How MSTR "Works"

Breaking down the strategy behind MicroStrategy

Imagine someone, centuries ago, telling all their neighbors every year “Give me your gold, and whatever it’s worth in wampum shells today, I’ll owe you those shells at some point in the future.” Let’s say this person also knows that gold is becoming increasingly scarce, and that wampum shells happen to be appearing on nearby beaches more and more frequently every year. What is this person doing?

Basically, they’re taking on debt in the form of a depreciating asset (wampum shells) to buy an appreciating asset (gold). It’s a great bet. They think something like, “The increasing supply of wampum shells will reduce my relative debt burden, while the decreasing supply of gold will increase my personal wealth.” In hindsight, this would be a brilliant move right?

Well, there’s a company out there that’s basically implementing this strategy today. Let’s talk about that.

MSTR in a wampum-shell

MicroStrategy (MSTR) is maybe one of the most innovative / controversial businesses out there today. A brief summary might go something like:

• It’s led by Michael Saylor, a high-profile, often polarizing Bitcoin advocate

• It’s “technically” a business intelligence software company (whose software revenue has been declining / losing money lately)

• In recent years, MicroStrategy has effectively shifted its core growth plan to raising debt and equity to buy Bitcoin (BTC), which has become its primary treasury asset

• As of 9/20/24, Microstrategy holds 252,220 BTC on its balance sheet, roughly 1.2% of the total Bitcoin supply of 21,000,000 BTC

If you want more background on it, there are better summaries and articles around. My goal today is to roughly explain how MicroStrategy’s STRATEGY with Bitcoin “works” - because, if it works as planned, there is a lot of growth ahead. If it doesn’t…well, we’ll get there.

What’s up with the NAV ?

What I often hear is confusion around what exactly Microstrategy is doing, and how their overall plan makes any sense - in relation to Bitcoin ups and downs, in relation to its underlying software biz, in relation to [insert almost anything]. But most frequently, I hear confusion related to the MSTR “NAV” - this is the big one. What is the NAV and why does it matter?

Below, I’ll aim to give a simple explanation as I see it. I know it’s oversimplified, but I think the framework is really useful.

A few things to note to start:

• A company's NAV stands for its "net asset value" - its assets MINUS its liabilities. Call that "things you can sell or of value" MINUS "some form of debt"

• Let's assume that MSTR's actual software business is valued at $0. It's not, but this will help. You could argue it's worth less (it loses money) or that it's worth more (it has future potential) but we're gonna assume $0 for simplicity. So it doesn't factor into the NAV at all.

• So then, to calculate the NAV, we go like this:

  • NAV =
    MSTR Assets (cash in US dollars on the balance sheet PLUS Bitcoin holdings value in US dollars on the balance sheet)
    MINUS
    MSTR Liabilities (debt in US dollars on the balance sheet)

• For MSTR to "work," we have to assume that Bitcoin continues going up over time (it's the only way the company's thesis makes sense) so that's also an assumption.

Debt Financing

Given the above assumptions, I’ll ask you to indulge me in a pretend scenario of MSTR’s debt-financing strategy:

• Year 1 - MSTR starts as a software business worth $0 and with $0 in cash. It raises $10M in debt, so now it has $10M in cash. It then uses that cash to purchase $10M of Bitcoin.

  • NAV = $10M BTC - $10M debt = $0 NAV

• Year 2 - after 1 year, Bitcoin has had a nice growth streak, and that $10M in Bitcoin has doubled in value, now worth $20M. But the debt is still only $10M. So now...

  • NAV = $20M BTC - $10M debt = $10M NAV

  • Following its strategy, MSTR issues another $20M in debt, to get $20M in cash, that it uses to purchase another $20M Bitcoin. Thus…

  • NAV = $20M BTC (from before) + $20M BTC (newly bought) - $10M debt (from before) - $20M debt (newly acquired) = $10M NAV (same NAV before the new debt, but now poised for more potential growth)

• Year 3 - another year, another bull run for Bitcoin! The $40M Bitcoin on its balance sheet has doubled in value, now worth $80M. But the debt is still only $30M. So now...

  • NAV = $80M BTC - $30M debt = $50M NAV

• And so on...as long as Bitcoin goes up, not only does the company keep increasing in value because the value of its Bitcoin keeps increasing, but it keeps being able to add MORE Bitcoin to the company’s balance sheet through debt. And hopefully, that Bitcoin increases in value, which allows more debt to be issued, etc.

As Bitcoin continues to increase in value, MSTR can issue more debt, buy more Bitcoin at a "today's value" that will ideally grow over time to "tomorrow's value" that gives it power to issue more debt, raise more cash, buy more Bitcoin, rinse and repeat this cycle.

Equity Financing

Interestingly, MSTR doesn’t just use debt to raise cash to buy Bitcoin - it also achieves this by issuing new shares (equity). This helps balance the debt load, but at the cost of dilution to existing shareholders. Here’s a pretend scenario of their equity financing strategy, picking up where we left off:

• Year 3 (continued) - at a $50M NAV with $80M in BTC and $30M in debt, MSTR decides to do some equity financing next. Instead of taking on more debt, MSTR issues $20M worth of new shares (equity) to the public market. This brings in $20M in cash without adding new debt. MSTR uses the $20M in cash from the equity issuance to purchase $20M in Bitcoin, increasing its total BTC holdings to $100M. Updating the NAV after this…

  • NAV = $80M BTC (previous holdings) + $20M BTC (newly bought) - $30M debt = $70M NAV

  • This $70M NAV reflects the benefit of raising cash through equity instead of adding more debt. With no new liabilities, NAV increases more than it would with additional debt financing. However, issuing $20M in new shares dilutes existing shareholders, meaning each share now represents a slightly smaller portion of the company’s total assets.

