Software firm turned Bitcoin treasury Strategy (NASDAQ:MSTR) has made waves in the market in recent years, rising nearly 150 percent in the last 12 months alone on the back of a bullish crypto market.
Strategy’s executive chairman, Michael Saylor, has also become a celebrity in the cryptocurrency investing world for his bullish long-term predictions and for being among the crypto leaders invited to the White House’s Digital Assets Summit earlier this year.
Now, Strategy and Saylor are embarking on the new project of offering Bitcoin-collateralized fixed-income instruments that are intended to produce direct yields from Bitcoin holdings for investors while also giving Strategy a new means of raising capital that won’t require diluting its shares.
We take a look at Strategy in light of these new offerings to see whether the stock is likely to shoot higher from here or whether the market is fundamentally misunderstanding MSTR at the moment.
Will MSTR Rise or Fall on Dilution and Fixed-Income Products?
Up to now, Strategy has used repeated rounds of share dilution to help raise the funds to add to its Bitcoin stockpile. Since the end of 2022 alone, the number of outstanding MSTR shares has skyrocketed from 113 million to 193 million.
While MSTR prices have still risen enormously over that time due to bullishness on Bitcoin itself, the high rate of dilution may very well still pose significant problems for investors if Bitcoin pulls back as it has many times in the past.
More recently, though, Strategy has made two fixed-income preferred equity products called Strife (NASDAQ:STRF) and Strike (NASDAQ:STRK) available that it can sell to generate more cash for Bitcoin purchases without diluting its own stock.
Shares of both products offer high, fixed yields, with STRF offering a 10 percent yield and STRK offering an 8 percent dividend with a perpetual call option for MSTR shares. Both instruments are collateralized by Bitcoin.
Management has proposed these instruments as a Bitcoin-based play on the fixed-income bond market, allowing investors to earn high coupons while helping Strategy raise money for its growing Bitcoin stockpile.
The bond market, Strategy notes, is massive and has barely been touched by digital asset innovation. STRF and STRK have also outperformed similar preferred equity instruments in terms of price so far, delivering a combination of rapid appreciation and high yields.
While the introduction of the new fixed-income products may help to address the problem of dilution, it hasn’t solved what may be a much more significant and structural problem for MSTR shareholders in the long run.
Specifically, MSTR is valued at a significant premium to the value of the Bitcoin it holds. So far, Strategy holds $62.7 billion in Bitcoin and has a market cap of $107.9 billion, representing a 72 percent premium.
Indeed, according to Saylor, investors should be valuing the stock in this way in order to account for both the net value of the assets and Strategy’s ability to generate yield on those assets. This claim, however, has been met with extreme skepticism. Jim Chanos, a notable short-seller, recently called Saylor’s arguments “complete financial gibberish,” criticizing both the case for paying a massive premium to NAV and Strategy’s consistent leveraging of its balance sheet.
Taking the argument against its premium into account, it seems possible that there might well be significant downside potential in MSTR at the moment. It’s also worth noting that Strategy may face some legal headwinds that could also affect its share prices, as a class action lawsuit was filed last month against it alleging failure to accurately represent material facts about its investment strategy.
The Even More Basic Problem at the Heart of Strategy
From an investment perspective, the even more fundamental question beneath all assumptions about MSTR is whether or not Bitcoin will prove to have lasting value.
Michael Saylor is perhaps one of the most vocal Bitcoin bulls in the market today, having even gone so far as to propose that huge businesses like Microsoft and Berkshire Hathaway should put their cash reserves to work buying Bitcoin instead of more traditional activities like buying back shares.
As Saylor himself has acknowledged, creating the kind of fixed-income instruments that Strategy has issued requires an essentially all-in approach of putting a business’ entire balance sheet in Bitcoin. This not only creates considerable concentration risk but also puts all of Strategy’s capital in an asset that is historically very volatile.
Though Bitcoin has certainly appreciated at a sky-high rate over several years, there’s still a surprisingly strong argument to be made that the cryptocurrency with a current market cap of over $2 trillion has little to no intrinsic value.
This case, which has previously been argued by the likes of Warren Buffett, Charlie Munger and Jamie Dimon, was most recently set out by Nobel laureate economist Eugene Fama.
According to Fama, an expert in efficient market hypothesis, Bitcoin will eventually fall to near-zero prices due to its extreme volatility and purely demand-driven pricing making it completely unsuitable as a medium of exchange.
To his credit, Saylor has made a counterargument that hinges on Bitcoin’s intrinsic scarcity and freedom from political and inflationary constraints. Even so, the Bitcoin evangelist’s views of ongoing upside as ETF inflows remain high could be overly rosy, potentially putting investors who pay MSTR’s premium today at the risk of substantial losses.
Will Fixed-Income Fix MSTR’s Dilution Problem?
Although the creation of instruments that can raise capital for Bitcoin purchases without reliance on issuing new shares is likely a positive development for MSTR shareholders, there still seem to be a number of large fundamental risks associated with the stock.
First and foremost is the large premium to NAV that investors are being asked to pay. On an even more fundamental level, the business is investing exclusively in a single extremely volatile asset that may or may not sustain its value in the long run.
In the end, STRF and STRK may prove interesting income assets for highly bullish cryptocurrency investors. They may also prevent further share dilution at Strategy, something that will likely be a welcome development to existing shareholders. They don’t, however, address the concentration risk or massive premium to asset value that also come along with MSTR. Given these concerns, MSTR may not be a particularly appealing stock for all but the most risk-seeking of investors today.
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.