A painful history lesson likely awaits MicroStrategy and its shareholders.
This has been a banner year for the stock market. All three major indexes — the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite — have catapulted to multiple record-closing highs, with excitement surrounding artificial intelligence (AI), stock-split euphoria, and optimism following the election of Donald Trump driving gains in 2024.
But in not-so-subtle fashion, cryptocurrencies and cryptocurrency stocks have blown these major stock indexes out of the water. Whereas the Dow, S&P 500, and Nasdaq have delivered year-to-date gains ranging from 19% to 28%, as of the closing bell on Nov. 26, the largest and most prominent cryptocurrency of all, Bitcoin (BTC 1.53%), has generated year-to-date gains of 118%.
Upside has been even more pronounced for the world’s first self-proclaimed “Bitcoin Treasury Company,” MicroStrategy (MSTR 9.94%). Even following a double-digit-percentage pullback during the Nov. 26 trading session, shares of MicroStrategy have gained 460% for the year, and more than 1,800% on a trailing-two-year basis.
Image source: Getty Images.
How MicroStrategy captivated Wall Street’s attention
If you’re wondering how an AI-driven enterprise analytics software company became the face of the cryptocurrency revolution (at least on Wall Street), look no further than the following three catalysts.
To start with, MicroStrategy provided a way for investors to gain access to Bitcoin without having to buy futures contracts or purchase tokens on a random cryptocurrency exchange. Following its latest round of buying activity, MicroStrategy holds 386,700 Bitcoin (as of Nov. 25), which represents 1.84% of the 21 million Bitcoin that’ll ever be mined. No company comes remotely close to holding as many Bitcoin in reserve as MicroStrategy.
It’s often easy for investors to buy or sell shares of companies that trade on major U.S. exchanges, and there’s minimal concern about nefarious activity or theft, which isn’t always the case when buying Bitcoin directly on overseas cryptocurrency exchanges.
Second, MicroStrategy is benefiting from first-mover advantages. In addition to Bitcoin being the first decentralized cryptocurrency, MicroStrategy is the first public company to effectively adopt Bitcoin purchasing/investing as an operating model. Investors have a tendency to flock to businesses that are first movers in ultra-popular trends.
Third, MicroStrategy has found a way, for the moment, to use leverage to its advantage. The company has been issuing ultra-low-yield or 0% yield convertible senior notes to raise capital to purchase Bitcoin. These convertible notes allow the holder to either be repaid in full, or convert their note into shares of MicroStrategy at a premium to where they are now.
On social media message boards, you might see this strategy referred to as “MicroStrategy’s infinite money glitch.” Convertible note sales allow the company to buy more Bitcoin, which in turn increases the price of the world’s largest cryptocurrency and allows the company to issue more convertible notes. It’s a repeating cycle that’s undeniably played a role in pushing Bitcoin close to the psychologically important $100,000-per-token level.
Image source: Getty Images.
A painful history lesson almost certainly awaits MicroStrategy and its shareholders
While there’s no question that MicroStrategy has proved the skeptics wrong, thus far, history has a way of rhyming on Wall Street. Similar leverage-driven scenarios like this have always eventually (key word!) ended in pain for the companies and shareholders behind them.
Perhaps the most front-and-center example of a seemingly can’t-fail leverage scenario that blew up in Wall Street’s face occurred less than 20 years ago.
All the way back in the 1970s, banks began packaging mortgages into more complex products known as mortgage-backed securities (MBSes), which our nation’s leading financial institutions could purchase and sell.
Roughly 20 years ago, banks began taking this highly profitable securitization of loans and applied it to subprime mortgages (i.e., mortgages offered to borrowers with poor credit). Although subprime MBSes offered tantalizing yields, they required subprime borrowers to pay their bills, and for housing prices to continue to climb.
Compared to the prior century of home-price-to-inflation data, the rate home prices were accelerating during the mid-2000s simply wasn’t sustainable. The other critical problem is that subprime borrowers were commonly pushed into adjustable-rate loans that offered low initial payments, but eventually reset and made their payments unaffordable, at least for some subprime borrowers.
Once these subprime MBSes began defaulting, it created a cascade effect for many of America’s largest financial institutions.
To be clear, what’s happening at MicroStrategy isn’t going to topple America’s financial system like subprime MBSes threatened to do during the financial crisis. But it’s the next in a series of examples of leverage being used in (what will be in hindsight) a disastrous way.
It’s not a matter of “if,” but “when” the bubble will burst for MicroStrategy
For MicroStrategy’s “infinite glitch” to work, the company needs buying interest in Bitcoin to remain frothy, as well as for the price of Bitcoin to head higher. However, history conclusively shows that this isn’t sustainable.
Bitcoin Price data by YCharts.
Since Bitcoin trading began 15 years ago, the world’s largest digital currency has undergone seven peak-to-trough pullbacks of at least 50%, including three that exceeded 82%. Crypto bear markets aren’t a walk in the park, and they’ve historically proved unavoidable. If the price of Bitcoin declines by 50% or more, the pressure to pay back its lenders could mount.
To make matters worse, hoarding Bitcoin as a reserve is only going to make the world’s most popular cryptocurrency less liquid. In other words, if MicroStrategy ever has to sell some of its Bitcoin to satisfy its debt obligations, it could lead to a situation that tanks the price of the world’s most prominent digital currency.
But the most glaring flaw of all is the premium being given to MicroStrategy’s Bitcoin assets. Based on a $92,754 price per Bitcoin, as of this writing, MicroStrategy’s Bitcoin portfolio of 386,700 tokens is worth $35.87 billion. But as of the closing bell on Nov. 26, MicroStrategy had an $81.5 billion market cap.
Assigning a very generous $1 billion market value to its declining enterprise analytics software segment — MicroStrategy’s AI software segment is losing money and has seen sales decline by 14% over the last decade — leads to investors paying a 124% premium for the company’s Bitcoin assets.
Mind you, this premium doesn’t take into account its rapidly growing debt obligations, nor does it factor in the possibility of a fully diluted share count of 266.5 million shares (as opposed to the 230.5 million basic shares outstanding its $81.5 billion market cap is based on). On a fully diluted basis, this premium to its Bitcoin assets is even more egregious.
If an investor were optimistic about the future of Bitcoin, they could purchase tokens on a reputable exchange for $92,754, as of this writing. Meanwhile, investors buying MicroStrategy stock are paying north of $208,000 per token based on the current premium of 124%, or almost $244,000 per token on a fully diluted basis with 266.51 million shares outstanding.
Although it’s impossible to precisely pinpoint when a bubble will burst, the tea leaves couldn’t be clearer that this premium, and MicroStrategy’s use of leverage, isn’t sustainable.
