Does MSTR Lose its Bitcoin if Prices Fall?

27 Des 2024

MSTR has funded Bitcoin purchases with debt. In this piece we're going to look at how some of the terms of this debt can potentially cause issues if BTC prices decrease.

This isn't talking about a margin call sort of event for MSTR, rather it's looking at the risk of terms they could be under in deals they've used to secure capital loans with BTC as collateral.

Note, it could be the case these deals have undisclosed agreements I do not know about. This is just generically looking at the terms of such loans.

Non-Recourse Loans

Non-recourse loans are generally better structured for the borrower. Giving them additional protection against "Recourse" from the lenders. However, there are still some terms under which the lender can do something. One of these terms is the loan, or collateral for it, can be called in if there's a significant change to the collateral value.

If you lend someone money against their home valued at $100,000 and then something happens to make the value of that home $10,000 - this is a very different deal to what you signed up for and in this situation you can make a claim to the collateral. Taking the house in exchange for the loan.

The Lenders

I do want to stress again I do not know the specific terms of the MSTR deals, but one thing that is notable is a lot of their money has come from places that would be expected to take big losses in a lot of areas in the event of their being a broad turn down in crypto and other hyper growth industries like AI.

This could be important because it creates a situation where it becomes possible that even although they do not want to do it, lenders may be forced into a situation of having to try to pull in as much as they can as they're bleeding out from other places. They could be required to call in the Bitcoin and then dump it on the market instantly to meet margin requirements.

Share Dilution

If this happens, then it seems almost unquestionable at this point Saylor would attempt to respond by raising more capital via share dilution. Something there's been more of during December of 2024. The problem is, what if it doesn't work? Previously selling shares and buying BTC made the stock rally. This time, not as much. Perhaps this has diminishing returns.

What would the attitude of investors become if the stock was dropping and there was more dilutions?

Not Your Cash, Not Your Coins?

How the specifics of the MSTR deals are structured is very important but hypothetically they may be in a situation where a dramatic change in BTC price made them vulnerable to lenders calling in loans and even being able to take these as Bitcoin given the collateral agreements.

Even if those lending to MSTR do not want to do something like that, it could be easily forced upon them if there was a concurrence of poor performance in different markets.

The trick of selling shares at market is no where near as effective when the stock price is down and it is declining. Didn't go so well for AMC.


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It seems like it could all go horribly wrong.

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Catatan

I've looked into this a bit more and it turns out Saylor did the same thing selling the convertible debt in 2000 and the debt was converted to stock - which dropped over 90%.

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Catatan

In 2000, Michael Saylor's company, MicroStrategy, was embroiled in a financial crisis involving convertible debt, which significantly contributed to the collapse of its stock price. Below is a detailed explanation of the convertible debt offering and its consequences:

What is Convertible Debt?

Convertible debt is a type of bond that can be converted into a predetermined number of shares of the issuing company at a later date, typically at the bondholder's discretion. This financial instrument is attractive to investors because it offers:


The safety of a bond with fixed interest payments.

The potential for higher returns if the company's stock price rises above the conversion price, allowing bondholders to convert their debt into equity and benefit from stock appreciation.

However, in MicroStrategy's case, the convertible debt became problematic due to specific events in 2000.
MicroStrategy's Convertible Debt Offering in Late 1999
Issuance Date: According to available information, MicroStrategy issued convertible bonds in December 1999, with a maturity date set for 2005.

Context: At the time, MicroStrategy was a software company, and its stock was trading at a high of $333 per share, reflecting the optimism of the dot-com bubble. Issuing convertible bonds during this period was a common strategy for tech companies to raise capital without immediately diluting equity, especially when stock prices were high.
The Accounting Scandal and Stock Price Collapse (March 2000)

Accounting Irregularities: In March 2000, MicroStrategy announced it would restate its financial results for 1998 and 1999 due to accounting errors, primarily related to improper revenue recognition. The company had recognized revenue too early, inflating its financials.
SEC Charges: Michael Saylor, as CEO, was charged by the SEC in 2000 for accounting and tax fraud, further damaging the company's reputation.

Stock Price Impact: Following the restatement announcement, MicroStrategy's stock price plummeted. Over time, it crashed from $333 per share to just 45 cents, reflecting a loss of nearly all its value.

Role of Convertible Debt in the Crisis

Conversion of Bonds into Shares: Typically, bondholders only convert their convertible debt into shares if the stock price is above the conversion price, as this allows them to gain more value from equity than from holding the bond. However, in MicroStrategy's case, available information suggests that the convertible bonds were converted into shares despite the stock price collapse.

Dilution and Stock Price Decline: The conversion of the bonds into shares likely led to significant dilution of existing shareholders. This means the company issued a large number of new shares to bondholders, reducing the ownership percentage of existing shareholders and further depressing the stock price.
Possible Restructuring: Given the company's financial distress following the accounting scandal, it's likely that MicroStrategy negotiated with bondholders to convert the debt into equity, even at a low stock price, to reduce its debt burden and avoid default. This would have been a strategic move to manage the company's liabilities, but it came at the cost of massive dilution for shareholders.

Toxic Convertible Bonds? Some sources refer to the convertible bonds as "toxic," suggesting they may have had features that exacerbated the dilution. For example:
The bonds might have had a floating conversion price that adjusted based on the stock price, leading to more shares being issued as the price fell.
Such structures, sometimes called "death spiral" convertibles, can create a downward spiral where conversion leads to dilution, which depresses the stock price further, triggering more conversions.
While the exact terms of MicroStrategy's bonds are not fully detailed, this aligns with the observed impact on the stock price.

Consequences of the Convertible Debt Offering

Financial Strain: The accounting scandal and subsequent stock price collapse put MicroStrategy in a precarious financial position. The conversion of the bonds into shares helped alleviate some debt pressure, but it significantly harmed existing shareholders.

Shareholder Impact: The rapid issuance of new shares to bondholders diluted the ownership of existing shareholders, contributing to the stock's decline to 45 cents per share.
Recovery and Survival: Despite these challenges, MicroStrategy managed to survive without filing for bankruptcy. The company eventually shifted its focus in later years, notably beginning its Bitcoin accumulation strategy in August 2020, which is unrelated to the events of 2000.

Conclusion

MicroStrategy's convertible debt offering in December 1999 became a critical factor in the company's financial struggles following the accounting scandal in March 2000. The bonds, issued during a period of high stock prices, likely had terms that allowed for conversion into shares under unfavorable conditions after the stock price collapsed. This conversion, possibly negotiated as part of a debt restructuring effort, led to significant dilution of existing shareholders and contributed to the stock's rapid decline from $333 to 45 cents. Additionally, the accounting fraud charges against Michael Saylor further damaged the company's reputation, exacerbating the crisis. While the exact terms of the convertible debt are not fully confirmed, the combination of the accounting scandal and the bond conversion played a central role in MicroStrategy's financial turmoil in 2000.