On September 14th, Michael Saylor made history revealing his company, MicroStrategy Incorporated (NASDAQ:MSTR), purchased 38,250 Bitcoin with $425 million in cash from the balance sheet.
“MicroStrategy completed its acquisition of 16,796 additional bitcoins at an aggregate purchase price of $175 million. To date, we have purchased a total of 38,250 bitcoins at an aggregate purchase price of $425 million, inclusive of fees and expenses.” Michael Saylor, MicroStrategy CEO.
Michael Saylor’s strategy is not to be considered a reckless bet, but rather a thoughtful and pondered decision motivated by several macroeconomic factors:
“Those macro factors include, among other things, the economic and public health crisis precipitated by COVID-19, unprecedented government financial stimulus measures including quantitative easing adopted around the world, and global political and economic uncertainty. We believe that, together, these and other factors may well have a significant depreciating effect on the long-term real value of fiat currencies and many other conventional asset types, including many of the assets traditionally held as part of corporate treasury operations.”
I evaluate the meaning and magnitude of the investment for MicroStrategy shareholders. I analyze the company’s balance sheet, the business operations, and the possible impact of this investment on the stock price, using a combination of scenario analysis and discounted cash flow analysis.
A Healthy Balance Sheet
Source: MicroStrategy’s financials, figure created by Author
MicroStrategy did not take a conservative approach, investing 1 or 2% of the cash at hand, but went all in instead investing the whole cash at hand on the company’s balance sheet. Looking at MicroStrategy’s balance sheet, we find a very healthy company. Before the Bitcoin investment, the company had a strong balance sheet with more than $500 million of cash and cash equivalents, and no debt. The Bitcoin investment is now more than significant, as it equals to almost one-third of the company’s $1.5 billion market cap. Many things could go wrong with this aggressive approach, but the strong balance sheet position seems to allow the undertaking of a “risky” activity of this kind.
Cash Flow & Operations Analysis
Source: MicroStrategy’s financials, figure created by Author
Moving on to analyze MicroStrategy’s financial situation, we evaluate the cash-generating ability of the company. MicroStrategy has been generating stable amounts of cash flow over the last 10 years, with an average of $64 million per year. The business has also shown resiliency in several economic cycles and it remained strong even through the unprecedented COVID-19 pandemic.
MicroStrategy has over $300 million in annualized subscription term and product support revenue, giving strength to the company’s financials. Five-year average gross margin is also very high at 80.5%, and the cost structure is composed in large part by variable costs that give the company significant flexibility.
Overall, both the balance sheet and the operational performance of the company provide a strong foundation for an aggressive investment strategy. Choosing Bitcoin as a $425 million investment bet is certainly not the most straightforward decision either, so it is important to analyze the investment thesis behind the decision.
In a recent interview, CEO Michael Saylor articulates his investment mainly as an inflation hedge. The Federal Reserve considers 2% a healthy and acceptable rate of inflation, but more recently, the FOMC announced it will allow the inflation rate to rise above the 2% target rate. Considering the record amount of quantitative easing that took place globally to combat the pandemic, the true, much higher, the inflation rate could be already reflected in the bond and equity market’s V-shaped recovery.
MicroStrategy’s CEO has decided to take a pro-active approach, worried that inflation would slowly burn his almost $500 million in cash slowly but surely. Bitcoin as an inflation hedge is becoming a popular bet amongst investors. I wrote about it back in April, as the quantitative easing was about to explode. The figure below shows an evolution in time of the amount of money needed to match the purchasing power of $100 in 1913.
Source: The Bureau of Labor Statistics. CPI Inflation Calculator
Since that date, the dollar has constantly decreased in value, eroded by inflation.
Source: Graph made by Author with data from CPI Inflation Calculator
Legendary fund manager Paul Tudor Jones also shared this view, betting on Bitcoin as the best long-term asset to own to face the upcoming “great monetary inflation“.
