Author: 100y Compiler: Luffy, Foresight News

If you can live to tomorrow, this Could mean: a) you're more likely to live forever, or b) you're closer to death.

——"Black Swan" by Nassim Nicholas Taleb

Two years have passed since FTX filed for bankruptcy in November 2022. The market seemed to have forgotten the collapse of FTX and Terra and quickly recovered, with Bitcoin reaching the $100,000 mark.

While the market's steady rise is exciting, as an investor entering the crypto market in 2020, I have witnessed so many crashes that I can't help but worry. What a black swan event would be.

FTX and Terra's collapse have different causes, processes and results, but they have an obvious similarity: virtuous circles and vicious circles. Both structures can achieve explosive growth under favorable market conditions, but can also fall into an endless death spiral when things go bad.

Currently, similar characteristics are also reflected in another entity, MicroStrategy. I personally think MicroStrategy is less risky than FTX and Terra, but its use of debt to buy Bitcoin is not without its dangers. I want to discuss this briefly.

1. Current situation 1.1 Company profile

MicroStrategy was originally founded by Michael Saylor in 1989 as a business intelligence company. In its early days, the company focused on analytics software, eventually expanding into mobile apps and cloud services as technology advanced.

Source: companiesmarketcap.com

< p style="text-align: left;">The company went public in 1998 with an initial valuation of approximately $1 billion. Except for a brief period during the dot-com bubbleOutside of the surge, MicroStrategy's market capitalization has been hovering around $1 billion, and it remained a relatively uninspiring stock into 2020. However, everything changed on August 11, 2020, when MicroStrategy announced its first purchase of Bitcoin as a public company. Since then, it has continued to accumulate BTC, driving its market cap to grow exponentially and now stands at approximately $90 billion. 1.2 Where do funds come from?

Source: SaylorCharts

MicroStrategy purchased a total of 402,100 BTC at an average price of $58,263, which is approximately 1.9% of the total Bitcoin supply of 21 million, which is an astonishing number. The company primarily funds its Bitcoin purchases in three ways:

1.2.1 Cash Reserves

Source: SEC

As a software company Company, MicroStrategy generates revenue through product licensing, subscription services and product support. The company's core business generated revenue of approximately $499 million in 2022 and approximately $496 million in 2023, according to its 10-K report.

After deducting costs and operating expenses (excluding cryptocurrency price fluctuations), MicroStrategy will post a surplus of $10.5 million in 2022 and $800,000 in 2023. These funds can be used to purchase BTC or pay interest on existing debt.

1.2.2 Convertible Senior Notes and Stock Issuance

Source: MicroStrategy 2024 Third Quarter Report

MicroStrategy's primary way of raising capital is through the issuance of convertible senior notes. As of third-quarter 2024 financial results, the company had accumulated approximately $4.26 billion in debt through such notes, with an average annual interest rate of 0.811% and annual interest expense of $34.6 million.

Most recently, on November 21, 2024, MicroStrategy issued an additional $3 billion in convertible senior notes. That brings its total debt to more than $7 billion. Notably, the new $3 billion in notes carries a 0% coupon, meaning no interest charges will be incurred. In return, investors can convert the notes into shares in the future at a 55% premium.

In addition to the convertible notes, MicroStrategy is also conducting stock offerings. In the third quarter of 2024, the company issued $1.1 billion worth of Class A common stock.

MicroStrategy announced plans to raise a total of $42 billion over the next three years (2025 to 2027). Of this amount, $21 billion will come from equity issuances and the remaining $21 billion will be raised through fixed income issuances. The specific timelines are: $5 billion from each funding source in 2025, $7 billion in 2026, and $9 billion in 2027.

1.3 Some interesting statistics

Here are some interesting statistics and facts about MicroStrategy:

Source: SaylorCharts

Bitcoin purchased by MicroStrategy Average price is 58,263 U.S. dollars, its Bitcoin holdings have a total market value of $38.5 billion and a book value of $23.4 billion, resulting in unrealized gains of approximately $15 billion.

Source: MSTR-tracker

< p style="text-align: left;">MicroStrategy’s market valuation is approximately 2.2 times its Bitcoin holdings. This valuation disparity is why funds like Citron are shorting MicroStrategy stock.

Source: MSTR-tracker

< p style="text-align: left;">Although the number of shares increased due to the stock issuance, the price of BTC per basic share actually increased. This is because MicroStrategy is buying Bitcoin at a rate that outpaces the dilutive effect of additional stock issuances. 2. Is Microstrategy the next FTX?

While structural issues played a role in the collapse of FTX and Terra, the moral hazard of their founders also played a role. By definition, black swan events are inherently unpredictable, so it is impossible to assess whether there is ethical risk within MicroStrategy based on publicly available information. Therefore, the focus here will be on analyzing structural risks.

While this discussion topic sounds grand, the structural risk involved in MicroStrategy is actually very simple: investing in Bitcoin with leverage. If the company only invested its equity in Bitcoin, the impact of the price collapse would be relatively small.

Source: MicroStrategy

However, as highlighted in the Q3 2024 report, MicroStrategy's goal is to use prudent leverage to acquire as much BTC as possible, increase shareholder value, and grow beyond Bitcoin itself. Performance.

As we all know, leverage is a double-edged sword. Leverage itself is accompanied by debt interest costs. If the value of BTC purchased with leverage falls, the company may be forced to sell Assets held to repay debts.

