Kerrisdale Capital’s commentary for the month of March 2024, titled, “Long BTC / Short MicroStrategy Inc (MSTR): Know When to HODL, Know When to FODL”
We are long bitcoin and short shares of MicroStrategy, a proxy for bitcoin which trades at an unjustifiable premium to the digital asset that drives its value. Shares of MicroStrategy have soared amid a recent rise in the price of bitcoin but, as is often the case with crypto, things have gotten carried away. The bitcoin price currently implied by MicroStrategy’s stock is now over $177k, i.e., two and a half times the spot price of bitcoin. The days when MicroStrategy shares represented a rare, unique way to gain access to bitcoin are long over. Bitcoin is now easily obtainable through brokerages, crypto exchanges, and more recently low fee ETPs and ETFs. None of the reasons commonly provided for MicroStrategy’s relative attractiveness justify paying well over double for the same coin. MicroStrategy’s trading history and basic common sense suggests the current inflated premium will contract, much as it has on prior occasions, providing a compelling opportunity for a pair trade.
MicroStrategy bills itself as a bitcoin development company. Its steady but sleepy software analytics business constitutes only 3% of the total enterprise value of the company. MicroStrategy’s value is driven by its bitcoin holdings, which were acquired predominantly though debt financings, equity linked convertible notes, and ATM equity offerings. Bulls tout management’s “intelligent” use of leverage and accretive bitcoin purchases from equity sales proceeds as reasons why shares should trade at a substantial premium. But we find the logic flawed. Leverage cuts both ways and while MicroStrategy has succeeded in increasing the amount of bitcoin held, the impact of massive dilution has also kept the amount of bitcoin per share virtually unchanged in recent years. Shareholder value creation has been overwhelmingly driven by simple bitcoin price appreciation – much as it would from owning bitcoin outright.
Other reasons cited for a substantial premium such as the ability to reinvest cash flows from the software business into bitcoin, lack of management fees, liquidity, and ease of trading all strike us as weak. Free cash flow from the software business was only $10m in 2023, enough to tack on 0.1% more bitcoin to MicroStrategy’s current holdings. The lack of management fee might be relevant if ETP management fees were 2% and the premium to spot in MicroStrategy was a modest 10%. But ETP fees are in fact only 0.25%, as is the case with BlackRock’s IBIT and Fidelity’s FBTC, and the NAV premium is 157%. IBIT, FBTC, and a raft of other vehicles offer liquidity and ease of trading that will only grow in number globally. These developments bode well for bitcoin, but represent a secular threat to MicroStrategy’s scarcity value and bloated NAV.
At 2.6x, MicroStrategy’s equity premium is exceptionally high. Since the beginning of 2021, the premium has been 2.0x or below on 94% of trading days. The historical average is 1.3x. Our thesis is not predicated on a bearish view of bitcoin or MicroStrategy, but rather a belief that the relationship between the two has grown distorted. Assuming the premium to NAV reverts to more historically consistent averages implies a 50% return.
Investment Overview
Co-founded in 1989 by CEO Michael Saylor, MicroStrategy is a bitcoin development company committed to using cash flows from its software business and capital markets proceeds to accumulate bitcoin. From August 2020 to 2023, MicroStrategy spent $726m in cash and issued $500m in secured debt, $1.7bn in convertible notes, and $3.1bn in equity to purchase bitcoin. MicroStrategy does not hedge or actively trade bitcoin. Its stated strategy is to opportunistically issue debt and equity when it believes there is an embedded premium to NAV in its stock price to buy bitcoin and HODL. In keeping with this strategy, earlier this month MicroStrategy issued two series of convertible notes totaling $1.4bn in rapid succession, and along with $72m in excess cash (primarily proceeds from ATM equity offerings) promptly purchased 21k bitcoin. The company presently holds just over 214k bitcoin.
Valuing MicroStrategy is a straightforward sum-of-parts exercise with three components: 1) the enterprise software business, 2) the value of the company’s bitcoin reserves and, 3) application of a potential premium/discount to total net asset value based on one’s view of bitcoin’s future prospects and management’s ability to drive incremental value versus owning bitcoin itself.
Given the size of its holdings and prevailing price of bitcoin, MicroStrategy’s operating business no longer contributes meaningful value to the overall enterprise. MicroStrategy’s software business, which provides analytics and business intelligence to a range of industries, operates in a competitive field and has exhibited little to no topline growth for years. Due to rising leverage, it generates little free cash flow (a mere ~$10m in 2023). Valued at $1.25bn (~2.5x consensus 2025E revenue / 12.5x EBITDA), broadly in-line with published sell-side estimates, the business represents only 3% of the total enterprise value of the company ($39bn). Deducting this software value from the total enterprise value of the company leaves an implied value for its bitcoin digital assets of ~$38bn.
$38bn is a substantial 2.6x premium to the actual current value of MicroStrategy’s bitcoin holdings at spot prices. In effect, MicroStrategy shareholders are now paying $177k per bitcoin when they could instead gain exposure to the asset through any of a growing number of ETPs, brokerages, payment platforms, and exchanges for less than half that. While not unprecedented, this particular level of premium is unusual. In the last 813 trading days for MicroStrategy, on only 51 of those days (6%) has there been a premium to spot above 2.0x. 2.6x is over 1 standard deviation from MicroStrategy’s observed average and median the last three years. In the past, this level of premium has been relatively short-lived and we believe the current premium will mean revert to more justifiable historical averages in due course.
Premium to NAV is Grossly Stretched by Historical Standards
Read the full report here by Kerrisdale Capital
