This article will explore:
- How do we discern the value of MicroStrategy (MSTR), a company in a unique situation in the cryptocurrency field, and the basics of how value investors operate.
- Regardless of whether MSTR ‘s large investment in Bitcoin is considered, the main opportunity cost of investing in MSTR is to own the same amount of Bitcoin. Therefore, why is it now more meaningful to denominate in Bitcoin than in U.S. dollars.
- Why Bitcoin pricing methods may become more and more important in the future.
As we all know, MicroStrategy is a company that now occupies an important position in Bitcoin. In August 2020, they announced that they would use Bitcoin as their main treasury reserve asset. They converted the entire company’s funds into Bitcoin and continued to convert free cash flow into Bitcoin. Two convertible bonds were subsequently issued, all of which were purchased as Bitcoin. The most recent time was in June 2021, they issued more non-convertible bonds and used the proceeds to buy more bitcoins.
According to the data disclosed on the MicroStrategy official website, the company currently holds 105,085 bitcoins, with a total value of approximately US$4.1 billion (purchased at an average price of US$26,080 per coin). And MSTR’s stock price is currently $666, and the company’s total value is approximately $6.5 billion. In the following two aspects, their situation is incomparable among other companies:
- The bitcoin they hold as a percentage of the company’s value or market value
- The overall size of the company.
In other words, relative to the size of the company, other large companies (such as Tesla) hold a much smaller proportion of Bitcoin, while other high-proportion companies hold much smaller scales.
Starting around August 2020, we began to see Bitcoin being added to the balance sheets of several listed companies. MicroStrategy is such a company. This is why you often hear that MicroStrategy is described as a proxy Bitcoin ETF. However, since they may continue to buy BTC in the future , this situation may be more dynamic. This is why it is necessary to study how traditional value investors evaluate them.
“The time I hold Bitcoin is…forever.”
Traditional dollar-based valuation
First of all, the stock market is mainly valuing MSTR in US dollars. After all, stock prices are in U.S. dollars, and profits are in U.S. dollars.
For those who are unfamiliar, I will explain how to gradually form this type of valuation.
MSTR’s profits are relatively stable and have not grown significantly in recent years. The most traditional way to value a company like this is to add up the present value of all projected future profits, and then add any other related assets (Bitcoin).
What do we mean by present value? The $100 received in 10 years is not as valuable as the current $100, so we need to discount future profits through interest rates to get the current value.
For example, we may value 100 USD in 10 years as: 100 USD / 1.0122 ^ 10 = 88.60 USD
The interest rate used here is the 10-year yield of U.S. Treasury bonds, which is regarded as the “risk-free” yield of the U.S. dollar. Treasury bonds are considered to be almost risk-free, because once this happens, the Fed can create more dollars to repay the debt.
In other words, if we want $100 in 10 years, we can now invest $88.60 to return it. Instead, we can say that the prospect of paying $100 in 10 years is now “worth” $88.60 to us. Then we can repeat this calculation every year to “discount” all expected future profits and add them up. This valuation method is particularly similar to valuing companies that pay dividends, because these profits are paid to shareholders as cash flows. It is also very similar to the method of evaluating bonds.
As it happens, historically, MicroStrategy did not pay profits as dividends, but accumulated a lot of cash on the balance sheet, which is why Michael Saylor considered Bitcoin in the first place. Whether dividends are actually distributed, included in the balance sheet, or reinvested in the business, the potential for profit generation is the basis for value investing.
In fact, analysts use a much higher interest rate than the risk-free rate when calculating stock valuations. The overall interest rate used may reflect the risk-free treasury interest rate during the relevant period plus an additional “equity risk premium”. The latter reflects the fact that the realization of future profits is far less than the nominal return of US Treasuries, which is considered risk-free. This premium is very subjective, but may be about 5-6% per year. The average is US stocks.
All in all, the current MSTR market value of $6.5 billion reflects the current value of Bitcoin holdings worth $4.1 billion, plus the present value of the sum of discounted future profits, and other factors. These may include any positive or negative market premiums to MSTR and adjustments to convertible bonds issued to determine whether these bonds may be converted into equity at a future date.
In June 2021, MicroStrategy announced the issuance of new bonds, which is another proof that MSTR is in a dynamic state and getting more bitcoins when opportunities arise. The newly issued bonds are not convertible. It has now been used to buy more bitcoins, but it will reduce their ability to convert future profits into bitcoins because they will have to pay the coupon coupons of these bonds first. To illustrate this point, the bond is US$500 million and the annual interest rate is 6.125%, so the company will have to pay about US$30.6 million each year to pay interest.
I think there are some minor problems with the traditional way of pricing MSTR in US dollars. It is related to the “opportunity cost” of buying MicroStrategy stock.
Every time we invest in an asset, we give up using the money elsewhere—this is called opportunity cost. But where else can we hold this money? Now no one can invest in MSTR without believing the large amount of Bitcoin they hold as a long-term investment. It can be said that investing in MicroStrategy is mainly to give up the “risk-free” investment in Bitcoin itself, otherwise they can hold it. The logical result is to try to price MSTR in Bitcoin! In doing so, assess whether MSTR investment is “worth” to invest in Bitcoin, not its risk.
