Under the leadership of Executive Chairman Michael Saylor, the company formerly known as MicroStrategy has accumulated 506,137 bitcoin (BTC), valued at around $44 billion at current BTC prices, over the past five years. While it may appear that the company has an endless supply of funds to purchase more bitcoin, Strategy actually acquired a significant portion of its holdings by issuing billions of dollars in equity and convertible notes, and more recently through the issuance of preferred stock.
However, with the recent 20% drop in the price of bitcoin from its peak of over $109,000 two months ago, Strategy’s average acquisition price has risen to $66,000. This leaves the company vulnerable to potential losses if the price of bitcoin continues to decline.
Could Strategy’s financial maneuvers backfire if bitcoin prices continue to fall?
According to Quinn Thompson, founder of crypto hedge fund Lekker Capital, it is unlikely that Strategy will face a scenario where it needs to liquidate its bitcoin holdings due to margin calls. The debt incurred by the company is likely to be refinanced, and the issuance of perpetual preferred stock provides a source of dividends for investors.
While Strategy has taken steps to mitigate risk, such as refraining from using its bitcoin holdings as collateral for loans, there is still uncertainty for MSTR investors. Saylor may be forced to issue more equity than the market can absorb in order to sustain the company’s operations.
Saylor’s financial balancing act
Strategy currently utilizes three methods to raise capital: equity issuance, convertible notes, and preferred stock.
Issuing equity involves creating new MSTR shares, selling them on the market, and using the proceeds to purchase bitcoin. This can create selling pressure on MSTR and potentially drive down the stock price.
Convertible notes have allowed Strategy to raise funds quickly without diluting MSTR stock. These notes offer investors a solid yield with the potential to benefit from stock surges.
Preferred stocks provide investors seeking lower volatility and predictable returns through dividends with an opportunity to invest in Strategy. The company offers two types of preferred stock: STRK with an 8% annual return, and STRF with a 10% annualized return.
By offering various investment vehicles, Strategy aims to attract different types of investors with varying risk tolerances, according to Jeffrey Park, head of Alpha Strategies at Bitwise.
Potential risks
Despite its strategic financial moves, Strategy now faces the challenge of paying dividends on STRK and STRF, as well as interest on its convertible bonds.
With limited cash flow from its software business, finding the funds to cover these obligations may prove difficult for Strategy. The company may need to continue issuing MSTR stock to meet its financial commitments, potentially impacting the stock price.
In the worst-case scenario, Strategy’s stock could trade at a discount due to the need to issue shares to cover interest payments and cash flow. Shareholders may demand share buybacks to close the discount, similar to what happened with Grayscale’s GBTC prior to its conversion into an ETF.
While Strategy currently adds value by selling stock at elevated prices to buy bitcoin, the situation may reverse in the future, where selling bitcoin to buy stock could be the best way to enhance shareholder value.
But that’s quite far away.
Saylor lost controlling voting power over the company in 2024 due to the continuous issuance of MSTR stock, meaning that the scenario above could theoretically happen, especially if activist investors decided to get involved.
Another potential risk for MSTR holders is that the 2x long Strategy exchange-traded funds (ETFs) issued by T-Rex and Defiance, MSTX and MSTU, have seen weirdly persistent demand despite the stock’s drawdown. Every time investors want to gain or increase their exposure to these ETFs, the issuers have to buy twice as many MSTR shares. The popularity of these ETFs has helped create constant buying pressure for MSTR — so far, they’ve accumulated over $3 billion in MSTR exposure.
The problem is that the music might stop someday. And if these ETFs begin to sell off their MSTR shares, the reaction on the stock price could be violent.
“I don’t know where the endless capital comes from to buy the dip. These ETFs have gotten obliterated. They’re down huge,” Thompson said. “I mean, this is not a structural move up in the demand curve that you should count on. It’s not something you should really bake into your 10-year predictions of bitcoin price, but as long as it’s existing, it’s important for bitcoin. So I’m continually amazed by it.”
