MicroStrategy: The Stock Is Better Than A Bitcoin ETF

The Securities and Exchange Commission's (SEC) prolonged delay to render a formal decision on several spot Bitcoin (BTC-USD) ETF proposals, including submissions from applicants such as BlackRock (BLK) and Invesco (IVZ), is disappointing news for investors looking to gain exposure to the flagship cryptocurrency through these proposed ETF products. However, for investors familiar with MicroStrategy Inc (NASDAQ:MSTR) and its successful (so far) Bitcoin strategy, the long delays by the SEC to approve a spot Bitcoin ETF only serves to strengthen the appeal of MSTR, which is in my opinion one of the most convenient ways to currently gain exposure to Bitcoin through a stock brokerage account.

MSTR is one of the largest publicly traded corporate holders of Bitcoin in the world thanks to a business strategy adopted in August 2020 that has seen the company aggressively accumulate Bitcoin over time using excess cash and proceeds from debt and equity fundraising.

As of July 31, MSTR held 152,800 bitcoins acquired for a total cost of $4.53 billion or $29,672 per bitcoin, according to its Q2 2023 earnings presentation. Of the total holdings, 15,731 bitcoins are held at MicroStrategy, the parent, and are pledged as collateral for the company's 2028 secured notes. The remaining 137,069 Bitcoins, or roughly 90% of its total Bitcoin holdings, are fully unpledged and unencumbered. This buy-and-hold approach has defined MSTR's Bitcoin's strategy since inception 3 years ago, explaining the strong correlation between Bitcoin's price return and MSTR's return over this period. As the chart below illustrates, Bitcoin has returned 149% in the past 3 years vs. MSTR's 117%.

MSTR is not the only game in town for investors looking to potentially profit from Bitcoin's price action. Stocks like Grayscale Bitcoin Trust (OTC:GBTC), Bitcoin miners such as Marathon Digital Holdings (MARA) and Riot Platforms (RIOT), and crypto exchanges like Coinbase (COIN), have historically moved in tandem with the price of Bitcoin. However, unlike these stocks, MSTR has an underlying core business whose financial performance is not impacted by near-term Bitcoin price fluctuations. This is a strong competitive advantage.

Stable core business limits downside risk

MSTR is an enterprise software company that has been providing business intelligence products and services for decades. MSTR employs about 2000 employees, including engineering teams that work in its core product. It has a solid customer base that includes brands like Hilton Hotels and Sony Interactive Entertainment and generates fairly predictable annual revenues, with sales of $499.3 million in 2022, $510.8 million in 2021, $480.7 million in 2020, and $486.3 million in 2019. Analysts expect it to earn $500.7 million this year.

A key strategic initiative currently underway in MSTR's core business is the transitioning of its business intelligence customers to the cloud. This involves a shift away from generating revenue from product licenses to generating revenues from subscriptions. So far, the subscription model is proving to be successful with high renewal rates. "Customer renewal rates were 93% for the quarter and remained above 90% for the sixth consecutive quarter, continuing to demonstrate the durability of our customer base even with a tough macroeconomic backdrop," noted Andrew Kang, Senior Executive Vice President & Chief Financial Officer in the Q2 earnings call.

In keeping with technological trends, MSTR's core business intelligence platform is also integrating with AI, particularly generative AI and deep learning. In Q2, MSTR expanded its relationship with Microsoft (MSFT), announcing a multiyear partnership that integrates MSTR's analytics capabilities with the Azure OpenAI service and Microsoft 365. The partnership also makes MSTR's products and services available on the Azure Marketplace.

MSTR is also pursuing new innovations through MicroStrategy Lightning, which aims to leverage on the Bitcoin network to enable new e-commerce use cases and tackle cybersecurity challenges.

While I'm not convinced these innovations and strategic initiatives will lead to explosive topline growth, I do believe that they are credible signs that MSTR's core business is healthy and will likely continue providing stable and sufficient cash to cover operational costs. This limits the downside risk to its share price, which implies a valuation that is roughly in line with the valuation of the broader software industry. MSTR has a Price to Sales (P/S) ratio of 7.1, which is at par with the average P/S of 7.14 for the software industry (system & application), according to industry data compiled by NYU Stern Professor Aswath Damodaran.

