An investment in MSTR is clearly not well-suited for an individual with low risk tolerance.
But if you believe that Bitcoin still has vast upside potential and that MSTR, through accretive Bitcoin purchases and/or mNAV expansion, could outperform Bitcoin, the volatility and downside risk potential may seem worth it.
The preferred stock alternative
Given the extreme volatility, many investors may not be comfortable making a sizable investment in MSTR.
Some investors may be prepared to commit a certain amount of capital to MSTR—perhaps just to have exposure to the “blue sky” scenario of extreme Bitcoin upside—but want to limit potential losses.
STRK and STRF were devised by Saylor, with a little help from AI, to provide an alternative for these investors.
The common element of both is a credit or fixed income component. Neither of these securities are bonds, technically speaking. They are both considered preferred stock.
The main reason these securities have value is that they represent a promise to pay a fixed dividend, on a quarterly basis, perpetually into the future. Unlike most bonds, there is no principal payment at the end (although there are limited scenarios where the shares could be called).
In the case of STRK, investors can expect $8.00 of annual dividends, payable quarterly. In the case of STRF, they can expect $10.00.
The board of Strategy must declare these dividends and could choose not to do so, or in certain circumstances pay the dividend in the form of MSTR shares (with the quantity of shares based on recent trading levels). However, unpaid dividends accumulate and eventually must be paid with the proceeds from any future equity issuances.
No company is interested in defaulting on its debt or preferred stock obligations, even if it might have some legal flexibility to delay payments.
In practice, we believe investors should expect to receive dividends from both STRK and STRF so long as Strategy is financially capable of making these payments.
Collateral is key
Whereas the value of MSTR lies primarily in its long-term upside potential, the value of STRK and STRF lies primarily in the asset value that resides within the company, specifically the Bitcoin holdings.
One way to think of these investments is as if they are loans one might make to an individual who has a lot of money in the bank but does not have a job or another source of income.
Strategy’s ability to pay back these loans (i.e., meet its dividend obligations) is entirely dependent on its ability to raise cash from its Bitcoin holdings, either by selling more securities or, worst comes to worst, selling Bitcoin.
If you were lending money to an unemployed but wealthy individual, the first question you would ask is how much money does he have. If he had $1 million in the bank, you might even feel comfortable lending him up to $1 million.
The difference with Strategy is that the money is not in the bank, but it is in Bitcoin, which is much more volatile. Strategy currently holds nearly 570,000 Bitcoin with a total value (assuming a Bitcoin price of $100,000) around $57 billion.
Balancing leverage and volatility
Because Bitcoin is highly volatile, it is not reasonable to expect investors to lend money to Strategy up to the current amount of Bitcoin that it owns.
What if Bitcoin goes down 10% or 20% tomorrow? How will they be paid back?
But it is reasonable to expect investors to lend Strategy money up to a fraction of the Bitcoin holdings. Of course, investors also need to receive an attractive interest rate that compensates them for the risk of the collateral possibly shrinking in a substantial way.
This is the logic that Saylor and his team apply to STRK and STRF.
Currently, all forms of debt at Strategy (convertible bonds and preferred stock) represent less than 10% of MSTR’s market cap and less than 20% of its Bitcoin holdings.
STRK is an At-The-Market (ATM) security offering, which means the company has the flexibility to sell more STRK shares to the public on a continuous basis. The long-term target is to raise up to $21 billion.
Strategy has also indicated an intention to make STRF an ATM offering with similar size.
Very importantly, Saylor has indicated that he will maintain an upper bound of 20% to 30% of total Bitcoin value in terms of how high the total amount of debt can rise.
So he has promised the market he will always try to maintain a large cushion, just in case Bitcoin falls very sharply.
Should Strategy be investment grade?
Strategy does not currently have a credit rating. When the company borrows money, it has to pay a relatively high interest rate (unless it is attaching some form of equity to the bond, as is the case with its convertible bonds).
On the most recent earnings call, Saylor made the argument that Strategy’s debt and preferred stock instruments should actually be considered investment grade because the company is so overcollateralized with Bitcoin.
If STRK and STRF were to become viewed as investment grade instruments, they are extremely undervalued.
The mathematical reasoning here is intriguing….
To continue reading Rise of the Bitcoin Treasury Company - Part II: Ordering from the Strategy Menu, which contains our proprietary scenario analysis on MSTR, STRK and STRF, subscribe now to the 76report.
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