When your entire corporate game plan and the investor base you’ve cultivated revolves around the rising price of bitcoin, a 35% tumble in a month is cause for alarm.
Last week bitcoin fell to $82,000, down 35% from its $126,080 October peak. For most big Nasdaq-listed companies, that drop is background noise. For Michael Saylor’s Strategy, the stock market’s biggest bull and largest corporate holder of bitcoin, it immediately raises the question of what comes next.
For almost two years, Strategy traded far above the value of its bitcoin holdings—at times 190% higher—turning its stock into a turbo-charged bitcoin bet for most institutional investors. Saylor’s transformation of his Tysons, Virginia-based data mining software company into a masterwork in using traditional corporate finance to harness bitcoin’s volatility has already attracted hundreds of copycats – publicly traded holding companies known as digital asset treasuries (DATs).
But Strategy’s premium has disappeared and its own shares have fallen 60% in a year, bringing its market capitalization down to $49 billion, lower than the value of the $56 billion in bitcoin it holds.
Last month, S&P Global Ratings assigned Strategy a B- credit rating, deep into junk territory, citing “high bitcoin concentration, narrow business focus, weak risk-adjusted capitalization, and low U.S. dollar liquidity as weaknesses.” JPMorgan analysts also warned in a recent note that Strategy is at risk of being removed from major benchmarks, including MSCI USA and the Nasdaq 100. If MSCI moves ahead, as much as $2.8 billion could flee the stock, with more at risk if other index providers follow. Passive funds tied to Strategy account for nearly $9 billion of exposure. A removal would not only force selling but drain liquidity from a stock whose high trading volume has long been one of its main attractions for institutional investors. And while Strategy has met S&P 500 inclusion criteria for two straight quarters, it has not been added, and isn’t likely to give its bitcoin woes.
Saylor, ever the evangelist, is not retreating. Never mind equity, he says. His latest mantra—“the credit is the product and the equity is the afterthought”—captures his belief that Strategy’s future now lies not in being a bitcoin-tracking stock, nor in providing sophisticated traders with a place to hedge, but in building a new market: bitcoin-powered income instruments attractive to investors who want yield rather than price swings.
To do that, Strategy has spent the past year rolling out an unusual menu of perpetual preferred securities. These are preferred stocks that have no maturity. His new issues, totaling $8.6 billion, read like a set of characters from a comic book—Strike, Strife, Stride, Stretch (plus the euro-denominated STRE)—but each is a different variation of the same idea: high, fixed dividends backed by Strategy’s stack of different securities. Strike, under ticker STRK, pays an 8% dividend and can convert into common stock at $1,000 a share (MSTR’s recent price:$170). Strife, or STRF, pays 10% annually and sits at the top of the preferred stack. Stride, or STRD, also pays 10%, but on cumulative terms, meaning missed payments pile up and must eventually be made. Stretch (STRC), introduced in August at a 10.5% fixed cumulative dividend, has hovered just above its offer price of $90.
Saylor’s key selling point is that these payouts are expected to be classified as “return of capital” for at least the next decade, which means investors reduce their cost basis instead of paying taxes on the distributions each year. For taxable investors, that translates into a significantly higher effective yield than similar corporate preferreds.
But the latest downturn in bitcoin has hit Strategy’s new preferreds. The 10.5% STRC securities issued in March, now trade below their $100 par and yield roughly 11%, a full percentage point above its stated coupon. The euro-denominated STRE, launched earlier this month, fell below its €100 issue price in under two weeks. Its yield has gone from 10% to 12.5%.
Investors are no doubt concerned about Saylor’s ability to cover his interest costs in a prolonged bitcoin bear market. Between preferred dividends and interest on its convertibles, Strategy now faces roughly $700 million a year in payments. The company also has some $8 billion in convertible debt outstanding, $7.4 billion of which sits out of the money, meaning the stock now trades below the bonds’ conversion prices, so holders are unlikely to take equity instead of cash at maturity. With the stock’s once-reliable premium now gone, issuing more equity—the way Strategy funded its bitcoin buying for years—is no longer an accretive option.
Mark Palmer, analyst at Benchmark, pointed out that during the company’s Q3 earnings call, Strategy CEO Phong Le outlined contingency plans including the generation of income by deploying bitcoin derivatives (such…