I’ve been wanting to write an article about MicroStrategy (NASDAQ:MSTR) for a while. This is one of my favorite companies and has been ever since they embarked on their Bitcoin strategy. I really admire the CEO of MicroStrategy, Michael Saylor. Why? I admire him for the courage and conviction he has to do something as revolutionary and “against the grain” as adopting a completely new currency as its standard. Obviously Bitcoin is not a currency yet, but rather something he hopes will provide greater value for his company than holding dollars. At the moment Bitcoin serves as a store of value. And over the years, as I have sought to understand Bitcoin better, Michael Saylor has had an instrumental impact on my learning.
The thesis for buying (or selling) MicroStrategy’s stock really boils down to its Bitcoin holdings. Below, I will provide my investment thesis for how I think about Bitcoin and why MicroStrategy’s Bitcoin strategy is the right strategy.
MicroStrategy’s Bitcoin Strategy
On August 10, 2020, MicroStrategy adopted its Bitcoin (BTC-USD) strategy and began buying Bitcoin. Since then, the company has continued buying throughout Bitcoin’s market cycle. MicroStrategy has received some flak from media and some investors for buying Bitcoin at higher prices, and even using leverage to do so. However, this comparison below demonstrates that MicroStrategy has performed very well relative to other stock market bellwether companies since adopting its Bitcoin strategy. It has even outperformed Bitcoin itself.
The Bitcoin Strategy
Currently, as of their last quarterly presentation, MicroStrategy owns 152,800 Bitcoin. As of this writing, Bitcoin’s price is about $26,500 so this equates to the company holding a value of just over $4 billion worth of Bitcoin. For those who worry that MicroStrategy’s Bitcoin is in danger of being collateralized, this slide below should put your mind at ease as this includes only 10 percent of their stack.
In the following sections, I will break this down in several different ways to help us think about this strategy, as well as Bitcoin’s price.
Currently, Bitcoin’s hashrate is just above 400 EH/s and has nearly doubled in the past year. Bitcoin’s hashrate is a measure of the computing power that is devoted to the Bitcoin computer network. With each additional Bitcoin mining machine that is added to the network, it becomes less profitable for miners to mine Bitcoin unless the Bitcoin price increases proportionately. So far in 2023, Bitcoin has not seen a proportional increase in price and so it has become a less profitable endeavor to mine Bitcoin. Although the market does not acknowledge it yet, this should make each existing Bitcoin more valuable over time.
Why does Bitcoin’s hashrate matter? If you’ve been learning about Bitcoin for any substantial measure of time, then you probably already know that Bitcoin’s increasing hashrate is what makes Bitcoin more secure. That’s because each increase in hashrate provides greater protection from a “51 percent attack.” A 51 percent attack is when a miner or group of miners owns greater than 50 percent of the computing power in the network and is therefore able to alter the Bitcoin blockchain. There is more nuance to this than I will explain here, but the takeaway is that this is an extremely unlikely occurrence, and becomes ever more unlikely as the hashrate grows.
Right now, one of the most efficient Bitcoin miners on the market is the Antminer S19 XP. With this particular miner, it will use roughly 3,000 watts of energy per hour. As of this writing, one Bitcoin is worth $26,500 and currently, running an Antminer S19 XP for one day will generate .00032 Bitcoin which at today’s prices equates to roughly $8.50 per day. Those 3,000 watts of energy translate into 72 kWh of energy per day. There is a wide range of energy costs in the Bitcoin mining space but let’s just say that energy will cost ten cents per kWh. This means that mining Bitcoin each day will cost $7.30 leaving the miner with a profit of $1.20.
I realize this amount of profit will vary depending on how much energy costs and I know there are Bitcoin miners who have energy sources for much less than 10 cents per kWh, but suffice it to say, Bitcoin miners are getting squeezed at the moment. But to accuse me of miscalculating profit of a Bitcoin miner is to miss the point. That’s because although profit varies depending upon the energy source, what I’m trying to understand is the energy equivalent value of a Bitcoin.
Said in another way, how much energy would it cost today to mine MicroStrategy’s Bitcoin holdings? If it costs 72 kWh each day to mine .00032 Bitcoin, then it currently costs 225,000 kWh to mine one Bitcoin. At ten cents per kWh, this makes one Bitcoin cost $22,500 to mine. This simple analysis also doesn’t take into account the amount of time that it would take to mine that much Bitcoin.