From a P/S standpoint, MSTR is fairly valued at the present share price when compared with other software companies. The only thing, however, is that MSTR is not just any software company. In addition to the software business, it owns more than 137,000 unencumbered Bitcoins (and counting). This explains why the stock has been outperforming a broad selection of assets in recent years. Since adopting its Bitcoin strategy 3 years ago, MSTR has not only outperformed Bitcoin itself, but has also outpaced key assets and indices, including some of the leading Big Tech and enterprise software stocks.

Access to low-cost capital a major advantage

Another major reason why MSTR is a compelling choice for investors looking to gain exposure to Bitcoin is the fact that it is able to raise capital at attractive terms. Its outstanding debt and convertible notes of $2.2 billion have a bundled weighted average interest rate of approximately 1.6%, according to the company. This is compared to the blended weighted average interest rate of 2.1% at the end of 2022, which equates to a decrease of over $15 million in annualized interest expense.

Being able to utilize low interest debt to accumulate Bitcoin is a smart move in my opinion since the value of the Bitcoin will likely surpass the cost of the debt and interest payment as crypto market conditions improve in the next few quarters due to factors such as possible ETF approvals by the SEC, the Bitcoin halving event in Q2 2024, and the potential for lower interest rates amid falling inflation.

The issuance of new shares to raise capital is another important financing opportunity for MSTR. Since the third quarter of 2021, MSTR has raised a total of $1.7 billion in gross proceeds through At-the-Market (ATM) offerings with the average price of all issuances of approximately $424 per share, as per the company CFO. The primary use of ATM proceeds has been to acquire additional bitcoin.

What makes MSTR's ATM program unique is that it has a very low outstanding share count when compared with other players in the Bitcoin space like MARA and RIOT that regularly utilize regular stock offerings to raise financing.

MSTR's total outstanding shares increased from 11.3 million in 2021 to 14.1 million in the most recent quarter. MARA, in comparison, has seen its outstanding shares jump from 102.7 million in 2021 to 174.2 million in the most recent quarter, while RIOT's count has increased from 117.3 million in 2021 to 185.3 million in the most recent quarter. A lower share count means that MSTR has more room to raise additional equity financing in future. Tellingly, MSTR on Sept. 24 sold a total of 403,362 of its shares for net proceeds of ~$147.3M, enabling it to make Bitcoin purchases for the same amount. Investors should expect more of these as the company leverages on its equity to acquire more Bitcoin.

Concluding with a word on risk factors

Before concluding, a word on some of the risks that come with buying MSTR is necessary. The first risk I foresee is that any potential decision by MSTR to dispose of part or all its Bitcoin for whatever reason in the future may lead to a disproportionately negative reaction by investors. The company must therefore continue taking on debt and diluting investors in order to sustain the Bitcoin strategy. There is also no assurance that it will be able to continue raising capital on attractive terms, especially if the price of Bitcoin continues to move sideways as it has in recent months, or worse, declines sharply. It's instructive to note that, during the last crypto bear market in 2022, a lot of crypto firms went under due to overleveraging themselves.

Another factor that makes MSTR a potentially risky investment is the difficulty in valuing the company. Although investors can utilize the P/S ratio to get a sense of its valuation as a software company, this only tells half the story as MSTR is also a Bitcoin holding company. Moreover, the company's Bitcoin holdings lead to frequent impairment charges due to GAAP accounting policies that require the firm to recognize impairments quarterly if there is a change in the fair value of its Bitcoin holdings. This makes it difficult to compare year-over-year data due to the volatility of the price of Bitcoin over any given timeframe. As an example, MSTR recorded a Bitcoin impairment charge of $24 million in Q2 2023 in contrast to $918 million in Q2 of last year. These wild swings in impairment charges make comparing MSTR's net income over different time periods impractical, adding a layer of complexity to the already laborious process of valuing the company.

These risks notwithstanding, I'm bullish on MSTR. For investors looking to gain exposure to Bitcoin, MSTR could be a better option than waiting for a spot Bitcoin ETF to come to market as I suspect the price of Bitcoin will have already moved up significantly by the time the SEC formally approves any of the pending ETF applications. MSTR can allow investors to lock in these potential Bitcoin price gains early. The arguments outlined in this article -- such as MSTR's core business limiting the downside risk to the stock, and the company's ability to raise capital at attractive terms to buy more Bitcoin -- are also compelling reasons to consider the stock over a spot Bitcoin ETF.