Key Questions:

What is the structuring of MSTR’s debt?
Does MSTR have a Bitcoin liquidation price? If so, what is it?
Is the underlying software business profitable enough to service the debt?
How do GBTC and MSTR compare to one another as a BTC investment proxy?

Amidst the carnage throughout the crypto market this year, one of the few “bull market heroes” that has yet to be slain is Michael Saylor and Microstrategy. Microstrategy became well-known for its massive Bitcoin bet made not only with the cash on its balance sheet but also with debt. Microstrategy currently holds 130k BTC worth roughly $2.08B. There has been an increasing level of speculation around Microstrategy’s debt structuring and whether their software business is profitable enough to service the debt.

Microstrategy’s Debt Profile

For the quarter ending September 30, 2022, MicroStrategy held $2.37B of total long-term debt. The specific breakdown of its debt profile can be found in the following table:

2025 Convertible Notes

Microstrategy completed its $650M private offering of 0.75% convertible notes due in 2025 on December 11, 2020. The interest rate is fixed at 0.75% and is payable semiannually on June 15th and December 15th of each year. The notes may be converted into shares of MSTR stock by Jefferies LLC at a conversion rate of $398 per share. The notes can not be converted into shares until June 15, 2025, unless the company undergoes a “fundamental change” as defined in the Indenture. A fundamental change would be ceasing to be listed on the NASDAQ or NYSE, a merger or acquisition of MicroStrategy, or a change of majority ownership in the company. The latter is unlikely given Michael Saylor, the CEO, owns 67.7% of the voting power. However, if any of the aforementioned events were to occur, MicroStrategy may be required to repay the loan in full if demanded by Jefferies LLC.

2027 Convertible Notes

On February 19, 2021, Microstrategy completed another $1.05B private offering of 0% convertible notes due in February 2027. The notes can be converted into common stock by Jefferies LLC at a rate of $1,432 per share. The notes cannot be redeemed until August 15, 2026, unless the company undergoes a “fundamental change” as described in the Indenture, which is in line with the description in the preceding paragraph for the notes due in 2025.

2028 Senior Secured Notes

On June 14, 2021, Microstrategy completed a $500M private offering of 6.125% secured notes maturing in June 2028 with Jefferies LLC. The interest on the notes are payable semi-annually on June 15th and December 15th of each year. These secured notes contain a springing maturity date, meaning that the maturity date will jump to either September 15, 2025 or November 16, 2026 if a few stipulations are not met on those days: Microstrategy has liquidity in excess of 130% of the amount required to pay in full in cash the remaining balance and accrued interest on the 2025 or 2027 convertible notes, or if the balance outstanding on the 2025 or 2027 convertible notes are less than $100M. As of Q3 2022, 14,890 BTC held by the company serves as part of the collateral on this loan.

2025 Secured Term Loan

Microstrategy took on a $205M secured term loan from Silvergate on March 23, 2022. The loan matures on the same day in 2025 and bears a floating interest rate equal to the sum of the Secured Overnight Financing Rate (SOFR) 30-day average as reported by the NY Fed and 3.70%, with a floor rate of 3.75%. The SOFR 30-day average was 3.49% on November 21st, resulting in an annualized interest rate of 7.19% on the loan. The loan was collateralized with $820M of Bitcoin, or 19,466 BTC upon origination; representing a loan-to-value (LTV) ratio of 25%. The loan must remain collateralized with a maximum LTV of 50%. In the event the LTV exceeds 50%, Microstrategy is required to deposit enough BTC or pay back the loan such that the LTV is reduced to 25% or less. In June 2022, MSTR topped up its collateral by depositing 10,585 more BTC into the collateral account. Additionally, there is a $5M cash reserve account, separate from the BTC collateral and LTV ratio, that must be maintained until the final six months of the loan.

Long-Term Debt Health

Microstrategy and its subsidiaries now hold approximately 130,000 BTC, purchased for $3.98B, or an average price around $30k per BTC. A total of 30,051 BTC, or $480M at a spot BTC price of $16,000, are being leveraged as collateral for the 2025 Secured Term Loan with Silvergate. The company will need to top up collateral on the loan at a BTC spot price of $13,644 to avoid a margin call that requires the LTV ratio to be returned to 25% or lower. In addition, 14,890 BTC are being used as part of its collateral for the 2028 Senior Secured Notes, leaving the company and its subsidiaries with 85,059 liquid BTC. Microstrategy would need to find external funding to finance its Silvergate loan at a BTC spot price of $3,561, or face liquidation.

