Author: @Web3_Mario

Abstract: Last week we discussed how Lido has benefited from changes in the regulatory environment potential, I hope it can help everyone seize this wave of Buy the rumor trading opportunities. There is a very interesting theme this week, which is the popularity of MicroStrategy. Many seniors have commented on the company's operating model. After digesting and studying it in depth, I have some opinions of my own that I hope to share with you. I think the reason for the rise in MicroStrategy's stock price is due to the "Davis Double Click", a business design to purchase BTC through financing, binding the value-added of BTC to the company's profits, and obtaining financial leverage through an innovative design that combines traditional financial market financing channels. This gives the company the ability to exceed the profit growth brought about by the appreciation of the BTC it holds. At the same time, with the expansion of its holdings, the company has certain BTC pricing power, further strengthening this profit growth expectation. This is also the risk. When the BTC market fluctuates or reverses, BTC's profit growth will stagnate. At the same time, affected by the company's operating expenses and debt pressure, MicroStrategy's financing capacity will be greatly reduced, thereby affecting profit growth expectations. , unless there is new help to take over and further push up the price of BTC, the positive premium of MSTR stock price relative to BTC positions will quickly converge. This process is the so-called "Davis Double Kill".

What is Davis double-click and double kill

Friends who are familiar with me should know that the author is committed to helping more non-financial majors understand these dynamics. Therefore, it will replay its own thinking logic. Therefore, first of all, let's add some basic knowledge about what "Davis Double Click" and "Double Play" are.

The so-called "Davis Double Play" was proposed by investment guru Clifford Davis, and is usually used To describe the phenomenon of a company's stock price rising sharply due to two factors in a good economic environment. These two factors are:

Company profit growth: the company has achieved strong profit growth, or the optimization of its business model, management, etc. has led to an increase in profits .

Valuation expansion: As the market becomes more optimistic about the company's prospects, investors are willing to pay a higher price for it, thus promoting an increase in stock valuations. In other words, the price-to-earnings ratio (P/E) of a stockRatio) and other valuation multiple expansion.

The specific logic of stimulating "Davis Double Click" is as follows. First, the company's performance exceeded expectations, and both revenue and profits were growing. For example, good product sales, market share expansion or cost control success, etc., will directly lead to the company's profit growth. This growth will also increase the market's confidence in the company's future prospects, causing investors to be willing to accept a higher P/E ratio, pay a higher price for the stock, and valuations will begin to expand. This combination of linear and exponential positive feedback effects usually leads to an accelerated rise in stock prices, which is the so-called "Davis Double Click".

As an example to illustrate this process, assume that a company's current price-to-earnings ratio is 15 times and its future earnings are expected to grow by 30%. If investors are willing to pay a P/E ratio of 18 times due to the company's earnings growth and changes in market sentiment, then even if the earnings growth rate remains unchanged, the increase in valuation will push the stock price to rise significantly, for example:

Current stock price: $100

Earnings growth of 30% means earnings per share (EPS) increased from $5 to $6.5 .

P/E ratio increased from 15 to 18.

New stock price: $6.5 × 18 = $117

The stock price rose from $100 to $117, It reflects the dual effects of profit growth and valuation improvement.

"Davis Double Kill" is the opposite. It is usually used to describe the rapid decline in stock prices caused by the combined action of two negative factors. These two negative factors are:

Decrease in the company's profitability: The company's profitability has declined, which may be due to factors such as reduced revenue, rising costs, management errors, etc. Earnings were lower than market expectations.

Valuation contraction: Due to declining earnings or worsening market prospects, investors' confidence in the company's future declines, resulting in a decline in its valuation multiples (such as price-to-earnings ratios). Stock prices fell.

The whole logic is as follows. First, the company fails to achieve the expected profit target or faces operating difficulties, resulting in poor performance and declining profits. And this will go furtherThis makes the market's expectations of its future worse, and investors lack confidence and are unwilling to accept the current overvalued price-to-earnings ratio. They are only willing to pay a lower price for the stock, which leads to a decline in the valuation multiple and a further decline in the stock price.

