Introduction
As the world suffered from Covid, governments around the world took interest rates down to zero and pumped money into the economy. Assets of all stripes started going up. Michael Saylor, the CEO of a marginally profitable software company named MicroStrategy (NASDAQ:MSTR) had an idea: why not invest the company’s spare cash in Bitcoin? That worked out well, so Saylor doubled and tripled down, issuing convertible bonds, debt and equity to fund further purchases amounting to billions of dollars. For a while, it seemed like a smart bet as Bitcoin soared above $60,000 in 2021 from a mere $7,000 level pre-pandemic. MSTR stock followed suit, rising from $140 to above $1,200.
This year, it isn’t looking so good as the price of Bitcoin has halved, below the company’s average acquisition price. MicroStrategy has effectively become a leveraged play on Bitcoin, with bulls believing the company will be vindicated in the long run, while bears finding it a convenient way to short Bitcoin. I decided to see what the company’s reported results say about its business and valuation.
My Questions
The value of the company derives from its operating business and its Bitcoin holdings. I thought it would be a useful exercise to build an interactive model, plug in the data and see the resulting real-time valuation based on the current price of Bitcoin.
I had a number of questions I was curious about and wanted to answer as I set about. Among them were the following:
- What is a fair value for MSTR shares at the current price of Bitcoin? What is the upside/downside?
- How much of the company’s intrinsic value derives from its Bitcoin holdings?
- What price would Bitcoin need to be at for the company’s current share price of $313 to be justified?
- How much does a $1,000 change in Bitcoin’s price affect the per-share value of MSTR?
- 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 anything. While I believe there is a future for blockchain technologies, it is unclear to me whether these will require any particular cryptocurrency. There has been no legal use case so far for any cryptocurrency, 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 some amount of excess cash in the world trying to find a home in the oldest and most established cryptocurrency. There will also be some amount of demand from criminals, those looking to diversify into alternate assets, and people distrustful of fiat currencies. However, it becomes increasingly more expensive from an opportunity cost point of view to hold it as interest rates go up. At a zero short-term rate, you are giving up nothing by holding a cryptocurrency. At 3%, that is a meaningful ticking cost. Many retail investors buy assets because they are going up. The initial shock of having it go down spurs them to buy more to average cost down. But a sustained downdraft is likely to make them throw in the towel and find something else to do. So, the environment for Bitcoin going forward is likely to be challenged, until we reach a period when interest rates start going down.
However, I am attempting here to value MSTR stock on the current price of Bitcoin without taking a strong view on where it is headed.
External Ratings
What do others think of MicroStrategy? The company’s SA quant rating is 1.1, equating to a strong sell. Looking at its factor grades, it garners a D for everything. Not a good picture, but Wall Street analysts seem to be mostly positive on the company. They have a composite rating of 4 on it, with three rating it a strong buy and one having it as a strong sell.
Answers To Questions Above (Based On Linked Model)
Here is the model based on the company’s recently disclosed Q2 2022 results. I believe this is the first and only publicly available model that allows a transparent look at MicroStrategy’s valuation. And the answers to my questions are:
- At the current $23,000 price of Bitcoin, the fair value of MSTR shares is $150, for 50% downside.
- 75% of the company’s intrinsic value as calculated derives from its Bitcoin position, assuming the operating business is valued at 2x revenues (equating to a 25x multiple on a 10% normalized operating margin).
- Bitcoin would need to be at $37,500 for the current share price of $313 to be justified.
- At a Bitcoin price of $10,000, the company’s enterprise value would be less than its debt and bankruptcy becomes a possibility if the company cannot roll over its debt.
- Every $1,000 change in Bitcoin’s price changes MSTR’s stock value by $11.50.
Recommendation
Based on the 50% downside at the current price of Bitcoin, I would recommend that investors avoid MicroStrategy stock. If you are a believer in Bitcoin, you would be better off buying it directly. For those with a stomach for risk, I would recommend shorting the stock, selling calls or buying puts. The short interest is high here at 45% of the float and 32% of shares outstanding. The borrowing cost to short the shares is approximately 10% a year, though this may be different across brokers. The market cap is not huge at $3.5 billion, so there could be a short squeeze if the shares go up. Those who think of themselves as sophisticated arbitrageurs can short the stock and buy 11.5 Bitcoins for every 1000 shares shorted to flatten out the Bitcoin position.
In a bull case where Bitcoin doubles in price to $46,000, the shares would be worth $410 for 30% upside. In a bear case where Bitcoin loses a further third of its value to $15,000, the shares would be worth $55 for 80% downside. Bankruptcy lawyers who wouldn’t mind getting paid in Bitcoin should be watching the $10,000 level!
The company can create value by selling shares at this level and buying back its debt at a discount. Its 2027 convertible notes, for instance, are selling at half the price the company issued them at, according to the company’s latest 10-Q report.
Risks Are High
The risks here are high for both a long or short position. With the company’s high debt load, any operational improvements or moves in Bitcoin price get magnified for equity holders. Anyone without a high tolerance for risk would be better off avoiding the stock.
With the high short interest, there could be a short squeeze. However, with money getting tighter, I would regard the chances of this happening to not be very high. The company would also likely issue equity in such a scenario.
The company could be acquired at a premium by another company or investment fund looking to get its hands on a stash of Bitcoin. I do not see any 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 with each one being small.
The gap between the company’s intrinsic value and share price could widen over time.
Preemptive Disclosure
Writing a short thesis on a stock on a public forum is an invitation for blowback from holders of the stock. I welcome respectful comments from eponymous readers.
Joe Raedle
Be the first to comment