MSTR received very advantageous fixed interest rates on its 2025 and 2027 convertible notes, with share conversion prices far above the $157.22 closing price for its common stock on November 21, 2022. However, the 2025 Secured Term Loan from Silvergate with a floating interest rate has proved costly in a rising interest rate environment. On top of the unfavorable interest rate, the LTV ratio required to maintain the loan is locking up a considerable amount of its collateral. This begs the question of whether they would have been better off holding the BTC unencumbered on its balance sheet without taking on the additional $205M of debt. Lastly, the 2028 Secured Notes have a relatively high fixed interest rate of 6.125% while having reduced the company’s liquid BTC holdings. Perhaps more importantly, Microstrategy could be forced to repay the remaining balance on this loan plus accrued interest on September 15, 2025 if they do not have 130% of excess liquidity to repay what is owed. This would likely result in some BTC selling by Microstrategy given the fact that the company holds just $67M of cash and cash equivalents.

The contractual interest expenses and amortized issuance costs on all of MSTR’s notable outstanding long-term debt for the nine months ended September 30, 2022 can be found in the following table. Microstrategy has paid approximately $22M on the four debt instruments below for the nine months ended September 30, 2022.

Income from Operations and Interest Expense

While the aforementioned risks to Microstrategy and its BTC reserve are relatively far out from becoming immediate concerns, the bigger worry lies in the company’s ability to service the interest on its outstanding debt. Prior to taking on over $2.37B of debt, Microstrategy was earning interest on its operations. However, they now see a net outflow of cash from the interest expense to service its debt. For the quarter ended September 30, 2022, Microstrategy incurred over $38M of interest expenses, as depicted in the chart below.

When looking at the operating income from its software business, we see a clear decline in profitability. We calculated the income from operations by subtracting the operating expenses from the gross profit, while excluding any digital asset impairment losses from the operating expense category. This allows us to get a better picture of how the software business is performing by removing the large impairments incurred as a result of suboptimal BTC accounting standards. The nearly $40M of interest expense paired with the declining income from operations is a cause for concern.

As stated in its most recent 10-Q filing, “If our revenues are not sufficient to offset our operating expenses, we are unable to adjust our operating expenses in a timely manner in response to any shortfall in anticipated revenue, or we incur significant impairment losses related to our digital assets, we may incur operating losses in future periods, our profitability may decrease, or we may cease to be profitable. As a result, our business, results of operations, and financial condition may be materially adversely affected.” However, the company maintains a cash and cash-equivalents balance of nearly $67M, providing MSTR with a buffer through 2023 in the event that its income from operations continues to tread water.

GBTC vs. MSTR

GBTC and MSTR are thought of as a proxy for BTC exposure by many equity investors, but which one is the better deal? For starters, both entities custody their BTC holdings with Coinbase’s custody offering, so the custody risk is the same for both investment vehicles. In terms of NAV, GBTC holds 633,430 BTC compared to MSTR’s 130,000 BTC reserve.

Grayscale’s GBTC was trading at a market capitalization of $6.19B on November 22 versus its $10.13B of NAV at a $16k spot BTC price. MSTR, on the other hand, was trading at a market capitalization of $1.58B on the same day but has $2.37B of debt when evaluating based on its book value. Thus GBTC is trading at a ~39% discount whereas MSTR is trading at a ~90% premium to NAV. In other words, purchasing MSTR for BTC exposure at a $16k spot price is akin to purchasing BTC for $30.4K. It is worth noting, however, that there is some value in terms of optionality for MSTR equity given that it is essentially a leveraged BTC bet. Albeit an expensive option, it makes sense for MSTR to trade at a premium to NAV.

Final Thoughts

The short-term concerns around Michael Saylor and Microstrategy’s liquidity profile and its ability to service its debt to maintain its levered Bitcoin position seem misguided. For the time being, the business has ~85k of liquid BTC on its balance sheet to top up collateral should Bitcoin fall below $13.5K and push the LTV on its Silvergate loan above 50%. The more legitimate concern is the company’s ability to service its financing payments over the coming years. The company’s software business needs to improve profitability to be able to do so, assuming the current $67 million in cash on its balance sheet will be used for more Bitcoin purchases or be drained as a result of interest payments. This is especially true between 2025 and 2026 if the springing maturity date on its 2028 senior secured notes is triggered. But for the time being, Microstrategy poses no immediate risk to the Bitcoin market.

This report was written in collaboration with Will Clemente and the Reflexivity Research Team.

The Health of MicroStrategy's Bitcoin Bet