Delving Into MicroStrategy’s Bitcoin Bet

Bitcoin’s emergence as an asset class has been tumultuous. Amidst a raucous debate about its utility, the cryptocurrency’s price volatility has transfixed investors and traders looking for short-term profits. But they do not have much choice in terms investing avenues because the cryptocurrency remains largely outside the perimeters of regulation. Instead, players have crafted unique investing configurations to provide exposure to the asset class.

The Grayscale Bitcoin Trust (GBTC), a pink sheet trust masquerading as a closed end fund, is one. Business Intelligence company MicroStrategy is another. The firm has risen to Bitcoin fame (or, infamy, depending on your perspective) quickly since its purchase of Bitcoin since 2020.    

It headlined news sites again yesterday after its CEO Michael Saylor announced that he was stepping down from his job and promoting his long-time deputy – CFO Phong Le – to the top post. Saylor, who also co-founded the company, will still preside over it as Chairman.

A Quick Ascent

By most market metrics, there is not much in MicroStrategy’s business to generate such media interest in an executive reshuffle. The Virginia-based company is a small market cap company that sells business intelligence platforms to customers. It was a relatively unknown entity before 2020 and reported profits that were not exactly earth-shattering. In fact, it reported a decline in profit in 2019, before its bitcoin investment.

Former CEO Saylor says his company had a market capitalization of $666 million on August 11, 2020. That was the day its new treasury management strategy of purchasing bitcoin to use up its cash reserves. The new strategy converted MicroStrategy into front page news and skyrocketed its market capitalization. It touched $5.3 billion at one time and stands at $3.54 billion, as of this writing. The stock’s trading volume has multiplied from 2020 and its price is up 123% during the same time period. At the end of its second quarter, the company had purchased 130,000 bitcoin valued at roughly $3 billion, based on current prices.

MicroStrategy has had prior experience with intense media attention, when its founders were charged with dubious accounting practices and fraud by the Securities and Exchange Commission (SEC) for reporting misleading profits. The company settled that case by paying a fine and returning money to shareholders.

Its recent public relations blitz for Bitcoin, however, is less controversial and has not raised the agency’s hackles. In fact, if anything, Saylor’s pronouncements about the cryptocurrency being “digital energy” and “monetary energy” have attracted institutional interest. Bitcoin’s price volatility has increased coverage of MicroStrategy on mainstream business news and multiplied the number of analysts and funds interested in its stock by “one or two orders of magnitude”, he says.  

Institutional Interest Surges

Institutional investors are ostensibly interested in MicroStrategy because it is a convenient vehicle for them to gain indirect exposure to a volatile asset’s spot price. GBTC also offers a similar service. But its share price, as I wrote earlier, is prone to significant premiums and discounts to bitcoin’s price. Investing in bitcoin through MicroStrategy is cushioned by the company’s cash flow from its software business and its relatively stricter SEC disclosures. [GBTC trades in OTC markets and is, therefore, not subject to disclosure requirements].

Institutional inflows into MicroStrategy peaked in the second quarter of last year, when bitcoin was trading at record prices, at $860 million. Before MicroStrategy’s bitcoin adventure, investors had dribbled a measly $55 million into the company in the third quarter of 2020.

The flow of money runs in the opposite direction as well. During the recent crypto downturn, sellers have stepped on the gas and sold $750 million worth of MicroStrategy’s stock. Short interest in MicroStrategy’s stock has also peaked and stands at about 40% of its total float in the markets, as of this writing.

How Does MicroStrategy Benefit?

All this drama is beneficial for MicroStrategy, and Saylor is actively promoting his company’s stock as a “spot bitcoin ETF” to investors. The importance of Bitcoin to the company’s narrative was highlighted in yesterday’s earnings call. Saylor said his firm had two corporate strategies: to operate and grow its enterprise analytics business and to acquire “whole bitcoin”.

At first glance, that strategy statement seems laughable. But a reading of the company’s financials shows the difference that bitcoin is making to its business.

Its software segment pivoted to profitability for the first time last year since 2014. Overall revenues in 2021 jumped to $510 million, an increase of 6.2% from the previous year, reversing a 1.2% decline from 2020. Revenues from software licenses for its business intelligence platform grew 5% in the latest quarter as compared to the same period last year while cloud subscription revenues grew 36% during the same time period.

Saylor attributes the increased revenues to bitcoin. The publicity engendered by the company’s investment in Bitcoin has created awareness about it among interested investors, prospective customers, and C-suite professionals, he says. “We don’t have to try to convince companies to want to cover our stock and explain why we’re unique. They’re hearing from lots and lots of other channels that we’re unique,” he said during the company’s latest earnings call.

Can MicroStrategy Maintain Its Momentum?

As a proxy for investment into Bitcoin, MicroStrategy is an interesting case study. The company has milked that interest interest through news releases designed to evoke publicity. For example, it borrowed $205 million from Silvergate Bank in March to fund purchase of bitcoin. The idea, Saylor said later, was to “create a market” for such borrowing. [The recent crash in crypto markets has been attributed to similar forms of borrowing by less well-capitalized entities].

But it will need more than publicity to propel profits for its main business – selling business intelligence platforms to enterprise customers. The news is mixed on that front. While MicroStrategy’s sales jumped, that development is part of a general industry trend as Covid-afflicted businesses move from on premise solutions to the cloud to accommodate an increasingly remote workforce.

In the near term, MicroStrategy will struggle to produce profits. This is because cloud business models rely on recurring revenues from Software-as-a-Service (SaaS) offerings. Monthly revenues are meant to amortize cloud investment costs in the long term. Most major cloud players are still struggling to report profits even after years of operation. Salesforce, a pioneer of SaaS services, reported years of losses before finally turning a thin profit in 2015.     

MicroStrategy also faces stiff competition from software industry giants with a thick customer rolodexes and fat cash reserves. For example, some competitors to the company’s business intelligence platform are offerings from Microsoft, Salesforce, and IBM.

In recent times, MicroStrategy’s business intelligence platform has fallen behind their offerings. Between 2017 and 2018, its solution rose from Visionary to Challenger status in research firm Gartner’s Magic Quadrant. In the Quadrant’s latest edition, however, it was categorized as a niche player. “Gartner questions [these vendors] ability to compete with market leaders – in terms of both innovation and performance,” the firm’s analysts wrote. They also pointed to “feature gaps” and “a lack of surrounding data” in MicroStrategy platform’s capabilities as factors holding it back.

MicroStrategy’s product problems are further hampered by bitcoin’s price volatility. Its treasury management was meant to put cash reserves to productive use. But that practice is generating losses right now. Meanwhile, the chief architect of the strategy, its former CEO, has converted it into a quasi-philosophical pursuit of “energy” in society.

Unlike Tesla, the other publicly listed company that invested in bitcoin, MicroStrategy has not sold its bitcoin holdings. As a result, the company has had to contend with significant write downs. In the latest quarter, it reported a $918 million write down of its bitcoin assets. For context again, its revenues last year were $510 million. Thus, the company’s profits and losses are affected by its treasury management practice.

MicroStrategy’s performance, thus, depends on two prongs – bitcoin and business intelligence platforms. A prolonged downturn in bitcoin prices could affect investor interest in the MicroStrategy stock and cash flows for its business. The company might want to rev up its sales engine and improve upon its products while riding the bitcoin gravy train.

As with GBTC, the SEC’s refusal to approve a spot bitcoin ETF has helped MicroStrategy’s prospects. If the agency changes course quickly, the unusual configuration of MicroStrategy’s business could come to an end and the company might have to choose between its two corporate strategies.  

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