MicroStrategy Is A $1 Box Of Bitcoin Trading For $1.91 (NASDAQ:MSTR)

Editor’s note: Seeking Alpha is proud to welcome Nick Jessop as a new contributor. It’s easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

Overview

MicroStrategy (NASDAQ:MSTR) is a $28.9 billion market cap company, with business operations worth $2.5 billion (at best), sitting on $15.1 billion worth of bitcoin. If you find that these numbers don’t add up, it’s because, in my opinion, they don’t. This piece will work through MSTR, its management, holdings, business, and finally, a proposal meant to exploit this mysterious valuation.

Background

The Company

MicroStrategy, as described in its most recent 10-K, is “the world’s first bitcoin development company”. In simple terms, this only means that the company uses bitcoin as its “primary treasury reserve asset”. Though MSTR stands to gain from upward movements in bitcoin prices, revenues are generated through software sales. The company sells business intelligence or enterprise analytics software that is “AI-powered”. MSTR sees software sales as a means for accumulating bitcoin, “Our software business, which we have operated for over 30 years, is our predominant operational focus, providing cash flows and enabling us to pursue our bitcoin strategy.” Their “bitcoin strategy” can be seen below.

This excerpt comes from page 7 of the company’s 2023 10k, the first page of the business section. It is not until page 12 that we see a single heading dedicated to the company’s software. If it is not clear, MSTR is bitcoin first, analytics software second.

Software

Though MSTR’s technology is not this paper’s primary concern, it may be worth taking a quick tangent to provide some context on their place in the industry. First, a quick note on reviews from two leading enterprise software websites. Gartner Peer Insights rates the MicroStrategy platform a 4.6/5, yet it is also ranked at 9th place among competing business intelligence tools on PeerSpot. Competitors include Microsoft Power BI, Oracle OBIEE, and IBM Cognos among others. While this is not a conclusive examination of business insight technologies, and I am no subject matter expert, two things are certain: This is a highly competitive business, and MicroStrategy is not in the lead.

Proposal

MicroStrategy appears to be more like a bitcoin holding company than a software company. MSTR sells software, but parts of its leadership are held by bitcoin-focused leaders, and its own investor materials suggest that those leaders hold influence on the decisions of the company. Equity markets seem to hold the same viewpoint. MSTR started buying bitcoin in 2020, and since fiscal year end 2020, the stock has traded at a median 11% premium to its bitcoin holdings on a per share basis. In early February 2024, this changed as bitcoin rallied and the stock now stands at a whopping 91% premium to its bitcoin holdings. Investors are now paying $1.91 for $1 of bitcoin and shares in a company that has not produced EBITDA of over $100 million since 2016. Hard to wrap your head around, yes, but historically speaking, inconsistent. To benefit from this situation, an investor can simply rely on mean reversion, by taking a short position in MSTR and a long position equal to the amount of bitcoin value per MSTR share.

Risks

Not a Perfect Hedge: As will be seen in the economics below, one cannot perfectly hedge out bitcoin exposure (unless there is a way in which you can, and I am wrong). For example, an investor could short a stock at $120/share, with the shareholding $100 of bitcoin, and go long $100 of bitcoin, in hopes of capturing the 20% premium upon convergence. If bitcoin prices rise 20%, the investor makes 20% on his long position. On the other hand, the share now holds $120 of bitcoin and if the premium holds the same, the share now trades for $144, causing the investor to lose $4 overall. The perfect hedge in this example, and in the MSTR scenario, only exists if the bitcoin premium sinks to 0%.

Margin Calls and Mark to Market Losses: While in my opinion, the MSTR bitcoin holdings premium will fall in the long-term, this may not hold true in the short-term. This trade hedges that risk to some degree, but investors could still face massive short-term losses and potentially face margin calls. To give context, MSTR briefly traded to a 266% premium on its bitcoin holdings in early 2021. A return to that valuation, even if brief, would send MSTR shares up over 100%.

Meme Risk: There is massive and unpredictable meme risk associated with any stock, meaning stock x could go hyperbolic if some guy on reddit convinces other guys to buy stock x. This is especially true given that the company is heavily associated with bitcoin.

Borrowing costs: This write up and the proposed economics are not inclusive of borrowing costs associated with shorting the stock, or any transaction fees associated with trading either security. As of March 28th, 2024, borrow rates for MSTR shares are just under 5%.

IBIT Correlation with Bitcoin: While IBIT is designed to track Bitcoin spot prices, it is a new security (listed in January of 2024) with not much historical track record to study. However, its coefficient of correlation thus far is .936 in relation to Bitcoin spot prices, i.e., it is highly correlated with Bitcoin spot prices.

Economics

Current Bitcoin Premium: As of end of day 3/28/2024, MSTR trades at $1,705 per share or a market cap of $28.9 billion. This is a 91% premium to MSTR bitcoin holdings of $892 per share. If we throw an average NASDAQ price/sales multiple of 5x on LTM revenues (which is very generous), bringing the company’s operations to a market cap of $2.5 billion, the premium is 75%. To reiterate, the company has traded at a median 11% premium to its bitcoin holdings over the past three years.

The Trade: As aforementioned, the proposed trade involves shorting shares of MSTR and going long the value of the bitcoin per MSTR share. In this case, we will go short one share of MSTR, with bitcoin holdings of $892. To hedge the bitcoin price risk, we will go long 22 shares of IBIT, a bitcoin ETF that trades at $40 per share. If the MSTR bitcoin premium were to move down to just 60%, investors would be completely shielded from net losses assuming bitcoin stays within 50% of its current price in either direction.

Returns: Under our base case scenario, in which MSTR trades down to last quarter’s median premium to its bitcoin holdings (21%), the investor makes a gross ROI of 24% assuming no bitcoin movement. Obviously bitcoin is volatile and will likely move, and its movements will affect returns. That affect can be seen in the below graphic. In the bull case, MSTR trades down to its three-year median premium of 10%, and the investor makes 29% assuming no bitcoin movement. The bear case assumes that MSTR trades to a 150% premium on its bitcoin holdings, and the investor loses 20% assuming no bitcoin movement.

Conclusion: While this trade is by no means arbitrage, and is not completely unexposed to bitcoin price fluctuations, the current MSTR premium to its bitcoin holdings is not permanent in my opinion. Investors can also be reasonably confident that MSTR should trade like a pot of bitcoin, with an unsubstantial software business attached to it. If these two points of view hold true, investors can achieve a market beating return with limited long-term downside.