MicroStrategy: Highly Attractive As Bitcoin Looks To Bottom

The intense selling in risk assets in recent months has taken an enormous toll on a variety of industries, from just about any kind of tech stock, to retail, to Bitcoin (BTC-USD) and related stocks. Bitcoin has been absolutely decimated, and as I write this, is making a new cycle low on tremendous selling pressure in risk assets across the globe. While it’s painful to be sure, I also think we’re likely not that far from a bottom in stocks, and given the correlation, Bitcoin. If that’s correct, Bitcoin assets stand to do very well in the coming months.

There are plenty of ways to own Bitcoin exposure, including the coin itself, exchange-traded products, the stocks of miners, and the stocks of companies that own Bitcoin but don’t mine it. MicroStrategy (NASDAQ:MSTR) is counted in the latter category, having decided a couple of years ago it wouldn’t be an enterprise software stock any longer, but would instead stake its future – quite literally – on the future of Bitcoin.

MicroStrategy has been fascinating to watch, and I’ve dabbled in it a time or two. But it’s extremely volatile so moves are big in both directions, and it therefore is not for everyone. However, based upon my view that Bitcoin’s low is near (along with stocks), I think MicroStrategy has a sound risk/reward here for those that do not think Bitcoin is dead. In addition, MicroStrategy has almost half of its float being shorted, so if I’m right, the move to the upside could end up being explosive, as it was the first time around when MicroStrategy ran to its eventual ATH.

An ugly chart

As you’d expect, the price chart is hideous, unless you’ve been shorting. MicroStrategy is down almost 90% from its ATH about a year and a half ago, and all indicators are well into bearish territory. However, we have to keep in mind that MicroStrategy is essentially just a leveraged play on Bitcoin, so this price action makes sense. More on that in a bit, but let’s finish up the chart discussion first.

I’ve drawn two support lines, one of which is being violated as I write this around $175. The stock is indicated in the low-$150s in the pre-market as equity and risk assets completely melt down across the globe on recession fears. Melting down is part of the bottoming process, so while no one wants to go through it, that’s a key and healthy attribute of a market that is looking to bottom.

The $134 level is the low that must be watched for MicroStrategy, and depending upon how bad it gets this week, we may see that. Where you get concerned is if we blow through that level and keep falling, so if you’re one to use stop losses, that’s a good place for a protective measure.

Now, I’ve drawn some possible paths for the indicators to get an idea of what I believe may occur in the coming weeks. What the bulls need to see is a bottom in the price, preferably over the $134 low, along with a positive divergence in the PPO. Positive divergences at market bottoms are extremely bullish signals, and barring a disaster scenario where Bitcoin goes below $20k, that’s what I’m looking for.

Speaking of that, the second-to-last panel has the price of Bitcoin, and I’ve drawn a possible path where it bottoms between here, which is $24k, and $20k, and then moves higher. We’re so oversold on Bitcoin, as well as risk assets around the world, I don’t think we’re all that far in terms of days/weeks from a tradable bottom. Are we at the bottom today? No. However, I don’t think we’re months out and that’s key for this trade with MicroStrategy.

Since MicroStrategy is just a leveraged Bitcoin play let’s take a brief look at Bitcoin’s chart. It looks largely the same as MicroStrategy’s so I won’t spend a huge amount of time repeating the same points.

Bitcoin has broken all prior support levels so the door is now open for the final flush lower. While “final flush lower” is great for the long-term health of the market, this only happens when investors panic and just sell everything. That means that support levels count for nothing, so it’s difficult to know when the flush may stop and reverse. However, I don’t think we’re that far away. Bitcoin is likely to put in the positive divergence from a momentum perspective with this new low, barring the Armageddon scenario I mentioned above. I don’t trade based on Armageddon scenarios because by definition, they’re extremely unlikely. So my base case is that we’re close to the final low here; how close is the question, and that’s what each trader must assess for themselves in terms of risk levels.

Value and Debt

Now, let’s take a look at the fundamental picture for MicroStrategy to get an idea of its value, and its ability to continue to service its debt. Keep in mind that MicroStrategy is still an enterprise software company, it’s just that after management literally mortgaged the future of the company on Bitcoin price, it seems no one cares there’s a software business. I certainly fall into that bucket because the software business exists really at this point to fund the company’s debt servicing, and ultimately, purchase of more Bitcoin. Because of that, traditional measures like P/E ratio are completely useless for MicroStrategy. Rather, I prefer measures of value of the company’s book, which takes into account its debt and its Bitcoin holdings. Let’s have a look at price-to-tangible book value.

I like P/TBV because it excludes GAAP nonsense like goodwill, which doesn’t actually have any cash value. TBV is just how much the company owns in actual assets versus what it owes in liabilities. It’s a true measure of value, and as we can see below, MicroStrategy’s P/TBV has imploded.

