The saga of MicroStrategy reads like monetary fiction delivered to life. Its unbelievable resurrection from near-bankruptcy, its audacious pivot in August 2020 from software program vendor to bitcoin maximalist, the thorny legal entanglements, its messianically charismatic leader, its once-in-a-generation inventory value performance — all of it defies perception.
Lay on its issuance of prodigious quantities of inventory and convertible debt, and the tsunami of stock selling by insiders, and the story will get even wilder. See our previous coverage for a recap.
And the beat goes on. Final month, the corporate wowed Wall Road by rolling out its fifth convertible of the 12 months — a $3bn, five-year note with zero per cent coupon and a 55 per cent conversion premium to a share value that was already buying and selling at nearly three times the web asset worth of its bitcoin holdings — all to fund its relentless quest for extra bitcoin.
On paper, it’s genius. The plan is easy: borrow for zero curiosity with a convertible, purchase bitcoin, and repay the debt when the shares convert at nosebleed costs. So long as the share value stays up — and bitcoin is at the least hovering round $100,000 — we’re speaking about one of the crucial profitable feats ever of monetary engineering.
This hasn’t gone unnoticed. Simply final week, bitcoin miner Mara jumped on the bandwagon, placing $850mn in convertibles to refinance debt and, naturally, purchase extra bitcoin. The phrases have been fairly candy: zero-per cent coupon and a 40 per cent conversion premium.
So are we witnessing the embrace of bitcoin by the giants of mounted revenue? The argument goes that entry to bitcoin by way of these convertible bonds is so interesting that bond traders — who’re in any other case excluded from cryptocurrency as a result of their funding mandates — are keen to concede astonishingly beneficial phrases to issuers. Given the immense scale of bond funds, even a small allocation to such securities may have a seismic affect.
However whereas funds managed by stalwarts like German insurer Allianz reportedly bought chunks of an earlier MicroStrategy convertible, they’re doubtless not right here for the crypto revolution. The actual draw lies in MicroStrategy’s inventory — or extra exactly, its volatility.
And MicroStrategy is an energetic and keen confederate in creating volatility in its personal inventory.
Convertible bonds are the capital market equal of a mullet — severe enterprise within the entrance (debt), celebration within the again (fairness). They begin life as plain previous debt however include a kicker: the choice to transform into shares at a pre-determined value. For bondholders, this implies draw back safety (ie. you’re alleged to get more cash again) with upside potential. For firms, the embedded name choice permits them to borrow at decrease rates of interest, because it sweetens the deal for traders.
On this case, MicroStrategy has basically created a monetary instrument that’s half mortgage, half lottery ticket. How may it increase $3bn at a zero-per cent coupon and a conversion value of $672.40 per share when the inventory was buying and selling at $433? The reply lies within the inventory’s explosive volatility, pushed by and magnified by way of its bitcoin holdings. This volatility considerably enhances the worth of the embedded name choice within the bond, which, in flip, offsets the price of the bond itself. In consequence, the corporate is capable of borrow at charges far beneath these of standard debt.
And unstable it is. MicroStrategy’s inventory strikes like a hyperactive toddler let free in a sweet retailer, ricocheting from aisle to aisle with boundless, chaotic power. Its 252-day historic volatility is currently 106 per cent (implying a median transfer of 6.6 per cent per day!). The implied volatility of 30-day choices in its inventory is 2.5 times more than comparable period choices in bitcoin itself. And MicroStrategy is unembarrassed by this: in its third-quarter earnings presentation, administration crowed about MicroStrategy choices buying and selling a greater implied volatility than any S&P 500 inventory.
This sheds gentle on one of many paradoxes across the MicroStrategy story: why does co-founder Michael Saylor relentlessly hype bitcoin whereas his firm is shopping for it? Most individuals would speak down an asset they’re accumulating.
However for MicroStrategy, volatility is the actual forex. Saylor’s bombastic interviews, grandiose predictions, and relentless social media posting aren’t simply noise — they’re the gasoline for the monetary hearth. There’s by no means a uninteresting second with the man. The crazier the inventory, the higher the phrases for the subsequent convertible.
MicroStrategy has successfully engineered its personal volatility — and reaped the rewards. Earlier than August 2020, the corporate’s inventory exhibited each realised and implied volatilities within the low 30s. However as soon as MicroStrategy reinvented itself as a binge-buyer of bitcoin, volatility skyrocketed, first surpassing 70 per cent and later breaching 100 per cent. The dynamic is self-reinforcing: buying extra bitcoin amplifies share value volatility, permitting MicroStrategy to challenge convertible bonds on more and more beneficial phrases, which it then makes use of to purchase much more bitcoin — additional fuelling the volatility. And so the cycle continues.
Traditionally, convertible bonds within the power sector have traded on the “richest”, with at most 35-40 per cent implied volatility, and extra lately know-how firm points have taken it to the 40-45 degree. In accordance with IFR, MicroStrategy’s convertible was marketed at a 60 per cent implied volatility — an unprecedented degree within the equity-linked market.
