(Micro)Strategy Wasn`t A Free Money Bitcoin Glitch: The Market Is Starting To Catch On

Summary Just as alchemists of old tried to turn lead into gold, today`s crypto entrepreneurs attempt to create money for nothing with supposed "free money glitches." This is most apparent in Microstrategy, now simply renamed "Strategy". MSTR was the subject of a retail trader speculative blitz last fall that is now being unwound. It`s not alchemy– it`s a wealth transfer from retail investors to corporations and sophisticated institutional investors. Why MSTR still only has 59 cents in Bitcoin for each dollar in stock, and why I eventually expect it to trade at a discount. The ancient and medieval worlds were obsessed with the idea of turning lead into gold . This was one of the central quests of the alchemists, who would raise money from the local lords, or the king if they were lucky. But we know now that you can`t turn lead into gold, at least not without a full-scale particle accelerator and a willingness to lose tons of money for the amount of gold you`re going to get. The corporate finance world of today practices a different kind of alchemy, this time using the ones and zeros that underpin the financial system. Today, we have digital gold in Bitcoin ( BTC-USD ). Like gold, it`s worth a lot of money and is expensive to mine. Also like the gold rushes of bygone centuries, Bitcoin drew in prospectors from far and wide looking for an easy fortune. This was apparent in 2021 when the Bitcoin craze reached full blast. Claims of financial alchemy are also back. Last year, proponents of MicroStrategy (now S trategy) ( MSTR ) argued that the company had done what the alchemists of old couldn`t do– earn Bitcoin for nothing. I argued otherwise, publishing on November 18th to beware of the hype and buy Bitcoin instead . I was far from alone . MSTR`s premium to Bitcoin peaked on November 20th. What Is Going On At Microstrategy? Since November, the company has changed its legal name from Microstrategy to just "Strategy." While it`s a brilliant (and hilarious) exercise in branding, the stock is down about 25% since then, vs. 9% for Bitcoin. Investor interest in MSTR ebbs and flows, but this trend is very likely to continue, albeit with big swings in both directions. A few weeks ago, the spread was significantly higher than it is now. All the while, MSTR is aggressively selling stock and buying Bitcoin. I`ll make a simple argument here. You should do what MSTR does and not what they say. That means sell MSTR (if you own it) and buy Bitcoin instead. It`s simple supply and demand, and the trade works because the market value of MSTR is still higher than its Bitcoin. Therefore, MSTR can keep issuing stock to buy Bitcoin. It`s not actually alchemy, rather, it`s a wealth transfer that is set up between retail investors overpaying for MSTR and the company buying Bitcoin on the open market. History shows that this is not sustainable. A similar trade came into play with the Grayscale Bitcoin Trust ( GBTC ), which traded at a huge premium to its Bitcoin, and then later at a huge discount. I made money on that trade by simply exercising common sense. More on this later. The cumulative price change in MSTR vs. BTC over the last year is below. I expect this gap to continue to close and eventually go negative to account for the substantial operating costs that MSTR has and Bitcoin itself doesn`t. Data by YCharts As of the latest tally , MSTR has 528,185 Bitcoins. As of yesterday`s close, the market price of Bitcoin is $83,825. That means MSTR`s Bitcoin stash is currently worth about $44.3 billion. But MSTR`s market cap is $75.4 billion. Knowing the math here is important so that you can do it yourself shorthand in the future. Currently, there`s only about 59 cents in Bitcoin for each dollar of MSTR stock. That means that MSTR stock is only worth about ~$170, vs. a market price of ~$288. Going forward, I`d expect that the value of MSTR`s stock will go down, while the value of the Bitcoin per share should go up a little more. In a weakening economy, Strategy is not likely to find an endless supply of people willing to pay a premium to their NAV, especially since more and more of them are getting burned by the falling stock price. Is MSTR A Free Money Glitch? In short, no. Retail investors drove the price of MSTR skyward last fall, and the company responded by selling as much stock as was humanly possible to them. Those who bought at the peak are already nursing some substantial losses, which they would have largely avoided by buying Bitcoin. A few points on MSTR: Convertible debt is not free money. For one, they dilute shareholders, and for two, the way that institutions trade them is to do convertible arbitrage by delta hedging, meaning they buy the debt and short the stock. Decades of research show that this works a lot like the company simply selling stock in the first