It is worth noting that the only way for some stakeholders to allow them to access Bitcoin is to buy stocks in companies such as MSTR. Although this may be important to some people, let us temporarily assume other situations.
So how do we use Bitcoin to price MSTR? The starting point is simple: MicroStrategy currently holds 105,085 Bitcoins.
Then we need to add the present value of all bitcoins they may accumulate in the future. This is obviously the tricky part, because profits are calculated in U.S. dollars, so we have to estimate how the price of Bitcoin in U.S. dollars will change over time. We must also estimate the company’s future profits (the same as before).
This article focuses more on concepts rather than practices, because I did not use precise data for modeling. However, I have fabricated some predictable scenarios to illustrate. Regarding the profit converted to Bitcoin, we assume that MicroStrategy converts $40 million worth of profit to Bitcoin every quarter, and this situation continues for 15 years.
How will we discount these profits? Holding BTC does not provide a risk-free return, so we don’t have to use the aforementioned national debt interest rate-we actually used 0%.
However, the equity risk premium mentioned above should still exist. This again reflects the uncertainty of equity investment in this situation, rather than simply holding Bitcoin.
Finally, we need to convert the price to BTC. I think any random analysis is impossible to be correct! For the sake of simplicity, let’s use three “possible” scenarios for the next 15 years to illustrate:
- “Price takes off”-Bitcoin reaches $1 million per Bitcoin within 15 years.
- “Slow and stable”-to achieve annual growth of less than 5%, reaching $80,000 per bitcoin within 15 years.
- “False Dawn”-after this year, it quickly fell back to $5,000 per bitcoin and remained at this level. Since then, only hard-core long-term holders have supported it.
The picture below shows: In theory, how many BTC might MicroStrategy buy per year in each case.
So how do we evaluate today’s Bitcoin investment in MSTR?
For the sake of simplicity, let us consider a share of MSTR and try to evaluate the value of this share of bitcoin based on the bitcoin currently held by MSTR and the future profits converted to bitcoin.
Then, we need to discount the additional future BTC purchases in the table above and add their sum to this. so:
- In each scenario, we converted the hypothetical annual U.S. dollar profit at a rough interest rate (see the figure above);
- Only use equity risk premium discounts to obtain the present value of future bitcoin purchases (see the figure below);
- Add existing bitcoins held by MSTR.
Add these together and provide an estimate of MicroStrategy’s future purchases of Bitcoin in each case.
The question is: “If we invest a Bitcoin in MSTR stocks, when we value these stocks in Bitcoin, will we get a positive return?”
As shown in the figure above, when we compare the overall value of Bitcoin that may be generated by a share of MSTR with the current price of Bitcoin, we see the following returns −
According to scenario A, investing Bitcoin in MSTR may be miserable. Scenario B is close to the standard, while scenario C actually looks like a good return in terms of BTC.
When you consider these results, the most striking things become obvious. The worse Bitcoin’s performance over the 15-year period, when valued in BTC, the better it looks to invest in MSTR! This is because MSTR will earn more BTC at a lower Bitcoin price with the USD profit it earns.
Thank you very much for the early comments of @YATReviews on Twitter, who pointed out that this result is consistent with treating MSTR as a “bitcoin dividend security.” For common stocks denominated in dollars, when the share price is lower, their dividends (if consistent) can actually prove stronger compound wealth, because these dividends buy more stocks.
Another point to note is that if BTC performs very well in the next few years, under the current business scale, MSTR may not be too shaken in increasing its holdings (see Scenario A, which only increases about 10% of bits Coins are added to the future profits currently held)).
Risk warning: As mentioned earlier, there is currently no provision for convertible bonds that can be converted into equity. My understanding is that the conversion rate for the 1.6 million shares quoted for the first time is $398; a simple method is to include these in the number of shares in the valuation. The second issue price is $1,432, so the price is more complicated. I would love any feedback on simple ways to include them. In addition, there is the most recent “direct” bond issued from June 2021, which is non-convertible. Although we assume that the profit of converting to Bitcoin due to the annual coupon payment of $30 million is slightly lower, we should also consider the repayment of the $500 million principal at maturity.
Why this change of valuation method to Bitcoin value might prove to be relevant?
Preston Pysh has previously commented on this. Imagine that we will enter a world denominated in Bitcoin, in which Bitcoin continues to appreciate and more and more companies hold Bitcoin on their balance sheets.
Individuals who hold Bitcoin will still invest, but only if the potential of these investments exceeds the opportunity cost of holding only Bitcoin. This may cause “value” stocks to perform well again, because the profit-generating entity can add more bitcoins to its balance sheet. Conversely, companies that do not generate free cash flow cannot, so their valuations may be lower when they are priced in Bitcoin.
It can be said that the current trend of investing in growth stocks is because everyone has a fairly high time preference-and therefore does not pay so much attention to future dividends. Bitcoin reduces time preference, so this may change. In order for this concept to truly resonate, future profits will be realized in Bitcoin (or at least easily valued). Currently, only real Bitcoin miners can perform this type of calculation, but even they have costs denominated in fiat currency.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/microstrategy-is-booming-in-the-circle-but-how-should-traditional-value-investors-evaluate-it/
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