of the calculated intrinsic value of the company comes from its position in Bitcoin, assuming the operating activity is valued at 2x the revenues (equivalent to a multiple of 25x on a normalized operating margin of 10%).
- Bitcoin is expected to be at $ 37,500 to justify the current share price of $ 313.
- At a Bitcoin price of $ 10,000, the company value of the company would be less than its debt, and bankruptcy becomes a possibility if the company cannot roll over its debt.
- Each $ 1,000 change in Bitcoin’s price changes MSTR’s share value by $ 11.50.
Based on the 50% drop in Bitcoin’s current price, I would advise investors to avoid MicroStrategy stocks. If you believe in Bitcoin, you’d better buy it directly. For those with a stomach for risk, I would recommend shorting stocks, selling calls, or buying puts. The short-term interest is high here at 45% of the free float and 32% of the outstanding shares. The cost of borrowing to short the stock is around 10% per year, although this may differ between brokers. Market cap isn’t huge at $ 3.5 billion, so there may be a brief squeeze if the stock goes up. Those who consider themselves sophisticated arbitrators can short the stock and buy 11.5 Bitcoins for every 1000 short shares to flatten Bitcoin’s position.
In a bullish case where Bitcoin’s price doubles to $ 46,000, the stock would be worth $ 410 for a 30% rise. In a bearish case where Bitcoin loses a further third of its value to $ 15,000, the stock would be worth $ 55 for an 80% drop. Bankruptcy lawyers who wouldn’t mind getting paid in Bitcoin should keep an eye on the $ 10,000 level!
The company can create value by selling stock at this level and buying back its debt at a discount. Its 2027 convertible banknotes, for example, sell for half the price at which the company issued them, according to the company’s latest 10-Q ratio.
The risks are high
The risks here are high for both a long and a short position. With the company’s high debt load, any operational improvement or shift in Bitcoin’s price is amplified for equity holders. Anyone who does not have a high risk tolerance would be better off avoiding the stock.
With high short interest, there may be a short squeeze. However, with the money shrinking, I consider the chances of this happening not very high. The company could also issue shares in such a scenario.
The company could be acquired at a premium by another company or investment fund looking to get their hands on a stash of Bitcoin. I don’t see obvious buyers, but anything is possible in M&A! This is a risk that can be diversified by holding a large number of short positions, each of a small size.
The gap between the company’s intrinsic value and its share price could widen over time.
Writing a short thesis on a title on a public forum is an invitation to backlash from the title holders. I welcome respectful comments from readers of the same name.