This is only a snapshot in time and these numbers will continue to change. And if all of the parameters for Bitcoin remain unchanged, pretty much overnight, a Bitcoin will begin to cost $45,000 to produce or mine. But odds are that by April 2024, the cost to produce one Bitcoin will be greater than this thanks to additional Bitcoin miners coming online.
Converting Bitcoin’s Energy Into The Oil or Natural Gas Equivalent
The cost of a kWh of energy can vary wildly across the United States. In California, the average retail cost of one kWh of energy is 31 cents. When you factor in the industrial and commercial sectors, a kWh of energy averages 25 cents. In Texas, one of the more friendly states to mine Bitcoin in, a kWh of energy averages roughly 10 cents. This confirms that to mine a Bitcoin, its energy equivalent value is about $22,500 and probably less in some cases.
What if we converted the kWh needed to mine a Bitcoin, into the energy equivalent of a barrel of oil? Although oil varies between states, it doesn’t vary in price as much as kWh energy rates. There are 1,700 kWh of energy in one barrel of oil. This means that one Bitcoin is the energy equivalent of 132 barrels of oil. When we calculate the energy equivalent value of Bitcoin in terms of oil, one Bitcoin only costs about $12,000 per Bitcoin to mine. (132 barrels x $91 per barrel)
One thousand cubic feet (Mcf) of natural gas costs $3.60 cents. One kWh equals 3.41 cubic feet of natural gas. Therefore, 3.41 Mcf equals 1,000 kWh. Therefore, 1,000 kWh equals $12.26 equivalent of natural gas. And for the final calculation, in terms of natural gas, one Bitcoin equals $2,758 of natural gas. ($12.26 x 225)
Which Way Bitcoin?
|kWh||Oil (barrels)||Natural Gas (Mcf)|
|Energy To Mine 1 Bitcoin||225,000||132||767|
If I have done my math correctly, this presents an interesting problem that any investor should be able to see. One of two things need to happen. Either, oil and natural gas (and especially natural gas) need to increase in price to fill the large gap between the Bitcoin price and its energy equivalent when priced in hydrocarbons, or the price of Bitcoin needs to decrease. But also keep in mind that this simple analysis excludes any capital costs to purchase equipment necessary to directly mine Bitcoin with hydrocarbons, however, I suspect the capital expense is easily justified.
I described this “arbitrage opportunity” conceptually in my article titled The Bullish Case for Oil here. So what is likely to happen with this “opportunity?” I’m not the first one to know that there is an opportunity to mine Bitcoin with hydrocarbons and it is clear from Bitcoin’s continuously rising hashrate that there are Bitcoin miners who are exploiting this opportunity. As I’ve noted in previous articles, it was publicly disclosed that Exxon Mobil (XOM) began mining Bitcoin in 2021.
Over the long-term there will be several factors, each happening at once in order to bring this into an equilibrium state: 1) likely upward moves in the price of oil and natural gas (and retail cost of a kWh), 2) continued increases in Bitcoin’s hashrate, and 3) the Bitcoin halving 4) Upward (or downward) movement in Bitcoin’s price. Each of these will work together to find an equilibrium between Bitcoin prices and energy prices…eventually.
Why does this arbitrage opportunity exist? I will touch on this briefly in the section on MicroStrategy’s share dilution.
In the next section, I will describe how the Bitcoin halving will help solve this as well.
Bitcoin Halving Approaches
The Bitcoin halving is approaching quickly. It doesn’t have a set date but is estimated to arrive per the protocol sometime around April 2024. The halving is the moment in time when the number of Bitcoins that are rewarded to the miners is halved.
This is why owning shares in the public Bitcoin mining companies as the halving approaches is not advisable. When the Bitcoin halving happens, I don’t know how it will play out, but I would expect the Bitcoin mining industry to be forced to capitulate before Bitcoin begins to rise again. The market is brutal sometimes and it will likely go hunting for some Bitcoin mining bankruptcies following the halving.
And this begs the question, if you want to be leveraged to Bitcoin heading into the halving, why would you dare to own the Bitcoin miners? Wouldn’t you rather own shares in a company whose variable expenses and revenues are not tied to Bitcoin, but yet owns Bitcoin on its balance sheet?
And like many things, the answer is not this simple. Naturally, It depends.
MicroStrategy’s Bitcoin Carrying Cost
One dependent factor is MicroStrategy’s carrying cost. In other words, owning Bitcoin with leverage is not free but comes with interest expenses. What are those interest expenses? At the end of Q2, MicroStrategy’s annualized interest expenses were roughly $36 million. You can see below where MicroStrategy’s interest expense is coming from.
