Maybe you have heard that there are companies that “diversify” their assets into Bitcoin out of “fiat money”. Will the stock of Microstrategy go up together with Bitcoin? What sounds like a good idea at first sight, however, could be a costly and dangerous adventure for inexperienced stockholders.

The most prominent companies that have publicly admitted to reallocate parts of their assets into Bitcoin are Tesla, Block (former Square) and Microstrategy. This move shall be a diversification out of so called fiat-money that governments all over the world are printing ever more of (respectively their central banks).

It seems like a clever way for stockholders to also get indirect access to this asset class by buying stocks of these companies. You receive their main business AND a chance to participate in a possible crypto appreciation.

But is it all that simple?

In this article, we take a deeper look at the company Microstrategy (Ticker: MSTR, ISIN: US5949724083). It is by far the most aggressive in “diversifying” their assets and a prime example of bad risk management you can take valuable lessons from.

Note: This shall not be a discussion about Bitcoin or cryptos in general, but specifically about the company Microstrategy.

Tesla sold a big chunk of their holdings already

Tesla bought Bitcoins in the first quarter of 2021 for 1.2 billion USD. That was rather a symbolic move and only a negligible part of their assets as their cash holdings at that time were more than 17 billion USD. The share price hovered around the current level of 800 USD (or a market cap of around 900 billion USD).

In the meantime, Tesla has surprisingly sold most of its holdings. They announced with their Q2 results a few weeks ago the conversion of 75% of their Bitcoin holdings back into “fiat currency”. The result of this investment was rather a zero as they received 936 million USD (100% would be around 1.2–1.3 billion USD, thus what they invested).

Or at least they didn’t lose any money one could say with a sharp tongue as I like to do.

But let us take a deeper look at Microstrategy. It took its investments into Bitcoin to the extremes. It is worth a closer look and the main stock discussion of todays article.

Microstrategy – or the dangerously leveraged bet on Bitcoins

A nice sounding, but not so promising business

Microstrategy is a company founded in the year of my birth, 1989. It is since then founder-led and went public in 1998. Like many other tech stocks in that era, it got crushed during the bubble burst of 2000–2002. The stock price rose from April 1999 from under 90 USD to its still all-time high of over 2,200 USD just nine months later. That was a surge of more than 2,500%. It then dropped to 5 USD (no typo!) in 2002 (–99.8%).

That is certainly one of the more extreme examples of the dot.com-bubble era.

Today, we will see the same stocks again in extremes, but due to different reasons.

The main business consists of “intelligence software” and “analytics” and their business slogan is “Intelligence Everywhere”. MSTR describes itself as “the largest independent publicly-traded business intelligence company with the leading enterprise analytics platform”. Sounds promising and futuristic.

But it gets more exciting: “MicroStrategy is the largest publicly-traded corporate holder of bitcoin in the world and the first public company to adopt bitcoin as primary treasury reserve asset”.

Some of their competitors in the core business are Salesforce, SAP, Microsoft, Adobe – the big guys so to speak.

By the way, I am very careful and cautious when analyzing companies that claim to do something with “AI”, “intelligence”, etc. that is supposed to revolutionize the world. I don’t really understand these business models, because of their – call it – either uniqueness or opaqueness. My point is, someone who does not use such software e.g. at work cannot reliably judge it.

I have no personal experience with their software and some time ago have even never heard of them. In contrast, many know their competitor’s products.

Looking at the financials of MSTR already reveals that there seems to be more marketing claim than substance (I also read the last 10K). Analyzing the financials of a company often tells something objectively about the execution capabilities of the management. In my view, it is a good starting point to grasp a quick overview of a companies’ big picture.

For me the cash flow statement is more important than the P&L (profit and loss statement), but it’s nonetheless good enough for a first overview.

Here is a snapshot of their last ten year’s P&L:

When looking at the last ten years, we see that the revenue of MSTR has declined by 12%. Only in three out of ten years there was some revenue growth. Not so cool for a supposed to be niche leading company. Their operating profit to the contrary rose by 26% in the same time frame. That was mainly due to lower sales costs and thus higher margins.

The good thing is that there is no Bitcoin “interference” in either revenue or operating results. Hence, we can easily judge the performance of the core business.

Like many software companies, MSTR is currently in the state of changing from selling one-time licenses to recurring subscription services (and revenues). But as of now, their subscription sales are a meager 10–15% of total sales.

When you sell a one-time license, you receive all your money right upfront. With a subscription you at first only get a smaller part, but in sum you will receive more when the user crosses a certain duration of using the software (think of owning and leasing for simplicity reasons). This is often the case with high profile software that is hard to switch from.

The transition in MSTR’s case, however, seems not to be the reason for the weak financial performance.

The third thing worth looking at at this stage, is net income. You see that in the last two years (when they started their Bitcoin investments) it came to big writedowns (impairments of their Bitcoin holdings). More in the next section.

The forth thing to keep in mind – you have to watch more closely – is the interest expense row between operating and net income. Up until their “diversification”, there were no interest expenses. The company had no debt. But with their investments the interest expenses rose dramatically.

In 2021 the interest coverage ratio (how often are interest expenses covered by operating profit?) was less than 2x which in itself is a very low ratio. You want this ratio – depending on your business model and capital needs – to be as high as possible. At least 5x, I would say, especially in an environment of rising interest rates where you at some point in the future will have to refinance your debt at probably higher interest rates (and thus overall costs).

