In finance, of course, when a bank denies they are having liquidity problems it is a sure sign they are, in fact, having liquidity problems. So when I read the recent statement from MicroStrategy CFO Andrew Kang on their bitcoin holdings —
“Believe nothing until it has been officially denied.”
— Claude Cockburn
Everything is Fine
On March 10, 2008, Bear Stearns CFO, Sam Molinari, felt compelled to issue a press release stating, “there is absolutely no truth to the rumors of liquidity problems.”
Four days later, Bear agreed to be acquired by J.P. Morgan for the firesale price of $2 a share.
On September 10, 2008, Lehman Brothers CFO Ian Lowitt reassured panicked investors on a conference call that the bank’s “capital position at the moment is strong."
Five days later, Lehman filed for bankruptcy.
In finance, of course, when a bank denies they are having liquidity problems it is a sure sign they are, in fact, having liquidity problems.
So when I read the recent statement from MicroStrategy CFO Andrew Kang on their bitcoin holdings — “At this time, we do not have any intention to sell” — my finance brain couldn’t help but flashback to watching Bear Stearns and Lehman Brothers tell us everything was fine in 2008.
MicroStrategy is fortunately not a bank and therefore not subject to a bank run.
It has, however, taken on a fair bit of leverage. Which means that, like a bank, its fate is not entirely in its own hands.
We’ve just witnessed how Do Kwon’s celebrated foray into bitcoin was quickly exposed as a liability when the markets forced him to sell.
Could MicroStrategy, now underwater on its big bet, be bitcoin’s next champion-turned-liability?
Margin-loaning the Farm
The back cover of The Bitcoin Standard includes an endorsement unique in the history of book blurbs:
“The best compliment I can give this book is that I read it and I decided to buy $425m of bitcoin.” — Michael Saylor
If I were a MicroStrategy board member or shareholder, I would not have found that book review reassuring: We’re doing what??? Because the CEO read what???
But Saylor makes a compelling case for bitcoin and MicroStrategy’s stakeholders have clearly bought in: what began as a way to diversify the company’s treasury has morphed into the company’s raison d’etre.
Saylor has levered that initial bet first by issuing convertible bonds to fund more bitcoin purchases and then, in June of last year, by issuing $500 million of senior debt with a 1st lien on both MicroStrategy’s software business and a portion of its bitcoin stack (effectively betting the farm, so to speak).
That debt costs 6.125% to service, which highlights an obvious but possibly underappreciated fact: Bitcoin is not a productive asset.
An investment in bitcoin does not fund itself, which is why miners have to constantly sell their mined coins in order to service their dollar liabilities (taxes, staff, electricity, hardware).
MicroStrategy has similarly taken on dollar liabilities in order to stack bitcoin, but it services those liabilities with the cash flow generated by its software business.
That seems fine until you remember that cash flows from an operating business can be fickle. And that Saylor has not left himself much margin for error.
Doomberg noted in a recent blog post that MicroStrategy’s software business “barely produces twice as much EBITDA than the interest payments Saylor has saddled it with, making it virtually worthless by standard valuation methods.”
That includes interest on their recent bank loan of $205 million, which is backed by bitcoin collateral worth (at the time) about $820 million.
This, again, seemed fine to me — until I thought about it a little more: We’re all accustomed to taking out over-collateralized loans to buy a house, but we do that because we need somewhere to live.
No, you cannot live in your bitcoin.
You might argue MicroStrategy borrowing to buy bitcoin is more akin to taking out a mortgage to buy a rental property. But in that case, the rental yield likely pays for the mortgage.
Bitcoin, again being unproductive, will not pay your mortgage.
In any case, Saylor hasn't mortgaged the house — he’s margin-loaned it. Which is worse.
If your mortgage is underwater, you can always drop the keys in the mailbox and walk away. Not so with a margin-loan: In that case, a lender can seize and liquidate your asset before the loan is underwater.
MicroStrategy’s President Phong Le acknowledged this risk on their earnings call of May 3:
“As far as where bitcoin needs to fall, we took out the loan at 25% LTV, the margin call occurs at 50% [loan-to-value]. So essentially, bitcoin needs to cut in half to around $21,000 before we'd have a margin call.”
$21,000 does not feel so far away anymore, and when you give financial markets a target to shoot for, they usually try to hit it.
MicroStrategy can, of course, meet their margin call by posting more collateral — as of their Q1 report, they held at least 95,000 “unencumbered” bitcoin.
And in a very worst case scenario, MicroStrategy could issue new stock. (Although, as with LUNA, the market cap might not be there when you need it.)
Saylor remains confident in his ability to hang on to his leveraged bitcoin position. But my TradFi brain can’t help but see risks around every corner.
So when MicroStrategy CFO Andrew Kangtold the Wall Street Journal last week that shareholders are “aligned” with the company’s strategy and haven’t pressured it to sell its bitcoin holdings, I immediately fear the opposite: Shareholders tend to be fair-weather friends, especially in a bear market.
Could MicroStrategy turn seller of bitcoin? It still seems unlikely to me.
But so did the demise of Bear and Lehman — right up until it wasn’t.
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