December 13, 2020
MicroStrategy's Bitcoin Debt Bet

On December 7th, MicroStrategy announced its intention to offer $400M of debt to investors, and a plan to purchase Bitcoin with the proceeds.

This was the 4th time MicroStrategy announced plans to buy Bitcoin, but for the first time, the market had a strong negative reaction to MicroStrategy's announcement.

On December 8th, Microstrategy's stock was down by 14%, their largest single-day decline since March 18th.

Why the negative reaction? Because this time the Bitcoin would be bought with other people's money, instead of the cash reserves already on MicroStrategy's balance sheet.

Despite the negative reaction, this bet makes a ton of sense.

MicroStrategy is a business generating tens of millions of dollars in annual cash flow from operations, they've got almost no long-term debt, and they have access to some of the cheapest capital in the world.

They also have an ongoing Bitcoin bet that has returned over 50% in a few months, and this offering gives them an opportunity to almost double the stakes.

Let's break down the potential upside and downside of MicroStrategy's latest debt offering.

Microstrategy's Debt Offering

First, let's look at the type of debt MicroStrategy offered investors.

They offered "unsecured senior convertible notes", a quick break-down of the term is below.

Unsecured: Microstrategy is not giving investors ownership of any assets as collateral. For investors, this obviously comes with a higher risk than debt secured by some underlying asset like real estate or equipment.

Convertible: Microstrategy can convert this debt into shares of Microstrategy or cash. The equity conversion rate for the notes will be 2.5126 shares of MicroStrategy per $1,000 of notes, which is equivalent to a conversion price of $397.99 per share. Microstrategy currently trades for less, so this strategy only makes sense when the stock value rises above $398.

Senior: If Microstrategy defaults on its debt, company assets are paid out to creditors in priority sequence.

Secured debt is paid off first, then unsecured debt, and then finally the equity shareholders get whatever is left (if anything). Within each priority level, there are sub-levels of priority. Senior secured debt is paid back before junior secured debt, senior notes are paid off before junior notes, and preferred stock is paid off before common stock.

Notes: A particular kind of corporate debt, typically with a maturity period of 10 years or less.

MicroStrategy's Debt Offering Timeline

On December 7th, MicroStrategy's intention was to offer:

On December 9th, MicroStrategy officially priced their offering at:

On December 11th, MicroStrategy closed the round of fundraising, and sold the extra $100 million option too. As a result, their net proceeds were $634.9 million after fees.

And with that money, they plan to buy more Bitcoin - since they've already converted 100% of their cash and short-term investments into Bitcoin.

MicroStrategy's Bet In A Nutshell

Here's what this entire bet boils down to.

MicroStrategy must pay $4.9M in each of the next five years as interest on their debt offering. That adds up to $24.4M in interest payments, plus a lump sum payment of the $650M original debt offering in December 2025.

That's a grand total of $674.4M paid off over the course of 5 years.

But there's a bonus option for MicroStrategy. If their Bitcoin bet pays off and they want to de-leverage, or if their stock price rises above $400, they have the option to convert some or all of the debt into equity or cash.

From the $650M offering, MicroStrategy expects to keep $634.9M that they can invest in Bitcoin. The other $15.1 million goes towards various fees and commissions.

Therefore, to turn their $634.9M into $674.4M, they'll just need a 1.2% annual return on their Bitcoin investment.

In other words, assuming MicroStrategy acquires Bitcoin around $18,750 per coin, they'll have paid for all 5 years of interest payments once Bitcoin hits $19,916 per coin. Anything above that is all profit.

MicroStrategy's Upside Potential

How Much Could MicroStrategy Make?

MicroStrategy has made 3 prior Bitcoin purchases.

All together, their $475M of cash is now worth $765M (up 61%) in just a few months.

With this $634.9M of cash from investors, they can buy just under 35,000 more coins. Since they already have 40,824 BTC, they will likely hold over 75,000 BTC by the end of December.

How Much Higher Might Bitcoin Go?

Obviously this is unknowable, and no prediction will be perfect when we look back five years from now. Still, there are enough influential figures in finance who have put out Bitcoin price predictions that it would be unwise to ignore them completely.

In addition, these people have all been successful capital allocators outside of the Bitcoin world, so their stance on Bitcoin as an asset class is less biased than the price predictions one might find on Bitcoin Twitter. They don't need Bitcoin to succeed, but they still think it will.

Raoul Pal: $1M per coin in the next five years

Winklevoss Twins: $500k per coin (timeline not provided)

Citibank Analyst Tom Fitzpatrick: A move as high as $318k per coin by December 2021

Chamath Palihapitiya [in 2017]: Probably 100k per coin in the next 3-4 years, and I think it is in the next 20 years, $1M per coin

Mike Novogratz: Going to 65k per coin (timeline not provided)

I'm sure I've missed a handful of price predictions, but you get the point.

On the high end, if Bitcoin gets to $1M/coin, Microstrategy's 75,000 BTC would be worth $75B by 2025.

On the low end, if Bitcoin gets to $65k/coin, Microstrategy's 75,000 BTC would be worth $4.9B by 2025.

It doesn't take a genius to figure out that Microstrategy has massive upside potential if Bitcoin's price gets anywhere close to the predictions above. But what if it doesn't?

Microstrategy's Downside Risk

What Happens To MicroStrategy If Bitcoin Goes Down?

It's possible that Bitcoin's price in December 2025 may be lower than it is today, but it's not very likely. In its 12 year history, Bitcoin has never traded down over a five year period, and it's not even close. 5 years ago, it was trading for $436. It is now trading for $18,750.

That's a 42x gain since December 12, 2015.

Still, the past isn't always a good predictor of the future, so let's explore MicroStrategy's options if Bitcoin does have a negative 5 year return.

Microstrategy has a profitable business generating tens of millions of dollars in operating cash flow each year. In fact, from 2016-2019 they've averaged $65M of cash flow from operations per year.

That's plenty of safety margin to take care of their $4.12 million annual interest payment, assuming zero business growth and zero inflation. If either one is positive, it will be even easier to meet their interest payment obligations.

What Happens If Bitcoin And MicroStrategy Go Down?

Ok, but what happens if Microstrategy's business doesn't generate any cash in the next five years, and the price of Bitcoin is lower in 2025?

Even more unlikely considering MicroStrategy's track record of success dates back to 1989, but let's entertain the possibility. What can MicroStrategy do about a rough spell for both Bitcoin and their business?

First, they could issue more debt.

MicroStrategy's largest long-term liability is its office space, and otherwise the company carries almost no long-term debt on their balance sheet.

At a time when central banks are relentlessly printing money, and bond yields are basically zero, raising another round of low-interest capital in the future won't be a challenge.

Second, a remote-first future means they may not even have to raise more money.

Prior to 2020, Michael Saylor strongly believed in-person work was important for MicroStrategy's success, but the global lockdown in the spring changed his mind.

If MicroStrategy does pursue a long-term remote work approach, that eliminates their largest long-term liability. As their $100M of lease obligations for office space gradually expires, the extra money can help fund their debt interest payments. It's not a big enough saving to pay off their debt principal, but it gives them extra time to either raise more capital or improve their business cash flows.

Final Thoughts

MicroStrategy investors didn't run the numbers when they heard of this debt offering announcement last week, they panicked.

Microstrategy is a well-run, capital efficient business that took advantage of low interest rates to protect their purchasing power. While their Bitcoin allocation is aggressive by Wall Street standards, it's nothing that might risk the future of their software business.

And if it works out, it will be remembered as a bold (and very successful) bet that permanently shifted the way Wall Street thinks about Bitcoin.

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