No Bitcoin ETF? How about MicroStrategy’s Bitcoin Bonds?

  • MicroStrategy’s Bitcoin junk bonds do not give an investor any actual upside on Bitcoin 
  • Shares of MicroStrategy (-0.13%) may be a better way for institutional investors to gain Bitcoin exposure while hedging against risk 
For as long as institutional investors have been trying to participate in some sweet Bitcoin action, there have been costly vehicles to provide them a pathway to do so.
From Grayscale Investment’s Bitcoin trusts to the CME’s (-0.50%) cash-settled Bitcoin futures, institutional wrapping comes at a premium.
But short of a U.S. Bitcoin ETF, investors have had to pay a premium for institutional-grade Bitcoin, to avail themselves of all the institutionally-required bells and whistles to keep compliance departments happy.
And with MicroStrategy well on its way towards re-inventing itself as a Bitcoin proxy from a enterprise software company, the bigger question on Wall Street is why not just buy Bitcoin outright instead of buying a Bitcoin junk bond?
Yet despite Bitcoin dipping below US$30,000 momentarily before tacking back up again amidst a Chinese crackdown on Bitcoin mining, MicroStrategy had no difficulty selling US$500 million of junk bonds to fund its Bitcoin purchases, up 20% from its initial target sale of US$400 million.
And who was buying MicroStrategy’s bonds?
Hedge funds, which had a solid presence and snapped up MicroStrategy’s Bitcoin junk bond offering well ahead of its official launch.
At least some of the demand for MicroStrategy’s junk bonds came from institutional investors who were craving for Bitcoin exposure, but couldn’t buy the cryptocurrency outright because of how their funds are structured.
And with U.S. regulators kicking the bucket down the road on whether to approve a Bitcoin ETF, which would trade on exchanges just like any other stock, institutional investors aren’t left with a whole lot of choice.
But like ETFs, corporate debt (even if it’s used to buy Bitcoin) is fair game for a wide range of institutional investors.
Yet these institutional investors buying into MicroStrategy’s Bitcoin junk bonds may be selling themselves short.
While MicroStrategy’s Bitcoin junk bond offering yields upwards of 6% for a 7-year note, it’s not even a rounding error in the 5,500% increase in value that Bitcoin has enjoyed over the past 7 years.
Investors have to know that lending money to MicroStrategy to buy Bitcoin isn’t the same as actually buying Bitcoin – the issuer gets all of the upside (and downside) of the underlying asset.
Buyers for MicroStrategy’s offering were drawn to the downside protection baked into secured bonds – provided the software firm doesn’t abandon its existing business and maintains positive cashflow, there’s also the intellectual property from the software, with Bitcoins purchased that have huge upside potential that make it easy to assess the risk of losses from investing in the bond.  
While Bitcoin is now just over half of what it was worth in mid-April, investors will get a 6.125% coupon on the MicroStrategy bond which can’t be repaid early for the first three years.
Guaranteeing that new debt will be the Bitcoin that MicroStrategy intends to buy, but not the company’s existing hoard.
MicroStrategy’s bond could make sense for high-yield bond investors who believe in the fundamentals of the company’s software business (whatever those are) and even a hedge for those long on Bitcoin or the company’s equity.
And at current prices, even a punt on MicroStrategy’s stock might not be altogether unwise, given that it is down by around half from its most recent high, but is not without risk.
If Bitcoin falls too much, MicroStrategy may need to refinance its existing convertible notes with traditional debt, driving up leverage at the firm to 19 times based on its existing debt of US$2.2 billion against EBITDA (earnings before interest, taxes, depreciation and amortization) of just US$115 million.
According to S&P Global Ratings, MicroStrategy will need to do a distressed debt exchange before its convertible note matures if Bitcoin drops below US$6,000 – unlikely, but not entirely impossible.
But with each additional Bitcoin-based bond offering, MicroStrategy provides institutional investors something that the U.S. Securities and Exchange Commission hasn’t – a backdoor to Bitcoin exposure.

Novum Digital Asset Alpha is a digital asset quantitative trading firm.

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It does not constitute a recommendation or take into account the particular allocation objectives, financial conditions, or needs of specific individuals.

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