Source: Tom Carreras, James Van Straten, Stephen Alpher
Compiled by: BitpushNews
Did Michael Saylor and MicroStrategy (MSTR) discover some financial "loophole" that makes money from money?
It’s hard to blame people for thinking this way.
While the Saylor-led company began buying Bitcoin (BTC) more than four years ago, MicroStrategy has raised more than $6 billion over the past 10 months using a unique strategy with the express purpose of adding more Bitcoin to its balance sheet, which stands at 439,000 Bitcoins worth $46 billion as of December 15, at a current price of around $106,000.
MicroStrategy didn’t raise those funds by taking out loans or issuing more company stock (although it has sold billions of dollars worth of stock separately). Instead, the company sold convertible bonds — debt securities that can be converted into stock on a specific date or under special conditions. And it’s not over yet: Saylor and company intend to raise at least $18 billion more in such bonds over the next three years, according to a plan laid out in October.
Demand for the convertible notes has been so high that other companies, including bitcoin miner MARA Holdings (MARA), have taken a similar approach to raise billions of dollars to bolster their coffers.
But this raises the question: Could issuing so much debt ultimately be dangerous for these companies, and for the cryptocurrency market as a whole?
Quinn Thompson, founder of crypto hedge fund Lekker Capital, told CoinDesk: “If bitcoin prices remain low or decline for an extended period of time, [these companies] may have to issue more shares in order to raise capital, which would dilute existing shareholders… [or] sell bitcoin for less than they paid for it.” However, Thompson doesn’t think these companies will go bankrupt.
How Convertible Notes Work
Convertible bonds are a type of financial instrument that helps companies raise capital quickly without having to post collateral (like a loan) or immediately dilute their stock. These bonds are priced based on the interest rate they contain, the company's underlying stock, the volatility of that stock, and the company's credit worthiness.
For example, in November, bitcoin mining company Bitdeer (BTDR) raised $360 million by issuing 5.25% convertible bonds. The bonds mature on December 1, 2029, and are priced at $15.95 per share—about 42.5% higher than the price at which the shares were trading on November 21, when the convertible bonds were issued.
In other words, rather than simply buying the company's shares on the open market, investors can earn a nice yield by holding these notes, while also benefiting if the stock price soars. Even better, convertible notes come with downside protection. On a specific date, the bonds can be redeemed for cash equal to the original investment plus interest. In other words, even if the stock plummets before the notes mature, investors are virtually guaranteed to get their money back.
But MicroStrategy's situation is unique because the company has found that even as U.S. benchmark interest rates approach 5%, there is still demand for convertible bonds with a 0% interest rate. Why? Because of volatility. MicroStrategy common stock is essentially a leveraged trade in Bitcoin, with a recent 30-day average implied volatility of 106 and even higher in the past. By comparison, the implied volatility of the S&P 500 is usually around 15, while the implied volatility of Bitcoin is 60.
Stock volatility can impact the price action of MSTR Convertible Bonds, and experienced market participants can generate significant profits by trading this volatility in a market-neutral manner.
Richard Byworth, a convertible note expert and managing partner at asset manager Syz Capital, told the On The Margin podcast that he had spoken to a convertible note arbitrage trader.
The trader described his current crazy work status, saying: "Richard, I have become a cryptocurrency 'Degen' trader... This is crazy. If I don't adjust all the deltas (Greek letters used to describe the sensitivity of option prices to other factors) when I go to the bathroom, I may face millions of dollars in risk when I come back. The market changes too quickly."
As a result, there was huge demand for MicroStrategy's convertible bonds, which allowed the company to sell a large number of bonds - five issuances in one year, which is unprecedented.
As of now, the company has six outstanding convertible bonds with maturities between 2027 and 2032. Two of them have an interest rate of 0%, two more have an interest rate of 0.625%, the fifth has an interest rate of 0.875%, and the last has an interest rate of 2.25%. Because of these very low interest rates, MicroStrategy is able to sell shares at a price far above the current share price while only paying an average interest rate of 0.811% on the debt, or $35 million per year, an amount that is easily covered by the company's revenue.
Greg Magadini, director of derivatives at crypto data firm Amberdata, told CoinDesk: “If implied volatility stays high, I bet MSTR will sell more and more convertible bonds…which means they will buy more and more bitcoin. To me, the first sign of a bitcoin rally ‘TOP’ will coincide with a drop in MSTR implied volatility.”
Convertible bond boom
In addition to the aforementioned bitcoin miners, there is also medical device company Semler Scientific (SMLR), which unveiled its bitcoin financial strategy in late May. While the company has so far only used cash on its balance sheet and funds raised through stock sales to buy bitcoin, its shares gained an options market on Tuesday, which will make the bond issuance more attractive to investors and traders seeking debt yields similar to MicroStrategy.
According to MinerMag, Bitcoin miners took on about $5.2 billion in debt from June to December 5 alone. Some convertible notes, such as MARA and Core Scientific, were issued at 0% interest rates, while others, such as Bitdeer, IREN (IREN), and TeraWulf (WULF), issued them at rates ranging from 2.75% to 8.5%.
However, not every company is adopting this strategy for the same reasons. MARA and Riot Platforms (RIOT) are following MicroStrategy’s lead and using the proceeds from convertible bonds to add more Bitcoin to their balance sheets, but companies like Core Scientific are looking to use the funds to cover operating expenses, capital expenditures, and potential acquisitions. Meanwhile, Bitdeer said its goal is to further develop its mining equipment manufacturing business.
There is always a day when it expires
However, convertible bonds are not free money. As mentioned earlier, once the bond matures, the holder can decide to convert it into stock at an agreed-upon price per share, or redeem it for cash if the stock does not perform as expected.
The danger, then, is that the stock prices of these companies could fall sharply over a long period of time, incentivizing holders to redeem their notes for cash rather than stock. In the case of MicroStrategy, this could force the company to sell some of its Bitcoin assets to repay investors, while Bitcoin mining companies could be forced to sell various mining assets. In the worst case, these companies could end up facing bankruptcy.
Forced sales of Bitcoin aren’t necessarily the end of the world, at least as long as the company’s average purchase price is lower than its sale price. MicroStrategy’s reserves, for example, were acquired at an average price of $61,725 per Bitcoin, which gives the company some breathing room. The problem is that Bitcoin is known to plummet by 80% every few years. This year alone — in the middle of a bull run — the price fell nearly 40% at one point, so there’s no guarantee that BTC will never fall below MicroStrategy’s average purchase price.
Even so, MicroStrategy's bonds are staggered, meaning they mature over different years. This reduces the company's risk because it doesn't have to pay off all of its debt at once. In other words, Bitcoin and MSTR would need to remain depressed for quite some time before the company's situation becomes truly dangerous. Most of MicroStrategy's bonds already meet conversion requirements, which is another advantage for the company, and it always has the option to roll over its debt by issuing new convertible bonds, even if the terms of those bonds are less favorable.
In a sense, MicroStrategy is a seasoned veteran when it comes to using debt to buy Bitcoin, while newcomers like Bitcoin miners and Semler (if it does choose to issue bonds) may find themselves at greater risk because they are taking on large amounts of debt near the top of a potential market cycle.
