Will Strategy's Bitcoin-Backed 'Digital Credit' Plan Save the Stock?
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Key Points
As funding costs have risen, Strategy is adopting new ways to generate cash while continuing its aggressive bitcoin acquisition strategy.
The company aims to achieve CEO Phong Le’s goal of doubling bitcoin per share over seven years through its “digital credit” strategy.
Strategy’s evolving approach could make its bitcoin business more resilient, though its long-term success still depends heavily on bitcoin’s value.
Strategy (MSTR), the world’s largest bitcoin treasury firm, has long attempted to squeeze the price of bitcoin higher. With the total issuance of bitcoins limited to just 21 million tokens, Strategy believes that rising demand should result in an ever-rising price of bitcoin.Strategy has tried to capitalize on this approach for a while, positioning itself as a player that would “never sell,” even as it has begun to sell coins in recent weeks. As of the week ending August 2, Strategy owned 842,138 bitcoins, or almost exactly 4% of the maximum total issuance.The situation has at least one major wrinkle that works in Strategy’s favor: up to 20% of bitcoin’s total issuance is lost forever. While estimates vary on how much is irrecoverable, analysts agree that the figure is substantial. That means Strategy’s holdings of the actual issuance may be a lot closer to 5%.And as Strategy captures even more of the market, bitcoin’s “free float” becomes smaller and smaller, until demand begins to push prices of the remaining supply ever higher, or so the theory goes.But as Strategy’s cost of debt financing – which it uses to accumulate bitcoin – has risen significantly, it’s now working to find other ways to generate cash so that it can continue to rapidly increase its purchases and drive bitcoin’s price higher.Strategy has long turned to financial engineering, since its operating units are consistently unprofitable. It’s using convertible bond offerings as well as various series of preferred stock to raise the cash to keep its bitcoin buying binge on track. But executive chair Michael Saylor thinks he has found a new way to fund the company with an increased focus on its preferred stock.This approach may boost incremental demand for bitcoin, meaning higher bitcoin prices could follow.The ability to pay for more bitcoin purchases would help achieve what CEO Phong Le says is Strategy’s overall objective “to double Bitcoin per share in seven years through digital credit.”Strategy’s Buy-and-Hold, ‘Never Sell’ Bitcoin Thesis Has Derailed for NowBut Strategy’s generous use of leverage means that it must keep paying its preferreds to keep the money flowing in.These preferreds cost quite a bit, too. Its main preferred series, the Variable Rate Series A Perpetual Stretch Preferred stock (STRC), now pays out a hefty 12% coupon, after the company raised the payout in June. The preferred stock’s price had sunk as investors began to fret about the company’s ability to manage its cash while sticking to its “never sell” philosophy on bitcoin.Strategy had to raise the dividend on the preferred series to entice buyers back into the stock, which has subsequently risen, so that it can later issue more of the Series A stock. But the higher dividend means that Strategy is paying out even more cash to hold its bitcoin position.In fact, the Series A preferreds have been so crucial for Strategy that it has taken to repurchasing them, allocating $1 billion to push them back to their par value of $100 per share. Saylor all but promised to return those preferreds to par, targeting early September.These actions are meant to restore confidence that the Series A preferred will reach that price – and it has moved up significantly since its recent lows. If it returns to par, Strategy would likely begin reissuing the preferreds to raise more cash, so that it could pursue its bitcoin squeeze.Of course, any money Strategy is using on its preferred stock is not being used on its key thesis – buying bitcoins. And without a source of operating cash flow, it’s now hunting for ways to generate cash, including a new plan to refocus Strategy around its key preferred stock.Strategy’s New Plan for Raising CashStrategy reported an $8.2 billion loss for the second quarter, but that’s not really what’s driving things at the company. That’s a mark-to-market loss based on the decline in bitcoin’s price, and so the company records the decline as a loss for accounting purposes. The real challenge for Strategy is finding a new way to raise cash more cheaply, and Saylor thinks he’s found it.Saylor detailed the plan in the latest earnings call, explaining that the company will refocus on the Series A preferred as a “digital credit platform.” This preferred stock is “already the most liquid and largest preferred stock in the world,” according to Saylor.This preferred series will be the center of how Strategy will manage its financing moving forward. “We expect to keep laser focus on it,” says Saylor. “We’re going to do everything we can to make it the most appealing credit in the entire digital credit space.”Strategy’s plan involves carefully managing the price and yield of its Series A preferreds so that they remain an attractive place for investors but also a reliable source of funding for the firm.Think of Strategy as managing its own central bank of bitcoin, with some of the same tools as a real central bank, including the ability to control interest rates and liquidity.Key to this new approach is Strategy’s ability to manage the market for its Series A preferreds.
Strategy can use dollars to repurchase preferreds if they drift too low, or it can issue them for more dollars if the price reaches a favorable region.
Strategy can adjust the yield on this preferred to raise its price, for example, if it wants to raise cash or if bitcoin is surging and its preferred stock enjoys investors’ confidence.
By creating a greater market for this preferred, Strategy creates more liquidity in the financial instrument itself, meaning it can more easily issue the preferred and likely lower the cost of funding over time as investors come to trust the stock.
In short, Strategy’s innovation is to take advantage of pricing on both sides of its markets, its preferred and bitcoin. This defensive move protects the company from big drawdowns in bitcoin, which we’re now seeing. It gives it the potential to get more aggressive on offense when the time is right to accumulate bitcoin, especially if the Series A preferred stock becomes more trusted.So, Strategy’s approach appears to make it a more durable player. It also means that Strategy’s ability to squeeze the market is a longer-term game than perhaps Saylor envisioned at first.Is Strategy a Good Investment Right Now?The rationale for investing in Strategy is that it can be more volatile than bitcoin itself because of its use of leverage. That means it will rise faster than bitcoin but also fall faster than bitcoin. Bitcoin’s new strategy makes this approach more durable, if management can execute it well.What it won’t ever fully remove is the risk of bitcoin itself. Bitcoin is effectively unusable as a currency, since it can’t be traded for (legal) goods and services. Instead, its value derives from traders’ expectation that they’ll be able to sell it to someone else later for a higher price.Strategy’s new approach likely means its business of trading bitcoins will be more resilient. But if you think bitcoin is fundamentally worthless, it won’t matter that the business is more robust.Regards,James Royal, PhDEditor’s Note: One of the most successful fund managers of the past 50 years put more than HALF his $9 billion fund — roughly $4.5 billion — into a single stock. Then he bought more shares nearly every day for 61 days straight. Google’s former CEO Eric Schmidt just partnered with the same company directly. What did they know? Whitney Tilson reveals the name, free of charge. Click here…