Also give an example to illustrate this process. Suppose a company's current price-to-earnings ratio is 15 times and its future earnings are expected to drop by 20%. As earnings fell, the market began to cast doubt on the company's prospects, and investors began lowering its price-to-earnings ratio. For example, lower the P/E ratio from 15 to 12. The stock price may fall significantly as a result, for example:

Current stock price: $100

Profits drop 20% , meaning earnings per share (EPS) fell from $5 to $4.

P/E ratio dropped from 15 to 12.

New stock price: $4 × 12 = $48

The stock price fell from $100 to $48, It reflects the dual effects of declining earnings and shrinking valuations.

This resonance effect usually occurs in high-growth stocks, especially in many technology stocks, because investors are usually willing to pay for the future growth of these companies' businesses. Given high expectations, however, such expectations are usually supported by relatively large subjective factors, so the corresponding volatility is also large.

How MSTR’s high premium is caused, and why it becomes the core of its business model

After supplementing this background knowledge, I think everyone should be able to roughly understand How MSTR’s high premium relative to its BTC holdings came about. First of all, MicroStrategy has switched its business from traditional software business to financing the purchase of BTC. Of course, it does not rule out corresponding asset management revenue in the future. This means that the company’s profits come from capital gains on the appreciation of the BTC it purchases with funds obtained from equity dilution and debt issuance. As the value of BTC increases, the shareholder rights of all investors will increase accordingly, and investors will benefit. In this regard, MSTR is no different from other BTC ETFs.

What makes the difference is that its financing capacity brings leverage effect, because MSTR investors’ expectations for the company’s future profit growth are derived from the growth of its financing capacity. The leverage gains obtained, taking into accountThe total market value of MSTR's stocks is at a positive premium relative to the total value of its BTC holdings, which means that the total market value of MSTR is higher than the total value of its BTC holdings. As long as this positive premium is in place, both equity financing and its convertible debt financing, along with the purchase of BTC with the funds obtained, will further increase equity per share. This gives MSTR the ability to grow profitably unlike BTC ETFs.

For example, assume that the current BTC held by MSTR is 40 billion US dollars, the total outstanding shares are X, and its total market value is Y. Then the equity per share at this time is 40 billion / X. If financing is carried out with the most unfavorable equity dilution, assuming that the proportion of new shares issued is a, this means that the total outstanding shares become When all these funds are converted into BTC, the BTC holdings will become 40 billion + a * Y billion, which means that the equity per share becomes:

We subtract it from the original equity per share to calculate the increase in diluted equity for equity per share, as follows:

This means that when Y is greater than 40 billion, which is the value of the BTC it holds, which means there is a positive premium, the completion of the financing purchase of BTC will bring about The equity growth is always greater than 0, and the greater the positive premium, the higher the equity growth per share. The two are called a linear relationship. As for the impact of the dilution ratio a, it shows an inverse proportion in the first quadrant, which means that the fewer additional shares are issued. , the higher the equity growth rate.

So for Michael Saylor, the positive premium between the market value of MSTR and the value of the BTC he holds is the core factor for the establishment of his business model, so his optimal choice It is to protect this premium while continuing to raise funds, increase its market share, and gain more pricing power over BTC. The continuous enhancement of pricing power will enhance investors' confidence in future growth despite high price-to-earnings ratios, allowing them to complete fundraising.

To summarize, the secret of MicroStrategy’s business model is that the appreciation of BTC drives the company’s profits to rise, while the growth trend of BTCA positive trend means that the company's profit growth trend is improving. With the support of this "Davis Double Click", MSTR's positive premium has begun to amplify, so the market is betting on how high a positive premium valuation MicroStrategy can complete the follow-up Financing.

What are the risks MicroStrategy brings to the industry

Next let’s talk about the risks MicroStrategy brings to the industry. I think the core is that this business model will Significantly increases the volatility of BTC prices and acts as an amplifier of fluctuations. The reason is the "Davis Double Kill", and BTC's entry into a period of high volatility is the stage where the entire domino chain begins.