A comparison in store of value between dollar and Bitcoin is statistically premature, due to the lack of historical data for the latter. However, what MicroStrategy’s CEO Michael Saylor is trying to achieve is an asymmetric payoff, an investment that could half in value, while providing the possibility of a 10x return. In theory, Bitcoin is providing just that. Over a ten year time-horizon, Bitcoin could very well appreciate almost 10 folds, from its current 14,000$ price to 100,000$, especially if other CEOs or large institutions will follow suit. On the other hand, its value could not only half but go to zero, completely evaporating the $425 million from the company’s balance sheet. I rate the latter very unlikely, as the Bitcoin network has demonstrated strong resiliency even in the worst period of the coronavirus pandemic. It is still an option, however, so I’ll consider it in the following analysis as the worst-case scenario.
Investment Impact on The Stock Price
I undertake a discounted cash flow analysis of MicroStrategy over a 5 year time-horizon. With the following assumptions:
– Terminal Growth Rate: 2.00%
– Market Risk Premium: 5.00%
– Risk-Free Rate: 0.68%
– WACC: 4.61%
With future cash flows kept constant around $50 million per year, MicroStrategy’s fair share value totals $170 per share.
The worst-case-scenario, seeing Bitcoin go to $0, will evaporate all the $425 million on the balance sheet. Implementing this scenario into the DCF analysis brings MicroStrategy’s fair value down to $126, around a 25% decline from the current price. However, this price does not include the reputational repercussion the company would face in such an event, which would almost certainly drag the price down even further.
As a best-case scenario, I set a Bitcoin price of $100,000 per Bitcoin. Bitcoin maximalists would say this price is too low, Bitcoin deniers will say it’s too high, I think it constitutes a reasonable upside target to evaluate this investment decision. Implementing this expected value for Bitcoin into the DCF analysis brings MicroStrategy’s fair price to $564 per share, almost a 240% upside from the current price.
The discounted cash flow analysis shows that MicroStrategy has much more to gain than it has to lose. However, the chances of this investment strategy succeeding are impossible to determine. What is the probability of Bitcoin going to zero? Or to $100 thousand? Or to $1 million? The implied probability of a 10x bet (i.e. from $10 to $100 thousand) is 10%. Should this investment be categorized as an asymmetric binary bet, you should take the bet if you believe the chances of Bitcoin succeeding are higher than the 10% mark. This is, of course, an oversimplistic decision model, as there is no ceiling to Bitcoin price, while high technology risk makes the tail of the distribution significantly larger.
The analysis presented above helps MicroStrategy investors to set expectation boundaries on investment returns. If you invested in the company due to its healthy balance sheet and predictable cash flow, what you have now in your hands has changed. Realistically, from now on the stock price will be significantly influenced by Bitcoin price movements. Investors not comfortable with this are better off not holding this company’s shares. On the other hand, MicroStrategy now offers a remarkable opportunity to gain indirect exposure to Bitcoin with limited downside and still offering significant upside. To conservative investors wanting Bitcoin exposure, the 30% downside on MicroStrategy shares is more attractive than a potential complete wipeout, while the upside potential becomes lower (240% vs. 1000% with Bitcoin at $100,000) but still significant.
MicroStrategy’s treasury investment strategy is rather unique. The balance sheet before this decision was healthy, and cash flows over the past few years have shown stability and ability to support future expenses. The macroeconomic factors that motivate this decision are clear, and Bitcoin is gaining popularity amongst public companies and fund managers as a legitimate inflation hedge. However, the odds of Bitcoin succeeding as an asset class are impossible to quantify. Existing investors should be aware that this treasury investment will significantly impact the stock price returns, and ask themselves if they are willing to take the risk. On a purely mathematical basis, if you attribute to Bitcoin more than a 10% chance of success, then holding MicroStrategy share will still make sense for you. Either way, MicroStrategy now offers a remarkable opportunity to gain indirect exposure to Bitcoin with limited downside and still significant potential upside.
If you found this article of value and want to receive updates on this research, just click the “follow” button near the title.
Disclosure: I am/we are long MSTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: All articles are my opinion – they are not suggestions to buy or sell any securities. Perform your own due diligence.