The Bear Case For Microstrategy Stock

Microstrategy (NASDAQ:MSTR) and its CEO Michael Saylor are in large part confounding valuation experts worldwide.

The traditional method of valuing a company goes something like this. Analyze the cash flows a company will produce over its lifetime, discount them back to present day, sum them up and arrive at a fair market valuation for the company.

Microstrategy is turning this model upside down and instead creating value, not from its income statement where revenues, expenses and profits are the focus, but rather from the balance sheet, where it’s amassing hundreds of thousands of bitcoin.

Bulls are forecasting massive upside in MSTR while bears are predicting its demise, so who is right?

The Bull Case for Microstrategy

The optimists point to Saylor’s enormous and relentless accumulation of Bitcoin as a genius play on what is increasingly being perceived as a new asset class.

If Saylor can seize 2-5% of all Bitcoin supply, ignoring lost coins, the value of the firm in future decades, they claim, could be in the trillions of dollars.

Saylor is pursuing a highly innovative strategy and big question is whether it’s going to stand the test of time. Instead of building value through a traditional model of creating a product, selling it, and earning a profit, he’s looking to stack the balance sheet with massive Bitcoin reserves, but why and how?

First to the how. Saylor is selling shares of MSTR at-the-market, diluting the number of shares outstanding to buy Bitcoin. Secondly, he’s borrowing money to buy Bitcoin and paying, in some cases, low or even no interest on the debt. That latter strategy is really confounding skeptics, because it’s difficult at first glance to figure out why someone would lend capital to a company while earning no interest. 

The simple answer as to why is that those in the credit markets who are lending capital to Saylor are making money from the volatility, which is amplified versus many other alternative channels available to them. As a result, Microstrategy is a vehicle connecting the world of fiat credit markets to the volatility of Bitcoin without having to custody the cryptocurrency directly.

A flywheel is created whereby the more Microstrategy borrows, the more Bitcoin it buys, the more Bitcoin demand exists, and so the demand for MSTR stock rises, attracting growth investors, who buy the stock driving it higher, and that leads to more capacity for Saylor to sell stock or issue more convertible bonds, repeating the cycle.

So, what’s the catch to the seemingly infinite money glitch, as Max Keiser describes it?

The Bear Case for Microstrategy

As Microstrategy issues more stock to buy Bitcoin, MSTR share count will mushroom higher causing the share price to tumble.

Bears point to the risks of Bitcoin dropping and so ultimately driving Microstrategy, a levered bet on Bitcoin, to crash lower. This makes the share price highly risky and a speculative bet on the already-volatile cryptocurrency.

Bears also claim that selling shares puts downward pressure on MicroStrategy’s stock price while the proceeds are used to buy Bitcoin, so necessarily Bitcoin must outperform MSTR.

To support the claim, according to one astute market observer, bears will cite as evidence that MSTR’s strategy has “run its course” and label the stock’s performance a bubble but he sees this argument as short-sighted because when the ATM program ends, Microstrategy stock has the potential to “slingshot higher,” reflecting not only the value of its Bitcoin holdings but also a premium for the underlying business.

Microstrategy Bulls vs Bears: Who Will Win?

Whether bulls or bears end up victorious at Microstrategy, one thing is for sure now and that relates to the option premiums available at Microstrategy, which are simply exorbitant.

At $380 per share, a 100 share purchase needed to sell one call option would cost ballpark $38,000 (at the time of writing) but pays about $5,000 over the span of about a month.

Clearly, the options market is pricing in massive volatility to Microstrategy stock so shareholders need to be aware that a $50 swing in share price, up or down, is very much on the cards.

For those with a longer term view, the covered call strategy on Microstrategy may very well be too appetizing to skip because 7-8 months of call selling, assuming a similarly inflated option premium, has the potential to de-risk the originally invested principal entirely.

One way to consider this strategy is that the risk of Microstrategy going bankrupt entirely is probably quite low, given that its balance sheet is tied so intimately to the price if Bitcoin, so arguably the risk of investing in Microstrategy stock and selling calls is much less. Or in other words, perhaps the most Microstrategy stock would realistically decline by is 50% which means only 4 months of call selling effectively de-risks the trade. A worst case outcome might lead to an 80% crash in MSTR share price and so selling calls for 6 months might end up de-risking the trade.

Whatever the future, those attempting to capitalize likely won’t feel entirely comfortable for the first month or two given the massive volatility in the share price, and keep in mind all these numbers are theoretical because in practice the share price will likely not stay the same and so call premiums will be largely affected by what happens in the underlying. Either way, MSTR covered call sellers are likely in for a gyrating portfolio ride.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.