Let us imagine that when the growth of BTC slows down and enters a period of shock, MicroStrategy's profits will inevitably begin to decline. Here I would like to expand on the following, I saw that some friends attach great importance to the cost of holding positions and the scale of floating profits. This is meaningless because in MicroStrategy's business model, profits are transparent and equivalent to real-time settlement. In the traditional stock market, we know that the real factor that causes stock price fluctuations is financial reports. Only quarterly financial reports are announced, and the real profits are The level will be confirmed by the market. During this period, investors only estimate changes in financial conditions based on some external information. In other words, most of the time, the reaction of stock prices lags behind the company's actual earnings changes, and this lagging relationship will be corrected when each quarterly financial report is released. However, in MicroStrategy's business model, since its position size and BTC price are public information, investors can understand its true profit level in real time, and there is no lag effect, because the equity per share changes dynamically with it. Equivalent to real-time settlement of profits. In this case, the stock price has truly reflected all its profits, and there is no lag effect, so it is meaningless to pay attention to its holding costs.

Bringing the topic back, let’s take a look at how the “Davis Double Kill” unfolded. When the growth of BTC slowed down and entered the oscillation stage, MicroStrategy’s Profit will continue to decrease, or even return to zero. At this time, fixed operating costs and financing costs will further reduce corporate profits, or even be in a state of loss. At this time, this kind of shock will continue to erode the market’s confidence in the subsequent BTC price development. This will translate into doubts about MicroStrategy's financing capabilities, which will further undermine expectations for its earnings growth. Under the resonance of the two, MSTR's positive premium will quickly converge. In order to maintain the establishment of his business model, Michael Saylor must maintain a positive premium status.. So selling BTC in exchange for funds to buy back stocks was a must-do operation, and this was the moment MicroStrategy started selling its first BTC.

If a friend wants to ask, just hold the BTC and let the stock price fall naturally. My answer is no. To be more precise, it is not possible when the BTC price reverses. It can be tolerated appropriately when it fluctuates. The reason is MicroStrategy’s current ownership structure and what is optimal for Michael Saylor. untie.

According to the current shareholding ratio of MicroStrategy, there are many top consortiums, such as Jane Street and BlackRock, while Michael Saylor, the founder, only accounts for Less than 10%. Of course, through the dual-class share design, Michael Saylor has an absolute advantage in voting rights, because the shares he holds are more Class B ordinary shares, and the voting rights of Class B ordinary shares are less than those of Class A. The class is a 10:1 relationship. So the company is still under the strong control of Michael Saylor, but his shareholding is not high.

This means that for Michael Saylor, the long-term value of the company is far higher The value of the BTC it holds is because assuming the company faces bankruptcy liquidation, it will not be able to obtain much BTC.

So what are the benefits of selling BTC during the shock phase and buying back shares to maintain the premium. The answer is also obvious. When there is premium convergence, assuming Michael Saylor judges that the P/E ratio of MSTR is undervalued due to panic at this time, it is a cost-effective operation to sell BTC in exchange for funds and repurchase MSTR from the market. Therefore, the effect of repurchase at this time on reducing circulation and enlarging equity per share will be greater than the effect of reducing BTC reserves on reducing equity per share. When the panic ends, the stock price pulls back, and equity per share will change accordingly. High is conducive to subsequent development. This effect is easier to understand in the extreme case of BTC trend reversal and MSTR showing a negative premium.

Considering the current position of Michael Saylor, and when there is a shock or downward cycle, liquidity usually tightens, then when it starts to sellWhen selling, the price decline of BTC will accelerate. The acceleration of the decline will further worsen investors' expectations for MicroStrategy's profit growth, and the premium rate will fall further, which will force it to sell BTC to repurchase MSTR. At this time, the "Davis Double Kill" begins.

Of course, there is another reason that forces it to sell BTC to protect the stock price. The investors behind it are a group of Deep State with good hands and eyes, and it is impossible to watch the stock price return. Zero, and indifference will inevitably put pressure on Michael Saylor, forcing him to assume the responsibility of his market value management. Moreover, recent information found shows that with the continuous dilution of shares, Michael Saylor’s voting rights have fallen below 50%. Of course, no specific source of information has been found. But this trend seems inevitable.