• Year 4 – wouldn’t ya know it, Bitcoin has doubled again! The $100M in Bitcoin holdings rises to $200M. The debt remains at $30M. Final NAV calculation is:

  • NAV = $200M BTC - $30M debt = $170M NAV

By balancing debt and equity, MSTR can continue to increase its Bitcoin holdings and NAV. Equity financing adds less risk than debt but does dilute shareholders. For example, after an equity issuance, an investor who once owned 2% of the company might now own only 1.5%. This means their claim on future growth has decreased, even if NAV per share remains steady initially. Debt, on the other hand, allows Bitcoin purchases without diluting shareholders, but it carries repayment obligations and increased financial risk.

Generally speaking, MSTR shareholders gain leveraged exposure to Bitcoin’s price. As MSTR’s debt and equity fuel more Bitcoin purchases, any rise in Bitcoin’s value can drive NAV and stock price growth at an even higher rate than Bitcoin itself.

What if Bitcoin drops?

If Bitcoin drops in value a lot, we start to have a problem, and MSTR’s leveraged position becomes risky. Even as Bitcoin’s value declines, the MSTR debt remains, which can translate into losses for shareholders.

For example:

• Year 5: Let’s say, going into the year, MSTR still holds $200M in Bitcoin with $30M in debt - the $170M NAV is intact from Year 4. But suddenly, Bitcoin’s value drops by 50% and thus MSTR’s Bitcoin holdings fall to $100M. Let’s update that NAV!

  • NAV = $100M BTC - $30M debt = $70M

In this case, the MSTR NAV has dropped by nearly 60%, which is more than the 50% decline in Bitcoin’s value. Simply put, MSTR’s debt amplifies losses when Bitcoin’s price falls. If Bitcoin keeps dropping, MSTR could be forced to sell Bitcoin to meet debt obligations, locking in losses and further reducing NAV. This downside leverage highlights the fact that, while MSTR’s strategy boosts gains when Bitcoin rises, it also magnifies losses when Bitcoin falls.

Riding the waves

I won’t get into Bitcoin price predictions - that’s covered widely elsewhere. But I generally do think Bitcoin will continue going up a lot more than it goes down over any long enough (5+ year) time period, as it has done since it was created in 2009. Below is a logarithmic scale chart that smooths out Bitcoin’s growth, using percentage-based scaling to highlight long-term trends without being skewed by price fluctuations:

As you can see, the growth has been steadily upward over a long period of time. That said, Bitcoin is also known for high volatility, which makes MSTR (basically a leveraged Bitcoin holding company) even more volatile. For short-term investors, this can be an exciting but terrifying prospect (my investment could double or halve within a month!). Below is another chart of Bitcoin’s historical growth trajectory, this time on a linear scale. Bitcoin’s volatility gets emphasized here quite clearly, as it shows the full extent of price fluctuations over time:

I’ll spare you too many opinions here, but this volatility is why I think - along with Michael Saylor and many others - that Bitcoin is still in its infancy of growth. Volatility can be intimidating, and retail investors have yet to catch onto the long-term trends at scale. Saylor, however, sees volatility as a positive force: it signals growth potential and attracts attention, and he believes that, as adoption increases, Bitcoin’s price will eventually stabilize. For now, volatility presents both opportunity and challenge, especially for those willing to take a longer view.

More than the sum of its Bitcoin

I often hear people wonder why MSTR trades at 2, 3, or 4 (or more!) times its NAV, as it often does. My take: enough people believe in the process of leverage-fueled Bitcoin accumulation repeating successfully. MSTR shareholders gain leveraged exposure to Bitcoin’s price. As MSTR’s debt and equity fuel more Bitcoin purchases, any rise in Bitcoin’s value can drive NAV and stock price growth at an even higher rate than Bitcoin itself.

And this doesn’t even consider what MSTR (the actual operating business) could potentially achieve with that level of capital, power, and influence beyond its Bitcoin holdings. Ignoring the current software business, consider opportunities like strategic acquisitions, lending services, or the banking sector - each offering potential new revenue streams and growth avenues.

Put another way - MSTR’s Bitcoin strategy might end up being a foundation for building broader financial influence and/or operational expansion, amplifying its impact far beyond just holding Bitcoin. Or, it could just hold a ton of Bitcoin. Currently it holds about 1.2% of the TOTAL Bitcoin supply (which is permanently, forever capped at 21 million). That fact alone becomes increasingly impressive.

A bet against the dollar

This is a final point very much worth making. MicroStrategy isn’t just a bet on Bitcoin increasing in value over time due to its limited supply and increased demand; it’s also a bet against the US dollar. It’s a bet that the US dollar will lose value over time, as it has consistently done, due to inflation, over many, many decades. This is particularly relevant because MSTR’s debt is IN US dollars - essentially, it’s a strategy of taking on debt in one asset (USD) proven to lose value over time to buy a different asset (BTC) proven to gain value over time. This is a dual play on “Bitcoin go up” and “dollar go down” - boosting NAV from both sides (assets and liabilities).

Remember that story at the beginning about someone taking on debt in the form of wampum shells to buy gold? Can we all agree that would have been an AWESOME strategy at the time? Apply similar thinking to today 🧐

As always, I’m open to feedback, input, and discussion. Cheers.

— Alf London

NOTE: This is for educational purposes only and not financial advice. Please consult with a financial professional before making any investment decisions.