Should Investors Be Worried About MicroStrategy’s Bitcoin Debt-Financing Strategy?

If you’ve been following the news, you’d probably know about MicroStrategy and its unceasing appetite for Bitcoin. The company’s latest bet into the digital asset, however, got the thumbs down from investors — alongside some serious concerns over its mounting debts and Bitcoin financing methodologies. Despite the noise from the equity market, MicroStrategy is confident about its strategies in debt-financing and we are here to tell you why!

Will MicroStrategy Reach the Stage of Insolvency One Day? 

Under MicroStrategy’s two-pronged corporate approach, the U.S.-based business intelligence company has accumulated up to $2.7 billion worth of Bitcoin — or 0.5% of the total Bitcoin supply to date. Through a series of debt financing methods, MicroStrategy raised over $1.026 billion to finance its Bitcoin conquest. However, the wolves of Wall Street are howling about possible insolvency, should the price of Bitcoin continue to spiral downward.

It is not an uncommon practice for listed companies to adopt the capitalization structure, a combination of debt and equity financing methods to raise capital; the capital raised is usually used for the expansion of their businesses. In fact, a good combination of both methods will result in more returns for companies in the long term. Despite achieving such an impressive feat with Bitcoin in the span of a year, MicroStrategy is straying farther away from the golden ratio between debt and equity finance. Will Michael Saylor’s firm set a pioneering precedent of crypto financing for companies, or is it shooting itself in the foot?

What Are the Wolves of Wall Street Howling About?

As the debt-to-equity ratio rose from 1.65 to 5.69 after the BTC acquisition, investors are showing their concern by dumping their stocks. The wolves of Wall Street may not be barking up the wrong tree after all, as MicroStrategy disclosed in its Form 8-K filing that they expect to incur up to $284.5 million of impairment loss from the fluctuation of  Bitcoin’s price. Zooming into their financial statements released in March, the total shareholders’ equity has shrunk — by 78% quarter-on-quarter (QoQ).

The billion-dollar question is: Will the debt impairment bleed through its bottom line? The answer is highly dependent on the company’s financial health and the debt’s covenant. According to its latest financial release, the company now holds 105,085 bitcoins at an average price of $26,080 per coin — hence, the current market value of BTC that MicroStrategy holds is $3 billion.

By adjusting their balance sheet with the latest market value of BTC, MicroStrategy’s latest outstanding debt and restated shareholder equity value will equate to $2 billion and $1 billion, respectively. The real concern will arise if the price of BTC crashes by 50% to $17,000 or below, as the restated equity value will then be negative.  

However, this would not result in immediate insolvency. It is not rare to observe negative equity or a high debt-to-equity ratio in listed companies. The key to sustaining a business lies in the diversification of its revenue and positive operating cash flow (OCF). Will MicroStrategy generate enough cash flow from its dwindling sales to pay the first coupons in 2025?

(Source: MicroStrategy)

Are the Wolves Barking up the Wrong Tree?

(Source: MicroStrategy)

Fortunately, MicroStrategy has no obligations to redeem the debts before late 2025, and may even leverage on the BTC acquisition for the next bull rally. Before then, the company must pay interest only on the three existing bonds, equivalent to $35.5 million per year, or $17.75 million every six months if the interest is paid semiannually, which is well-covered by its last reported OCF of $62 million in March 2021. Its latest senior notes, which offer higher interest, also reveal its confidence in paying the premiums to the bond holders.

According to Puell Multiple, an on-chain metric that predicts market bottom and top, the cryptocurrency market has hit the trenches (green zone) and is bound for a reversal. The steep reversals were also witnessed, after the crypto crash that occurred in January 2015 and 2018. 

(Source: Glassnode)

The two-pronged approach has also resulted in an increase of top-line revenue by 9% QoQ, thus indicating a healthy financial flow for the company, as well as its ability to cover future interest payments.

(Source: MicroStrategy)

Why did MicroStrategy choose debt financing methods over equity methods? Interest payments for bonds are tax-deductible, while dividends paid to equity holders are not. As the world entered pandemic mode in 2020, MicroStrategy CEO Michael Saylor was worried over how large banks and constitutions would handle the crisis. As such, MicroStrategy started buying troves of Bitcoin to hedge inflation. But equity financing methods may well result in dilution of shares and increased voting rights of shareholders, jeopardizing Saylor’s control of the ship.

Conclusion

The cryptocurrency market has been growing in value, and on-chain metrics have predicted that the crypto market will be bound for a reversal. MicroStrategy has a strong cash flow, enabling it to pay for interest, and will not face immediate insolvency even as the price of BTC falls. Therefore, MicroStrategy is poised to be the first company that properly accounts for leveraging Bitcoin, and will also set a precedent for debt financing with cryptocurrency.