How MicroStrategy and Others Are Taking on Billions in Debt to Buy More Bitcoin

by

What to know:

  • MicroStrategy is using convertible notes in a unique way to raise funds and buy more bitcoin.
  • Sophisticated investors love these bonds because of the volatility allows for profitable trading strategies.
  • Companies copying MicroStrategy could be compelled to sell their bitcoin holdings or company assets if the crypto experiences another prolonged downturn.

As someone who has been closely following and participating in the cryptocurrency market for several years now, I find the strategy employed by companies like MicroStrategy and the bitcoin miners intriguing, but also fraught with potential risks.

Have Michael Saylor and MicroStrategy (MSTR) stumbled onto an infinite money glitch?

One could easily infer that such a move is questionable. MicroStrategy, under Saylor’s leadership, started acquiring Bitcoin (BTC) over four years ago. However, in the last 10 months, the company has employed an unusual tactic to gather over $6 billion, with the explicit intention of increasing its Bitcoin holdings. As of December 15, these holdings amounted to approximately 439,000 tokens, currently valued at around $46 billion, given a price of roughly $106,000 per token.

As an analyst, I would rephrase the given text as follows: Instead of borrowing money through loans or issuing additional company shares, MicroStrategy opted for a different strategy. They chose to sell convertible notes – debt securities that can transform into equity at predetermined dates or under specific conditions. Moreover, they have plans to raise an additional $18 billion via these convertible bonds over the next three years, as outlined in their October plan.

Due to the exceptional demand for this convertible paper, numerous corporations, including Bitcoin mining company MARA Holdings (MARA), have mimicked this strategy to gather billions in funding, thereby expanding their own resources.

Reflecting on this situation, I’m led to ponder: Might continually increasing debt pose a potential risk not only to these organizations, but also to the broader crypto market?

If Bitcoin experiences a prolonged period of low or decreasing prices, these companies might be forced to sell additional shares (equity) and potentially dilute shareholders at an inconvenient moment…or sell their Bitcoin for less than they initially paid for it. This is according to Quinn Thompson, the founder of crypto hedge fund Lekker Capital, who spoke with CoinDesk. However, Thompson also stated that he doesn’t foresee these companies becoming insolvent under such circumstances.

How convertible notes work

Convertible notes are financial instruments that enable companies to swiftly obtain funds without requiring collateral or immediately reducing their equity (as is necessary for a loan). The value of these notes is determined by factors such as the interest rate embedded within them, the company’s underlying stock value, the instability of that stock, and the creditworthiness of the company.

In November, Bitdeer (BTDR), a bitcoin mining company, managed to secure $360 million by selling convertible bonds with an annual interest rate of 5.25%. These bonds will be due on December 1, 2029 for around $15.95 per share, which is approximately 42.5% more than the price at which these shares were trading on November 21 when the convertible bonds were issued.

Essentially, instead of directly purchasing the company’s stocks from the market, investors have another option that offers a steady return and potential profit. This comes in the form of these notes. By holding onto them, investors can enjoy a consistent yield and stand to gain if the stock price increases. What makes this even more attractive is the built-in safety net – convertible notes include protection against losses. At particular points, these bonds can be converted into cash based on the initial investment plus accrued interest payments. In simpler terms, investors can feel secure about getting their initial investment back, with interest, even if the stock value decreases before the note expires.

From my perspective as an analyst, MicroStrategy’s unique position lies in its ability to secure convertible bonds with a zero percent interest rate despite U.S. benchmark rates hovering around 5%. This anomaly is primarily due to the high volatility associated with MicroStrategy.

As an analyst, I find that fluctuations in stock volatility significantly impact the price dynamics of MSTR’s convertible bonds. These complex market players skillfully capitalize on this volatility by trading it in a neutral manner, effectively reaping substantial profits. Recently, while discussing the intricacies of this with a seasoned convertible note arbitrage trader, he likened his current experience to that of a crypto day trader. He expressed that, due to the rapid and unpredictable nature of these financial instruments, even brief absences can lead to massive exposure if proper risk management measures aren’t in place beforehand.