Traders in these bonds make use of numerous buying and selling methods to capitalise on volatility, with one basic method being so-called gamma buying and selling. This technique includes buying the bond and short-selling the inventory, dynamically adjusting the scale of the brief because the inventory value fluctuates to maintain the mixed place share-price impartial. The online impact is to purchase shares low and promote them excessive, whereas staying lengthy the convertible.
Right here’s the way it works: traders begin by shorting MicroStrategy’s inventory in proportion to the convertible bond’s “delta” — a measure of how delicate the bond’s value is to modifications to the inventory value. (The speed of change of the delta in relation to the underlying asset, which on this case is the inventory value, is referred to as “gamma”.)
Let’s say you purchase $1,000 of a convertible bond and the delta is 0.5. So that you short-sell $500 of shares.
Because the inventory value rises and the convertible bond nears being “within the cash,” the bond’s delta will increase, and also you promote extra shares to remain impartial. If the delta reaches one, you’ll be brief the identical variety of shares as you anticipate to obtain from the convertible. Conversely, because the inventory falls and the convertible turns into effectively “out of the cash”, the delta decreases, and you purchase again shares, decreasing the brief place. The fixed rebalancing generates income from the inventory’s volatility, impartial of its total course.
Consider it like harnessing wind power: the generators spin so long as there is wind, regardless of course. The essential issue is the presence and pace of wind, not its orientation. For merchants, volatility is the wind that powers their technique. As for MicroStrategy, its inventory is well-suited for this sort of buying and selling: it’s unstable, liquid, and comparatively simple to borrow for shorting.
Now, earlier than you begin considering you possibly can do that at residence, cease proper there. Gamma buying and selling technique is not for amateurs. It is difficult, requires fixed rebalancing, and is finest left to the professionals with their fashions, dealer relationships, and buying and selling infrastructure. For the dabblers, potterers and different non-professionals, it’s like watching a efficiency of fire breathing on a Zanzibar seashore — dazzling to look at, seemingly doable by anybody, however you possibly can endure extreme burns in case you strive it with out correct coaching.
In fact, each flashy monetary technique comes with dangers. If the inventory calms down, these volatility-driven arbitrage alternatives may vanish, leaving idle and stranded the wind generators of gamma buying and selling. (This could occur, for instance, as a result of traders in convertible bonds are dampening volatility by promoting inventory as its value climbs and shopping for inventory because it falls.)
MicroStrategy’s volatility has, for no matter motive, cooled within the final couple of weeks, doubtless leaving some traders nursing losses, though they pale as compared with the hefty good points loved on earlier convertibles.
One other looming danger is that MicroStrategy’s 5 earlier convertible bonds — now deeply within the cash, with conversion costs between $143.25 and $232.72 — may finally not convert if bitcoin’s value (and, by extension, MicroStrategy’s inventory value) plummets. What occurs then? How would MicroStrategy handle as much as $6.2bn in bond repayments if the tide turns and the principal on the bonds comes due at maturity?
The corporate’s choices can be stark. Its lossmaking software business generates no money, and its treasure chest of 402,100 bitcoins, presently valued at $39bn, would provide little solace. Promoting bitcoin to boost money would doubtless be a final resort, however by then, the value of bitcoin would presumably have dropped considerably, exacerbated by the affect of any gross sales themselves. Whereas convertible bondholders maintain a senior declare to those bitcoin belongings over stockholders within the occasion of chapter, the precise “protection” might show far thinner than it seems.
And don’t assume the inventory can’t tumble beneath the conversion costs — it was buying and selling below $130 as lately as three months in the past. For context, the spot-price worth of MicroStrategy’s bitcoin holdings interprets to $166 per share. Till February 2024, the inventory traded kind of in keeping with the web asset worth (NAV) of its bitcoin. It’s solely the hefty premium to NAV that has stored most of those convertible bonds so comfortably within the cash.
Anyhow, mitigating this credit score danger isn’t simple for traders.
One method is to maintain a brief place even when the convertible is effectively out of the cash, hedging towards the potential for (and even probability that) the corporate’s creditworthiness deteriorates alongside its share value. However this creates its personal challenges. As a substitute of shopping for right into a falling market (as for gamma buying and selling), traders might discover themselves promoting shares as the value is tumbling. Relying on dimension and liquidity, promoting into weak point dangers being self-defeating; it is not a straightforward commerce to execute.
However, for now, the technique is working wonders. By weaponising its inventory’s volatility, MicroStrategy has created a seemingly self-perpetuating loop: low cost funding buys bitcoin, which boosts the inventory’s volatility, which secures even higher bond phrases to purchase extra bitcoin. The traders? They might or might not be bitcoin believers or Saylor groupies; many are simply thrill-seekers using the wave. So long as the inventory retains zigzagging, the present goes on. However like several high-wire act, there’s all the time the hazard of a fall.
Additional studying:
— Examining MicroStrategy’s record-shattering $21bn ATM (FTAV)
— The spectacle that is the bitcoin juggernaut MicroStrategy (FT)