Over the last twelve months the ratio is even negative, hence MSTR paid more in interest expense than it earned from its operations. That usually is a sign of a distressed company with real bankruptcy risks in the foreseeable future.

There is more to come, though.

Looking at the balance sheet quickly, there are more frightening facts to be found.

What is interesting when looking at the upper part of the balance sheet (assets), you see that MSTR over the years had rather growing accounts receivable (unpaid bills to them from their suppliers). But suddenly they have brought in a big 70 million USD.

Interestingly, that is the same amount of cash they have on the balance sheet… Aggressiveness against customers to avoid a cash crunch? Food for thought…

Here is also a snapshot from the lower part of their balance sheet (equity and debt):

What you see here in brief without diving too deep:

• MSTR rose equity dramatically in 2021 (to buy Bitcoins)
• the retained earnings as well as equity on the balance sheet are both negative (i.e. no reserves left)
• the total balance sheet (its assets) mainly consist of debt (net debt is nearly 2.4 billion USD)

As a reference, this company is only making earnings and cash flows of less than 100 million USD a year from its operations. That means more than 20x leverage!

What you need to take with you into the next section: MSTR has a slowly declining (or at least not growing) core business in a crowded competitive environment and a highly (massively) leveraged balance sheet with what seems to be even cash problems.

So far so good.

Let us now jump to the really interesting stuff you have been waiting for.

MSTR’s Bitcoin adventure

MSTR says that it officially has two business segments. The software business presented above and – oh wonder – acquiring Bitcoins!

To foreshadow the results a little bit, Microstrategy spent more on Bitcoin than their entire current market cap is (at the time of writing this article the market cap was about 3.6 billion USD vs. a total spend of 3.9 billion USD for Bitcoins).

As of June 30 2022, that’s a fat –50% currently as per MSTR’s current quarterly report (see p. 22).

Hence, an undervalued investment because you get the main business for free? And should Bitcoin come back to MSTR’s average buy price (they are deeply underwater at the moment) then you could buy now MSTR stock with a fat margin of safety, couldn’t you?

Not so fast. Let’s look at the last two years of Microstrategy in detail.

Do or die could be their motto.

The first interesting parallel is the price chart of MSTR in comparison to Bitcoin (here over five years). One follows the other very closely:

When Bitcoin rises, so does MSTR. The same on the way down.

The first purchases of Bitcoin began in Q4 2020 when MSTR bought around 70k Bitcoins at an averge price of 15,964 USD. With this position, they would be currently in positive territory (+50%).

But unfortunately management decided to average up aggressively, so that not only the amount of Bitcoins held nearly doubled, but also the average price they paid for all Bitcoins. Bitcoin currently trades at around 24k USD. That’s still a minus of 20% for MSTR’s entire position as of now, though better than –50% per June 30 2022.

As shown above, MSTR heavily leveraged its balance sheet to buy Bitcoins. They have nearly 2.4 billion USD in long-term debt, but only 70 million USD in (fiat) cash. The yearly free cash flow is also way less than 100 million USD (around 70 million USD and not even growing).

That means it will be very difficult to pay back those debt positions with current reserves (don’t forget that half of MSTR’s operating earnings go to interest payments).

Already the first bunch of debt (844 million USD) due in 2025 will be highly unlikely to be paid of from MSTR’s core operations. They would have to generate an additional more than 600 million USD in free cash flow over the next three years – let’s be realistic here…

There are two possibilities to solve this: Either sell Bitcoins (maybe with a loss and despite investing “for the longterm”?) or heavily dilute shareholders. Additional new debt would be costly and not feasible. As of now, the 639 million USD in 2025 convertible debt would dilute the shareholder base – in case the bond gets converted completely – by an incredible 1.6 million shares or 15% of shares outstanding as of the current 10Q.

The “good” thing is that the dilution is limited to “only” 1.6 million shares (at currently 320 USD / share the dilution would be 1.9 million shares in theory).

And then there is the 2027 convertible bond with 1 billion USD (capped at 733k shares or “just” around 7% of current shares outstanding)… You see the point.

We could add some valuation thoughts and see if there is potential should Bitcoin go through the roof.

But as a conservative investor with a risk management mindset, we can stop here. The risks are significant. Think of Buffetts famous two rules: “Rule number one, don’t lose money”. “Rule number two, don’t forget rule number one”.

Crypto and Bitcoin bulls will go up the wall and yell “buy the dip for the longterm!”.

I don’t think this is a wise attitude. That is rather a very hot gamble.

Funny thing aside: The founder-CEO sidestepped as CEO and went on to the executive chairman position. Why?

[…] As Executive Chairman I will be able to focus more on our bitcoin acquisition strategy […]

MSTR 8K Q2 2022

I truly on’t know what there is to focus on…

Conclusion

To wrap up, MSTR has not only an opaque, not easy to understand core business (with seemingly limited growth potential), but also a pretty risky one. A weakening core business is highly leveraged with aggressive Bitcoin bets.

The main business will probably not be able to handle the heavy debt load on its own. Strong dilution to shareholders seems unavoidable.

The stock can rise and my analysis can be nuts. But from a risk management perspective one should avoid this stock…