Is Strategy’s strategy sustainable?

IN the world of arbitrage, an investor can realise a profit from selling and buying the same marketable instrument quoted in two different markets and take advantage of the price difference.

This is done by traders who see a small window of opportunity, and when the price difference is large enough to offset trading costs, the profits, when annualised, can be substantial.

There is also another form of arbitrage when a listed company owns a specific marketable security or asset, and there is a great price disparity between the value of the company and the underlying asset.

In the case of Strategy Inc or MSTR (formerly known as MicroStrategy), it has now emerged as bitcoin’s largest holding by a public company, with 592,345 coins that were purchased at an average price of US$70,681 per coin.

MSTR turned aggressive after US President Donald Trump was elected in November last year, as it went on a massive buying spree and to date has purchased 340,125 coins since then, more than doubling its holding from 252,220 coins before Trump was elected.

The cost of purchase since Trump won the election is now reaching US$32bil or US$93,980 per coin.

Based on bitcoin’s last observed price of US$105,462, MSTR is sitting on a paper profit close to US$20.6bil.

42 + 42

MSTR has only one strategy when it comes to bitcoin, which is buy and hold to perpetuity.

MSTR’s principles when it comes to bitcoin also include prioritising long-term value creation of the company’s share price and achieving a positive bitcoin yield.

In addition, MSTR’s other key focuses include issuing innovative fixed-income securities backed by bitcoins, as well as structuring MSTR to outperform bitcoin via intelligent leverage and to promote bitcoin globally as a treasury reserve asset.

Towards this end, MSTR has revealed that it plans to raise in total US$42bil in equity and US$42bil in fixed income securities up to the end of 2027.

MSTR has filed to issue up to US$21bil Class A common stock, which will bring it to its targeted US$42bil worth of equity issuance, while another US$35.6bil in fixed income papers are in the pipeline.

With US$56.7bil worth of capital raising exercise and assuming an average price of US$120,000 per coin (which is higher than the current price and there is a tendency for MSTR to be aggressive when bitcoin share price rallies), MSTR is set to add another 470,000 bitcoins, bringing its holdings close to 1,050,000 coins or approximately 5% of total bitcoin that will ever be issued in time to come.

As of now, MSTR owns approximately 3% of the total bitcoin issuance of 19.88 million coins.

Intelligent leverage

For MSTR to have a strategy that works, the company is raising new capital to buy more bitcoin through debt, as well as the creation of financial products that are designed to take advantage of the underlying security’s volatility.

MSTR has effectively engineered what is now known as “intelligent leverage”, designed to lure demand in an endless positive feedback loop.

Funds raised via its capital raising exercises are used to purchase bitcoins in the open market, which in turn pushes the price of bitcoin higher.

As bitcoin prices move up, MSTR’s share price will rise too, which in turn allows MSTR to issue more debt and equity.

Bitcoin yield

Unlike the traditional method of how yield is calculated, which is based on income divided by the market value of the underlying asset, bitcoin yield is a vastly different concept.

Just like gold, bitcoin is an asset that does not generate an income other than capital gain/loss.

Hence, one wonders how the bitcoin yield is calculated.

In essence, because of the nature of how bitcoins are purchased by MSTR, which is using equity, debt, or preferred stocks, bitcoin yield is the rate at which MSTR is acquiring bitcoin relative to the resulting dilution from capital markets activity used to purchase the bitcoins.

It is the percentage period-to-period change of the ratio between the company’s bitcoin holdings and the assumed fully diluted shares outstanding.

Premium to bitcoin

For the longest time, MSTR has been trading at a premium to the market value of bitcoin that it holds.

Based on MSTR’s current market capitalisation of US$102.7bil, investors are paying 1.65 times the value of the total bitcoin holdings and if one were to take account of the market value of debt, MSTR’s enterprise value of US$114.2bil is 1.83 times the market value of its bitcoin holdings worth some US$62.5bil at the time of writing.

One may wonder how the market does not see an arbitrage opportunity here, as traditional finance sees an opportunity for investors to sell MSTR and purchase bitcoins either directly or via other instruments such as bitcoin exchange-traded funds.

However, this premium has held on for more than a year now as MSTR’s share price decoupled from bitcoin’s performance since February 2024.

It is widely believed that this is due to the market’s perception of MSTR’s strategy and potentially the future value that it may have based on its planned bitcoin purchases worth US$56.7bil in the next few years.

This has also allowed MSTR to be innovative in product offering, namely convertible preferred (referred to as Strike) and perpetual preferred (referred to as Strife) instruments that pay 8% and 10% coupons and provide the company with permanent capital with no refinancing risk, collateral requirements, or any covenants.

All about leverage

While MSTR is about leverage, and hence, the premium valuation that it commands against the value of its bitcoin holdings reflects its game plan, which is to ensure the annualised returns it generates from bitcoin holdings far exceed the cost of capital.

This is akin to using borrowed funds to buy equity or properties, as percentage gains will far outweigh the cost of borrowings, provided the equity or asset that is purchased moves in the right positive direction.

In MSTR’s case, it has to make sure this strategy works.