Michael Saylor has repeatedly stated in the media that he has no intention of selling BTC, which means that any forced liquidation could seriously affect the value of the company. This could lead to a decline in MSTR’s share price and future financialFunding difficulties. The collapse of leverage strategies could also have a major knock-on effect on the market.

To evaluate whether MicroStrategy's leverage strategy is sustainable, I will look at two key aspects:

Interest costs

Sustainable fluctuations

2.1 Can MicroStrategy control interest costs?

First, let's consider interest costs. With the recent issuance of $3 billion of convertible senior notes at a 0% coupon rate, MicroStrategy has total debt of approximately $7.3 billion, an average interest rate of 0.476%, and annual interest expense of $34.6 million. The key question is: Can MicroStrategy continue to make these interest payments?

Source: SEC

In addition, MicroStrategy generates significant revenue from its core business of business intelligence software. What's concerning, however, is that residual profits after revenue and operating expenses are relatively small and have been declining.

The scale of future debt cannot be ignored. As previously mentioned, MicroStrategy plans to issue an additional $21 billion in convertible senior notes over the next three years. That would increase its total debt to $28.3 billion. At the current average interest rate of 0.476%, annual interest payments could rise to $134.7 million, which could be an unaffordable amount in the long run.

While MicroStrategy recently eased its interest burden by issuing 0% coupon bonds, the company's continued access to this low-interest debt remains uncertain. This issue is explored further in the next section.

2.2Is fundraising sustainable in the future?

2.2.1 Will investors continue to provide funds?

Source: MicroStrategy

The primary issue is the sustainability of financing. While the current positive sentiment in the cryptocurrency market has made it easy to obtain financing, historical data shows that MicroStrategy did not issue any convertible senior notes between February 2021 and March 2024. This period coincides with the period from the 2021 Bitcoin crash to the recent market recovery.

Source: Bitbo

Although there is no conclusive evidence, Bitcoin's price cycle has historically been consistent with its four-year halving cycle. This points to a high likelihood of a bear market around 2026-2027, with the BTC long-term power law model suggesting a potential price floor of $53,000-$70,000 during this period. Considering MicroStrategy's average Bitcoin purchase price is $58,000, a bear market could make financing difficult.

2.2.2 Volatility is crucial

Source: MicroStrategy

In addition to the price of Bitcoin, volatility for convertible senior notes The sustainability of financing also plays an important role.

Some readers may ask: Why is MSTR stock trading at more than 2x its net asset value (NAV)? Why did investors participate in the recent issuance of $3 billion of convertible senior notes with a coupon rate of 0%?

Source: MicroStrategy

The key to these issues is volatility. Bitcoin and MSTR exhibit significantly higher volatility compared to other assets, which is attractive to investors. MicroStrategy even highlighted the volatility of its stock in its Q3 2024 IR report.

High volatility enables a variety of trading strategies such as delta hedging, gamma trading, and volatility arbitrage.

Delta measures the sensitivity of an option price to changes in the underlying asset price.

Gamma measures the change in delta as the price of the underlying asset changes.

Gamma trading takes advantage of these changes to profit from market fluctuations, making higher volatility profitable.

Source: MSTR-tracker

< p style="text-align: left;">Because Bitcoin is more volatile than traditional stocks, and MSTR amplifies that volatility through leveraged purchases of Bitcoin, MSTR stock and its convertible senior notes have attracted hedge fund interest Great interest. The notes are not just a debt instrument but a call option that allows the holder to convert them into stock at a specific price, further adding to their appeal.

Source: Bitbo

For MicroStrategy to maintain smooth funding, volatility in BTC and MSTR must persist. However, with the approval of Bitcoin ETFs and the continued entry of institutional investors, the market is becoming more stable and volatility is gradually decreasing. If Bitcoin volatility decreases, MSTR's NAV premium could shrink, affecting its stock price and making the financing attractiveness of its convertible senior notes less attractive.

3. In the end, price is the most important

In the final analysis, the most critical factor is the price of Bitcoin. What if the cryptocurrency market didn’tAfter a downturn, FTX could become a major exchange rivaling Binance. Likewise, if Curve Finance’s UST pool had not been attacked, Terra could have become the third largest network after Bitcoin and Ethereum.

If the price of BTC continues to rise steadily, MicroStrategy's current strategy could form a positive flywheel that drives explosive growth for the company and the cryptocurrency market. However, if the price of BTC plummets, the worst-case scenario is that MicroStrategy sells its Bitcoin holdings to pay off debt, triggering a vicious death spiral.

Thankfully, MicroStrategy's debt is unsecured. The company had previously issued bonds backed by Bitcoin, but they were not fully repaid until the third quarter of 2024. If Bitcoin remains as collateral, being forced to liquidate if repayments are difficult could have disastrous consequences.

In my personal opinion, MicroStrategy does not appear to be facing significant immediate risks. Its interest costs remain manageable and its capital raising has been going well so far. However, the scale of future planned financings is unprecedented, and the volatility of the underlying asset Bitcoin is expected to decrease. Therefore, I expect risk levels to become higher between 2025 and 2027.

Bitcoin’s value is growing rapidly, becoming a challenger to its gold status. But the question remains: will MicroStrategy continue to buy BTC in a sustainable manner to become one of the most powerful companies in the world? Or will it become another cautionary tale, trapped in the tulip bubble narrative? Only time will tell.