Here is a graphic of the company’s debt that is coming due in relation to the Bitcoin halving. If the Bitcoin halving has a similar effect as it has in the past, by 2027 and 2028, Bitcoin will have appreciated to some degree from current levels. Will Bitcoin appreciate by more than MSTR’s weighted average interest expense that sits somewhere less than 3 percent? Time will tell, but I like that bet.
MicroStrategy Share Dilution
Michael Saylor’s conviction to exchange MSTR shares for Bitcoin comes from the fact that he is happily exchanging a non-scarce asset in company shares for a perfectly scarce asset, Bitcoin. The verdict is still out, but this strategy is likely a brilliant one. This is a strategy that won’t avail itself to public companies forever and hopefully in this case, fortune will favor the bold. Very simply, Michael Saylor understands Bitcoin’s scarcity (along with its other attributes that lend value to its scarcity).
And one way to tell if the strategy is working is if MSTR shares have been penalized for its dilution…and to date, it has not. Remember the slide above where it showed that MSTR shares have outperformed the market as well as tech bellwether stocks? If exchanging shares of MSTR for Bitcoin was going to penalize MSTR’s performance, it perhaps would have by now. Similar to mining Bitcoin with hydrocarbons, MicroStrategy is exposing with their shares what they believe is a type of arbitrage opportunity. As the world transitions from the fiat money world back to the hard money world, arbitrage opportunities will abound. And in fact, Bitcoin is a kind of arbitrage all its own against the inevitable growing money supply. This is nature’s way of coming back into equilibrium.
MicroStrategy Shares Outstanding Table
Bitcoin ETF vs. MicroStrategy vs. Bitcoin
In this slide, as I have laid out above, MicroStrategy lays out why owning MSTR shares is advantageous relative to other forms of gaining exposure to Bitcoin, including Bitcoin itself.
MicroStrategy touts the following advantages they provide:
- Ease of Access – Most people have a stock brokerage account where they can buy MicroStrategy. Not everyone wants to learn how to hold Bitcoin in a cold storage Bitcoin wallet. (although that is likely advisable)
- Downside Protection – MicroStrategy can leverage their non-Bitcoin business to limit risks to their Bitcoin holdings.
- Intelligent Leverage – A weighted average interest rate on its Bitcoin-related debt below 3 percent
- Generate Yield – It does it with “intelligent accretive financing” as well as buying incremental Bitcoin with cash flow.
- Healthy Derivatives – MicroStrategy provides a way to use derivatives to hedge one’s Bitcoin holdings by using MSTR puts and calls.
- Tracking Bitcoin’s Price – MSTR tracks the price of Bitcoin relatively closely.
Balance Sheet and Tax-Advantages
MicroStrategy carries Bitcoin on its balance sheet and in the table below you can see that their debt-to-asset ratio has risen above 1. Surely this is a terrible sign, right? Not really. You can see below that their carrying value on the balance sheet is much lower than the actual value of their Bitcoin.
And as we said above, at a moment’s notice, the company has approved the ability to sell shares at-the-market if it needs greater liquidity. And with a perfectly scarce asset like Bitcoin on the balance sheet, demand for MSTR shares is not likely to suddenly dry up.
It is important to note that current accounting standards allow MicroStrategy to impair its Bitcoin assets at the prices they reach at the end of each quarter. This creates an accounting tax advantage for MicroStrategy which they fully capitalized on in 2022. However, when you read the footnotes on the slide below, this tax advantage for “digital assets” may be getting cancelled by FASB soon. MicroStrategy has responded to FASB’s proposed changes. To me, this would seem like a double standard and simply a way to penalize a company who owns Bitcoin versus other assets. This will be something to watch over time.
MicroStrategy’s Debt-To-Asset Ratio Table
MicroStrategy’s (Other) Core Business
Although most investors are focused on MicroStrategy’s Bitcoin strategy, it is important to remember that they also operate a software analytics business.
Here I am using MicroStrategy’s revenue and net income as a metric to measure the company’s top line growth and profitability where I normally like to use operating cash flow. I’m not using MicroStrategy’s operating cash flow as its Bitcoin business has muddied up its operating cash flow statement, somewhat.
What I want to understand, however is how strong and steady is its core business. I will take a look at the trend in its revenues and income to provide that for me.