Due to significant market interest in MicroStrategy’s convertible notes, the company has been able to issue and sell a large number of them – five times within a year, which is quite unusual. As of now, there are six of these notes still outstanding, with maturity dates ranging from 2027 to 2032. Out of these, two have no interest rate, while two others provide a yield of 0.625% and 0.875%, respectively. The fifth one offers a return of 2.25%, and the last one is the highest at 0%. Since the rates are relatively low, MicroStrategy can sell its equity at a substantial premium over its current share price, while only having to pay a combined interest rate of 0.811% on its debt, equating to approximately $35 million per year, an amount that the company’s revenue can comfortably handle.

As an analyst, I anticipate that if implied volatility persists at a high level, MicroStrategy (MSTR) could increasingly opt to sell convertible bonds, which in turn would translate to them acquiring more bitcoin. Conversely, I perceive the commencement of a significant bitcoin rally might be indicated by a decrease in MSTR’s implied volatility, signaling what I refer to as a potential “top” for the market.

Convertible notes mania

Beyond the previously mentioned bitcoin miners, there’s also the medical device company Semler Scientific (SMLR), which revealed its strategy for managing a bitcoin treasury in late May. So far, the company has only bought bitcoin using cash it already had and funds raised through stock sales. However, on Tuesday, an options market was granted to its stock, making it more appealing to investors and traders who wish to profit in a way similar to MicroStrategy’s debt strategy.

Between June and December 5th, Bitcoin miners collectively incurred approximately $5.2 billion in debt, as reported by MinerMag. Some of these debt instruments, such as those issued by MARA and Core Scientific, carry no interest rates, while others like Bitdeer, IREN (IREN), and TeraWulf (WULF) have set their rates at varying percentages from 2.75% to 8.5%.

While some companies are following MicroStrategy’s lead by using the money from convertible notes to increase their bitcoin holdings, others like Core Scientific have different intentions. They plan to use the funds for operational costs, capital investments, and possible acquisitions. On the other hand, Bitdeer is focusing on expanding its mining rig manufacturing business.

Bill eventually comes due

Although convertible notes might seem like a windfall, it’s essential to understand that they aren’t just free funds. Upon maturity, the holders have the option to exchange these notes for shares at a predetermined price per share, or they can opt for cash if the stock has fallen short of expectations compared to its original value.

If these companies’ stock prices fall substantially over an extended period, shareholders might choose to exchange their notes for cash rather than shares. This could lead MicroStrategy to liquidate some of its bitcoin reserves to repay investors, and bitcoin mining firms to sell off mining equipment. In the most severe situation, these businesses could potentially face bankruptcy.

Selling bitcoin under duress doesn’t have to be catastrophic, especially if the company’s average buying cost is less than the selling price. For instance, MicroStrategy purchased its bitcoins at an average of $61,725 each, providing a level of security. However, it’s important to note that Bitcoin has a history of dropping around 80% every few years. Even in this year’s bull market, the price fell nearly 40% at one point. Therefore, there’s no assurance that Bitcoin won’t fall below MicroStrategy’s average buying price again in the future.

Despite this, MicroStrategy’s bonds are structured with varying maturity dates, which is advantageous because it means the company won’t have to repay all its debt at once. In simpler terms, a prolonged downturn in both bitcoin and MSTR would have to last for many years before the company encounters serious financial trouble. Additionally, a significant portion of MicroStrategy’s bonds are already eligible for conversion, which is beneficial for the company. Furthermore, MicroStrategy has the flexibility to renew its debt by issuing new convertible bonds, even though the terms might not be as favorable.

In essence, MicroStrategy has been around for quite some time when it comes to this particular strategy. It’s plausible that newer players such as Bitcoin miners and possibly Semler (if it decides to take on debt), whose average Bitcoin purchase prices are likely much higher, might find themselves in a more vulnerable position due to the substantial debts they’ve taken on, which could put them at risk closer to a potential market peak.

Read More

2024-12-17 20:35