Is MSTR facing challenges?
Under the guidance of Executive Chairman Michael Saylor, the company, once known as MicroStrategy, has accumulated a staggering 506,137 bitcoins (BTC), which currently hold a value of approximately $44 billion at the present BTC price of around $87,000, in just about five years. To an average observer, it appears as though the business has an endless reservoir of funds available for purchasing even more bitcoin. However, much of this significant accumulation has been made possible through the issuance of billions in equity and convertible notes (debt securities convertible into equity under specific conditions), and more recently by offering preferred stock, which is a type of equity that offers dividends to investors.
Nonetheless, the price of bitcoin has decreased by about 20% since reaching a high of over $109,000 two months ago. While such price fluctuations are common, the aggressive purchasing strategies employed by Saylor and his team have resulted in an average acquisition price of $66,000 for the company. This means that MSTR is merely one moderate downturn away from incurring losses on its investments.
This raises an important question: Could MSTR’s financial strategies backfire if bitcoin continues to decline?
“It’s highly improbable that this results in a situation where [MSTR] has to offload a significant amount of bitcoin due to margin calls,” explained Quinn Thompson, founder of a crypto hedge fund, in a recent interview. “For the most part, the debt can likely be refinanced for the convertible notes. Moreover, [the company] has started issuing perpetual preferred stock, which does not require repayment.”
In essence, not only is the likelihood low that MSTR could experience the kind of collapse that affected numerous crypto firms in 2022 (such as Genesis or Three Arrows Capital), but the company has also refrained from using its bitcoin holdings as collateral for loans, save for one loan from Silvergate that was paid back in 2023.
However, this does not guarantee a smooth path ahead for MSTR investors. In various scenarios, Saylor could be compelled to issue additional equity beyond what the market can absorb to stay on track.
“If he isn’t using MSTR’s cash flow to pay dividends, he’ll need to issue more shares, which would negatively impact the stock price. This is akin to what he’s already doing; every time retail investors drive the price up, he dilutes the stock by issuing more shares. In the future, this will have to happen again, and the proceeds may not go towards bitcoin purchases. They could instead be used to settle debts, further harming the share price,” Thompson noted.
Saylor’s tightrope walk
MSTR currently employs three strategies for raising capital: issuing equity, convertible notes, or preferred stocks.
Inevitably, when MSTR issues equity, it generates new shares of MSTR, which are sold in the marketplace with the funds directed towards acquiring more bitcoin. This inherently creates selling pressure on MSTR and could potentially push the stock price down.
Convertible notes have enabled MSTR to secure funding rapidly without diluting stock value. Investors typically appreciate these notes due to their solid returns, potential benefits from stock price surges, and the ability to redeem them in cash for amounts equivalent to the initial investment, including interest. The significant volatility of MSTR’s convertible notes, however, has allowed the firm to mostly issue them at zero percent interest while maintaining considerable demand from savvy market participants exploiting that volatility.
Additionally, MSTR has begun issuing preferred stocks, appealing to investors who seek reduced volatility and more stable returns via dividends. The current offerings include STRK, providing an 8% annual return, and STRF, yielding 10% annually.
So, why is MSTR utilizing these various types of investment instruments? The goal is to appeal to a diverse range of investors with differing risk appetites, according to Jeffrey Park, head of Alpha Strategies at a crypto asset management firm.
“Convertible bond investors and common equity investors generally share a focus on volatility,” Park remarked. “Preferred equities cater to those who want to minimize volatility entirely for consistent, reliable returns that justify the associated credit risk.”
“MSTR’s capital structure is akin to a seesaw at a playground,” Park elaborated. “Common shareholders and convertible note holders are one side, while preferred equity holders are on the opposite side. As market sentiment shifts, the balance may tilt, but the overall weight — MSTR’s enterprise value — remains constant. It’s merely a redistribution of perceived value across the company’s liabilities.”
Risks
That said, MSTR now faces the obligation to pay 8% dividends on STRK, 10% dividends on STRF, and a combined interest rate of 0.4% on its convertible bonds.
With MSTR’s software division generating minimal cash flow, securing funds for these dividends may pose a challenge.
It’s likely that the company will continue issuing MSTR stock to cover its interest obligations, Thompson suggested. “This could undermine the stock price. In extreme cases, the stock might trade at a discount compared to its bitcoin holdings because he would need to issue shares just to keep up with interest and to manage cash flow.”
“In a dire scenario, the discount could widen to 20% or 30%, reminiscent of Grayscale’s GBTC before it transitioned to an ETF, causing shareholders to demand share buybacks to eliminate the discount,” Thompson added. “Currently, he is adding shareholder value by selling stock at a premium price and purchasing bitcoin. However, in the future, it could become more beneficial for him to liquidate bitcoin to buy back shares. But that scenario is not imminent.”
Saylor’s control over voting rights ceased in 2024 as a result of continuous stock issuance, making the previously mentioned scenario conceivable, particularly if activist investors get involved.
Another risk for MSTR shareholders lies in the fact that the 2x long MSTR exchange-traded funds (ETFs) offered by T-Rex and Defiance, MSTX and MSTU, have experienced unusual, sustained demand despite the stock’s decline. Whenever investors seek to increase their exposure to these ETFs, the issuers must purchase twice as many MSTR shares. The sustained popularity of these ETFs has created continuous upward pressure on MSTR — they have already amassed over $3 billion in MSTR exposure.
The concern is that this buying spree could come to an end. Should these ETFs decide to offload their MSTR shares, it could trigger a sharp decline in the stock price.
“I truly don’t see how there is an unending supply of capital to keep buying the dips. These ETFs have been significantly impacted and are down considerably,” Thompson stated. “This should not be viewed as a solid long-term demand trend but, as long as it lasts, it remains impactful for bitcoin. I find it remarkable.”