place. While Strategy CEO Michael Saylor`s decision in 2020 to issue convertible debt to buy Bitcoin was brilliant, we should understand it for what it was– an all-in bet on Bitcoin with borrowed money. This is not the same thing as MSTR discovering a corporate finance loophole that gives them a free money glitch. Selling shares is not free money. Basic supply and demand here– when MSTR sells stock to investors, it creates supply, which pushes the price of MSTR stock down in equilibrium. When the company buys Bitcoin, it creates demand for Bitcoin and pushes the price of Bitcoin up in equilibrium. These trades with MSTR are getting quite large, this is likely to ramp up this trend. Preferred stock is definitely not free money. MSTR recently raised over a billion dollars in preferred stock in two issues , one that had a roughly 11.7% yield at issue ( STRF ), and another with a convertible option paying 9.5% ( STRK ). From a company perspective, borrowing money at 11.7% is expensive, and maybe a sign that the market isn`t going to lend them endless money. From an investor perspective, these are a little more interesting as you can get higher on the capital stack and can potentially benefit from the ongoing dilution. Of these, I think STRF is the most interesting, paying 10.7% after catching a bid off the offering price. The risks of the preferred are that the company`s only current sources of cash flow are investing in Bitcoin and issuing stock, but I think it could make sense as a short-term yield play in some cases. It`s still obviously pretty risky, though. I estimate that MSTR currently has an operating income of -$1 billion to -$2 billion per year. Last year they lost $1.85 billion . If you wanted to invest in a Bitcoin fund, you`d likely rather not have it be attached to a money-losing business with 1500+ employees . If we were to compare MSTR to an ETF on an apples-to-apples basis, that`s effectively an expense ratio of 4% of NAV. Can MSTR make it up with leverage? Perhaps a little, but MSTR has very limited ability to borrow money to buy Bitcoin, except through convertible debt, which the studies show functions much like selling equity. If you consider the preferred stock as borrowing, then they`re paying double-digit interest rates to buy Bitcoin. Chances are that you could borrow cheaper yourself. I personally hold the opinion that if retail investors want to punt on MSTR, then they should be allowed to. At the same time, retail investors don`t really have the full story of how corporate finance works, in particular with MSTR. MSTR Should Probably Trade At A Discount To Its Bitcoin What is a fair price for a company that has a money-bleeding underlying business and a big stash of Bitcoin? I`d argue that the fair price is a discount to NAV. We clearly saw this in GBTC, which had a 2% management fee and traded at a steep discount to NAV before it converted to an ETF. In fact, for much of MSTR`s history, it has traded at a discount to its Bitcoin. The graph below covers MSTR vs. the value of its Bitcoin from 2020 to December 2024, from an excellent Substack piece by Sumit`s Investment Takes: MSTR Vs. Its Bitcoin (Substack) To me, this is telling that MSTR`s rise in price is not alchemy. Rather, investors got carried away in a fad in 2024 that is now correcting. In other words, this is not a free money glitch. GBTC Premium/Discount (Substack) Here we see the same dance in GBTC, which traded at a 100% premium and then a 50% discount to its Bitcoin. I bought it at a discount and sold it at par. For MSTR, the same playbook would necessitate selling at a premium and buying Bitcoin. More evidence that Strategy might not deserve to trade above NAV is the market`s reaction to GameStop ( GME ) pulling out the same playbook last month. The market didn`t love GameStop issuing convertible debt to finance Bitcoin purchases last month– the stock is down about 7% over the last month and 20% since the offering. In many ways, GME is more stable than MSTR, for example, the operating losses at GME are much, much smaller , and the company has much more cash as a percentage of its share price. If you`re thinking critically about all of this, it doesn`t really add up. Bottom Line You don`t need an expensive middleman to buy Bitcoin. The iShares Bitcoin Trust ( IBIT ) currently has about $50 billion in assets with fees of 0.25% per year or less. For reasons unknown, it`s still less popular than Microstrategy, a.k.a. "Strategy," with a market cap of $75 billion with a massive amount of dilution and underlying losses. This is totally upside down, and I expect the recent losses for MSTR shareholders to continue as the company keeps blasting away with new equity offerings. I wouldn`t touch MSTR. If your intention is to buy Bitcoin, cut out the middleman and buy it at the fair market price through an ETF.

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