The stock will be trading very near its low of P/TBV, which is in the low-2s, based upon where the stock is indicated at the moment. That’s a far cry from the 6X TBV we saw just a couple of months ago, and a very long way from when Bitcoin was in more bullish pastures at 13X TBV. I’m not saying MicroStrategy will definitely trade at 13X TBV again, and keep in mind that TBV is falling every day that Bitcoin price falls. However, if you believe Bitcoin is going higher than it is today, MicroStrategy’s share price should reflect not only higher TBV (via higher Bitcoin value on its balance sheet), but also a higher multiples on that value. Remember that the phenomenon that has decimated MicroStrategy’s share price this year (lower Bitcoin pricing driving lower TBV, along with lower TBV multiples) works in both directions. That’s what you’re betting on if you buy MicroStrategy today.

Now, most of MicroStrategy’s Bitcoin purchases have been made with debt issuances, so the company now owes bondholders about $2.4 billion. The company has Bitcoin to offset that but obviously the goal would be that Bitcoin is much higher by the time the debt comes due, and either MicroStrategy can roll the debt out, or pay it off with some of its Bitcoin, keeping the rest as profit. MicroStrategy literally is leveraged to Bitcoin pricing so if it doesn’t work, the company may go out of business longer-term. Its software business has zero chance of paying off $2.4 billion in debt long-term so it’s Bitcoin or nothing.

While I don’t think that’s going to happen, let’s take a look at the company’s ability to service its debt for the more foreseeable future. Below we have trailing-twelve-months operating income in blue, interest expense in black, and cash on the balance sheet in green. All values in millions of dollars.

Operating income has been declining in recent quarters as the company’s enterprise software business isn’t a standout in any way. However, it has produced enough cash up to this point to service the company’s debt. That’s an important inflection point because if MicroStrategy reaches the point where it cannot service its debt without selling Bitcoin, I don’t think investors will take kindly to that development and may re-rate the stock even lower than it already is. Like I said, this is not one for the risk-averse.

In the TTM period, operating income was $35 million, and MicroStrategy accrued $38 million in interest expense. That’s close enough that the company can make up the difference with cash on the balance sheet, which was $93 million at the end of the last quarter. I would get concerned if TTM operating income is more than $30 million less than interest expense because that would cause MicroStrategy to blow through its cash reserves quickly. To be clear, that is not happening at the moment, but that’s something you want to keep an eye on if you plan on holding this stock. To me, this is the key risk because so long as the company can hold its Bitcoin through this bear market, at some point there should be a turnaround. However, if it cannot make it through and is forced to liquidate Bitcoin to survive the bear market, I think Wall Street will be quite harsh.

Short interest is through the roof

Short interest came to the fore at the beginning of 2021 with the GameStop (GME) saga that was so well publicized. While short squeezes are pretty rare, they do occur, and I think MicroStrategy is a potential candidate. The ingredients for a short squeeze are 1) high percentage of the float being shorted and 2) a rally that takes the stock above prior resistance. You need most (or all) short sellers to be underwater on their shorts before a squeeze can take place, and MicroStrategy is nowhere near that level today. It would need to be at least double the level it is today to trigger a squeeze (or something like that), so I’m not saying a short squeeze is imminent. However, if I’m right about Bitcoin and risk assets bottoming sometime soon, and MicroStrategy takes off higher, it could squeeze.

Short interest is 35%, so that’s an enormous number of participants betting against the stock. This is not the primary reason to buy MicroStrategy and I want to reiterate that most heavily-shorted stocks never squeeze. But the potential is there in the coming months so I wanted to make sure we looked at it. If this comes into play, it would be in the latter part of this year after the stock has already rallied significantly.

Margin Call Risk

There are stories out everywhere early this week about MicroStrategy’s potential margin call, which the CFO estimated earlier this year to occur around $21k per Bitcoin. Since MicroStrategy has essentially borrowed dollars to swap for Bitcoin, if that relationship breaks down via lower dollar-denominated Bitcoin prices, which is exactly what’s occurring, the company’s Bitcoin can be called as collateral.

The company has also said it can contribute more Bitcoin before the margin call such that it never occurs, and I have to imagine those plans are in place right this second to ensure no disruption from a margin call. However, we won’t know for sure until (or if) Bitcoin goes below $21k, and it releases news that it’s been margin called.

Now, this is a risk, clearly, given we’re only about 10% above the estimated margin call level right now. Ten percent moves in Bitcoin can take a couple of hours in this market so I don’t want to downplay it. However, the CFO was ready with an answer (and a plan) for this event months ago, so I have to imagine there are stops in place to avoid a margin call. If the company did get a margin call, the stock could be absolutely destroyed, so that’s something to keep in mind. In other words, if a margin call occurs, nothing else I said above will matter.

Final thoughts

This period of selling risk assets has been very painful for millions of investors around the word, but I also think it’s quite good for the long-term health of this market. I think we’re near the ultimate bottom, and that it could be reached with a swift move lower in the next couple of weeks. We’ll see on that, but if I’m right, risk assets related to Bitcoin – which should bottom with stocks – could see monumental returns.

This one is very risky so please size positions accordingly, or just skip it altogether. But if you take the plunge, I think the upside here is several hundred dollars over the next year or so, with the downside being much less than that with shares at ~$150.