Author: lowstrife, Crypto KOL
Translator: Felix, PANews
Recently, companies such as MSTR, Metaplanet, Twenty One, and Nakamoto have garnered significant attention as Bitcoin reserve companies. However, I believe their “reserves” are a destructive leverage that represents one of the worst things Bitcoin and what it stands for have encountered. Below is an analysis of how this model could collapse under certain conditions.
The feedback loop employed by these companies involves using corporate funds to purchase Bitcoin, recording it on their balance sheets, and then leveraging various corporate mechanisms to raise more funds based on that balance sheet. This model has been praised as one of the greatest inventions of all time.
Funds raised through methods such as issuing new shares (ATM), bonds, preferred stocks, and loans are immediately used to purchase Bitcoin, driving this flywheel. An important distinction here is the use of appreciating leverage: companies like Tesla simply deposit assets into Bitcoin (which I have no objection to).
However, the key to this flywheel is that common shareholders are the ultimate holders of these financial assets. All these fundraising mechanisms ultimately lead to the dilution of common stock, selling shares into the market to fund this flywheel. The primary method employed by MSTR is issuing new shares (ATM) to achieve appreciation dilution. This method works well if the mNAV (PANews note: representing the ratio of current stock price to the value of its Bitcoin holdings) is greater than 1.0. The problem arises when this leverage depends on issuing new shares to meet its cash flow. If MSTR’s stock price drops below 1.0 times mNAV (as it did in 2022), issues will arise.
Another tool is leveraging to enhance the yield of its products, such as convertible bonds and perpetual preferred stocks. Because future buy-ins are expected, this accelerates the anticipated value of equity and initially amplifies the stock premium. Issuing more common stock dilutes existing shareholders’ equity, and this leverage will ultimately expire. However, they allow such dilution to occur later, exchanging today’s dollars for tomorrow’s cash flow/dilution, deferring this payment and “cost” to a distant future. How “clever”.
There are two problems here: The first issue is that if the underlying stock fails to meet performance targets, these products cannot serve as the fulcrum for all leverage. For convertible bonds, MSTR must refinance or sell BTC to raise cash.
The second issue concerns preferred stocks. They require MSTR to pay perpetual, non-appreciating dividends (i.e., interest) to the holders of this debt. MSTR plans to issue trillions of dollars in such securities, with these payments coming from diluting the ownership of MSTR’s stock. In particular, Strategy’s STRF (PANews note: a fixed-income product packaged as a preferred stock issuance to easily and continuously raise funds to purchase Bitcoin), which has no maturity date and offers a fixed annual interest rate of 10%. MSTR will forever rely on non-appreciating ATM, diluting shareholder equity for every dollar it finances. Today’s purchases come at the expense of tomorrow’s shareholder interests. What does this sound like?
The problem with using ATM to provide the required cash flow is that it relies on mNAV, which does not stem from its own assets. It entirely depends on market sentiment: how much people believe the value of its treasury is.
This is a direct affront to the essence of Bitcoin. While there are provisions for suspending dividends, this will trigger more issues. STRK must pay all unpaid dividends and penalties to convert (mature). Not to mention that suspending dividends will significantly reduce demand for the product. If the meaning of yield-generating assets lies in stripping away risks, then the last thing we want to see is the destruction of the very purpose of holding that security. These risks are never mentioned by MSTR’s advocates. Suspending dividends will serve as a warning about solvency.
Supporters argue that the issuance of these preferred stocks is for purchasing Bitcoin now, and that dividend payments are worthwhile. They believe that if it has been “modeled and calculated,” then raising funds is justified.
“You must look at the transaction as a whole, rather than in isolation. If they finance with preferred stock, then you must consider their valuation/premium at the time of financing. Then, you can simulate using ATM to pay dividends and project the future based on your predictions of Bitcoin and stock performance, determining how many shares need to be issued and when conversion would be more beneficial. Once you do this, you realize how good these preferred stock issuances are.”
Currently, about $1.8 billion of such securities are in circulation, and it is still possible to make these payments. But Saylor proposes issuing $3 trillion of such securities, requiring the dilution of $300 billion of shareholder equity each year, which is clearly untenable.
So how will all this unfold? It all begins with mNAV; mNAV is crucial. It is life, it is vitality. If mNAV encounters issues, the company’s ability to raise funds will disappear, and debt conversion will impair mNAV, causing the company to lose its ability to repay debts.
GBTC is another closed-end fund that gained popularity during the 2021 bull market. People used it to invest in BTC because their existing accounts did not allow it at the time. Nowadays, the reason for buying MSTR is largely the same. The problem is that the avenues for acquiring Bitcoin are increasing.
GBTC is a closed-end fund that trades at a premium or discount relative to the underlying asset. Once the demand for this investment avenue dries up, the demand for the fund to purchase new assets will also decrease. Once mNAV is undermined, demand will evaporate.
Once mNAV drops below 1.0, MSTR’s fundraising capability will be jeopardized, akin to the loss of willingness and ability to buy GBTC. It is noteworthy that mNAV is entirely based on market sentiment. There is no mechanism or reason for it to trade according to asset value.
When mNAV declines, the ability to continue raising funds (and purchasing Bitcoin) in the future weakens, and the anticipated value of the stock will also decrease accordingly. If forced to pay debt dividends under adverse conditions, this situation may exacerbate.
Convertible bonds complicate matters further. Currently, MSTR has $8.2 billion in convertible bonds maturing between 2028 and 2032. The risk of these bonds does not lie in their prices; regardless of Bitcoin’s price fluctuations (within reasonable limits), the bonds will not “liquidate” or require margin calls.
The issue with convertible bonds lies in their name. They need to be converted. MSTR’s stock needs to appreciate to a predetermined price level for the bonds to convert into new stock issuances. Remember: this trigger point is MSTR’s stock price, which fluctuates based on mNAV, and mNAV is based on market sentiment. If, for some reason, the price fails to rise, the issue becomes a matter of time rather than price. Regardless of what the underlying Bitcoin price is, the bonds may mature. MSTR must refinance or sell BTC to repay the debt in cash.
Ultimately, the flywheel mechanism will reverse, ultimately rendering the entire plan ineffective. Repurchasing shares below mNAV 1.0 and selling underlying assets to raise funds. Some argue that this falls under fiduciary duty, and Bailey has publicly stated that he would do the same.
This is not a financial revolution. This is a frenzy of Ponzi schemers chasing leverage. I have held Bitcoin for a long time, and it is disheartening to see Bitcoin OGs cheering for Saylor while he replays the financial engineering of 2008 with Bitcoin. It is this very method that led to the birth of Bitcoin.
Related Reading: “Deconstructing Saylor’s Bitcoin Financial Magic: Stock Prices Have Tripled Since Last October”
Original link: This article is reproduced with permission from PANews.