It’lets not forgets important to remember that if you are going to buy MicroStrategy, you should not buy it for its core business. However, its core business affords it the levers necessary to execute on its Bitcoin strategy.
MicroStrategy Revenues and Net Income
|2018||2019||2020||2021||2022||Q2 2023 TTM|
The Historical Chart
MicroStrategy has an interesting chart. The company was founded in 1989 and didn’t go public until 1998, just prior to the 2000 tech bubble. As you can see in the chart, it rode the boom and bust of the tech bubble reaching over 3,000 dollars per share at the peak.
Then, when the company began buying Bitcoin, it reached another peak as Bitcoin appreciated in 2020 and 2021. There is no technical analysis involved here except to simply say that if MSTR reaches its 2021 peak, it will have increased over 3x from current prices. And if it reaches its 2000 peak, that will have been between a 9x and 10x increase in value from current levels.
I believe that with a reasonable amount of time, each of these scenarios is possible.
Despite admiring Michael Saylor and MicroStrategy’s Bitcoin strategy, there are obvious risks involved.
First, if there is such a large disparity in energy prices between natural gas, oil, and electricity kWhs of energy, there is a risk that as these come into greater equilibrium, one of the factors for these to come into equilibrium will be a lower Bitcoin price. The argument against this happening is that kWhs are sold at a very sticky price. Therefore, the more likely outcome is for there to be increases in hydrocarbon prices.
Second, as the Bitcoin halving approaches, there are Bitcoin miners that are overleveraged. This is well-known. Following the halving in April 2024, I expect there to be some liquidations as the weak miners get washed out. As their inefficient hashing power is removed by the market, there will be a temporary dip in Bitcoin’s hashrate. This will likely cause some people to sell their Bitcoin, depressing Bitcoin’s price. I can see a scenario where Bitcoin revisits the 2022 low near $15,000 per coin. If one thinks this is a probable scenario, then waiting to buy MicroStrategy until after the halving may be wise.
Third, MicroStrategy could make a mistake in financing their Bitcoin strategy. Right now, each of MicroStrategy’s bond issuances is a convertible issuance except the $500 million due in 2028. However, MicroStrategy has approved a large at-the-money equity issuance and I assume they will still have one in 2028, effectively making the 2028 bond a convertible bond as well. Some will see this dilution in shares as a risk, which may or may not be true but ultimately depends upon Bitcoin’s price.
Fourth, MicroStrategy could straight up lose their Bitcoin. I don’t know every detail in how the company has chosen to custody their Bitcoin, but it is always a risk that they can lose it, although this is extremely unlikely.
I see the largest risk coming from market disruptions as money markets and energy markets search out greater equilibrium prices. I’m not naïve enough to think that perfect equilibrium will be reached, especially thanks to government market intervention in both energy and money markets at the moment, but it is something to be aware of.
When you dig under the hood, MicroStrategy’s Bitcoin strategy appears to be a on solid footing. There are certainly risks involved but so far, the company has hedged itself effectively and protected itself from the wall-street “shorts” by using financial leverage very strategically.
When Bitcoin reached roughly $15,000 in 2022, there were many who thought MSTR had overleveraged itself and that if Bitcoin continued to fall the company would be in serious financial straits. It seemed like MicroStrategy and its Bitcoin holdings were about to fall into a vicious debt spiral. But if you think Michael Saylor is going to be outsmarted by the market, then you should think again. Saylor has not only been running a company for many years but has also been a successful retail investor himself. A seasoned veteran like Saylor likely already understood the risks of falling Bitcoin prices prior to 2022 and was prepared. Regardless, the company made the appropriate adjustments as the Bitcoin environment changed.
I’m rating MicroStrategy a “hold” as I believe it is more prudent to take a wait and see approach until after the Bitcoin halving. And based on the energy differential in the cost to mine a Bitcoin between natural gas, oil, and kWh, it is possible that Bitcoin trades down and sideways, maybe even for a few months after the halving occurs. Furthermore, there may be some debt liquidations for Bitcoin mining companies following the halving. That said, for the person who has a much longer time horizon and is simply dollar-cost averaging, I would rate MicroStrategy a long-term buy. And let’s not forget that the company has a steady software business.
What are your thoughts? Is it better to own Bitcoin outright OR a Bitcoin mining company, or own a company that owns Bitcoin like MicroStrategy? And do you think MicroStrategy’s Bitcoin strategy is a good one?