Is MicroStrategy’s convertible bonds really risk-free before maturity

After the above discussion, I think I have fully elaborated my logic. Another topic I hope can be discussed here is whether MicroStrategy has no debt risk in the short term. Seniors have already introduced the nature of MicroStrategy's convertible bonds, so I will not discuss it here. Indeed, its debt duration is quite long. There is really no risk of payment before the maturity date arrives. But my point of view is that its debt risk may still be reflected in advance through the stock price.

MicroStrategy The convertible bond issued is essentially a bond with free call options. When it expires, the creditor can ask the micro-strategy to redeem it with the equivalent value of the previously agreed conversion rate stock. However, there is also protection for the micro-strategy here, that is, the micro-strategy The strategy can actively choose the redemption method and use cash This is relatively flexible. If the funds are sufficient, you can repay more cash to avoid dilution of equity. If the funds are not sufficient, you can buy more stocks. Moreover, this convertible bond is unsecured. Therefore, it is true that the risk brought by debt repayment is not great. Moreover, there is a protection for micro-strategy, that is, if the premium rate exceeds 130%, micro-strategy can also choose to directly redeem the original value in cash, which creates conditions for loan renewal negotiations.

So the creditor of this bond will only have capital gains when the stock price is higher than the conversion price and lower than 130% of the conversion price. In addition, Other than that, there is only the principal plus low interest. Of course, after being reminded by Teacher Mindao, investors in this bond are mainly hedge funds who use it for delta hedging to earn volatility income. So I thought about the logic behind it in detail.

The specific operation of delta hedging through convertible bonds is mainly to purchase MSTR convertible bonds and short-sell an equal amount of MSTR stocks to hedge the risks caused by stock price fluctuations. And with the subsequent price development, hedge funds need to constantly adjust their positions for dynamic hedging. Dynamic hedging usually has the following two scenarios:

When MSTR's stock price falls, the Delta value of the convertible bond decreases because the bond's conversion right becomes less valuable (Closer to "virtual value"). Then more MSTR shares need to be shorted at this time to match the new delta value.

When MSTR's stock price rises, the delta of the convertible bond increases because the bond's conversion rights become more valuable (closer to "in the money"). Then at this time, the portfolio is kept hedged by buying back some of the previously shorted MSTR shares to match the new delta value.

Dynamic hedging requires frequent adjustments when:

The underlying stock price fluctuates significantly: For example, significant changes in the price of Bitcoin cause MSTR stock prices to fluctuate violently.

Changes in market conditions: such as volatility, interest rates or other external factors that affect the convertible bond pricing model.

Usually hedging funds trigger operations based on the change in Delta (such as every change of 0.01) to maintain accurate hedging of the portfolio.

Let's take a specific scenario for illustration, assuming that the initial position of a hedge fund is as follows

Buy $10 million worth of MSTR convertible bonds (Delta = 0.6).

Short $6 million worth of MSTR stock.

When the stock price rises from $100 to $110, the Delta value of the convertible bond becomes 0.65, and the stock position needs to be adjusted at this time. Calculate the number of stocks to be covered as (0.65−0.6)×10 million=500,000. The specific operation was to buy back $500,000 of stock.

When the stock price falls from $100 to $95, the new Delta value of the convertible bonds becomes 0.55, and the stock position needs to be adjusted. The calculation of the need to increase the short stock is (0.6−0.55)×10 million=500,000. Specifically The operation is to short $500,000 of stock

This means that when MSTR. When the price falls, the hedge fund behind its convertible bonds will short-sell more MSTR shares in order to dynamically hedge Delta, further hitting the MSTR stock price. This will have a negative impact on the positive premium, and thus affect the entire business model. Therefore, the risk on the bond side will be fed back in advance through the stock price. Of course, during the upward trend of MSTR, hedge funds buy more MSTR, so it is also a double-edged sword.