Evaluating MicroStrategy: A Leveraged Bitcoin Fund or Risky Gamble?

Mid Caps 2 replies 0 votes 2367 views Tags:  BitcoinCryptocurrencydebtFinancial AnalysisInvestmentleverageMicroStrategyrisk assessmentSEC litigationStock Market

Recently, I've been on the lookout for potential financial warning signs, and one company that caught my attention is MicroStrategy. In my opinion, it seems like MicroStrategy is essentially a leveraged Bitcoin fund posing as a company. Now, don't get me wrong, I don't have anything against Bitcoin itself, but I believe that if investors want to own Bitcoin, they can simply buy it directly.

One concern I have is MicroStrategy's excessive leverage on Bitcoin. It raises questions about their management's decision to make speculative investments. Instead of investing in something like Bitcoin, which may not be suitable for all investors, I think it would be wiser for a company with extra cash to consider paying out dividends to shareholders. This way, shareholders who are interested in Bitcoin can make their own investment decisions.

Additionally, MicroStrategy's heavy reliance on Bitcoin as a significant part of its capital structure raises concerns about its ability to pay back creditors. It's important to diversify and not put all your eggs in one basket, especially when leveraging to such an extent.

To assess the risks, let's do a pot odds analysis. It involves evaluating the potential downside, upside, and the probability of each scenario. Looking at MicroStrategy's debt stack, we can see that the amount due in 2025 and 2027 is approximately half the value of its Bitcoin holdings. However, the 2028 bonds are secured by a portion of Bitcoin holdings, which cannot be sold. This means that the breakeven price for MicroStrategy would be around 15k when the first bond matures.

Taking a closer look at the options market, the 15k strike put option expiring in December 2024 suggests a 12% probability of bankruptcy based on its delta. However, I believe the actual probability is higher, likely around 15% due to the contango nature of the Bitcoin futures market.

Moving on, another immediate concern for MicroStrategy is the lack of current assets to fund its working capital needs. With current assets lower than liabilities and consistently negative EBIT, the company continues to burn cash. Given the decline in Bitcoin prices and higher interest rates, issuing more debt might not be feasible, and trust in crypto-related companies has been shaken recently.

This leaves MicroStrategy with limited options, and stock dilution appears to be the most likely course of action. While the increase in outstanding shares hasn't had a significant impact on the market yet, there's a risk that if the company continues to issue more shares, the stock price could eventually trade below the Net Asset Value (NAV) of its Bitcoin holdings. This would defeat the purpose for many investors who initially bought the stock as a leveraged play on Bitcoin.

Furthermore, there's a potential risk of SEC litigation, as we've seen with other companies in the crypto space. MicroStrategy has a history of lawsuits, which can negatively affect public perception and raise concerns about management ethics.

Now, you might be wondering why anyone would buy this stock. Well, my belief is that if someone is bullish on Bitcoin, it makes more sense to buy Bitcoin directly rather than going through MicroStrategy. Bitcoin was designed to be a decentralized, bearer asset, and buying it in your own custody eliminates the idiosyncratic risk associated with the company. Nowadays, Bitcoin attracts a broader audience, primarily retail investors looking for upside potential rather than philosophical reasons.

To address the risks, one option is to hedge by doing a long-short trade, buying Bitcoin and shorting MicroStrategy. Another approach, which I prefer, is to purchase far-dated, deep out-of-the-money put options.

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