MSTR = Bitcoin (Garbage) Squared

The 0.5x Leveraged Bitcoin ETF

source: Cooper Academy

Buffett has famously called Bitcoin a “mirage” and “rat poison squared”. If so, then the corporate wrapper masquerading as intelligent leverage of Bitcoin known as MSTR equals that squared — and is perhaps the epitome of late-stage capital cycles expressed¹.

Before I start, let me just say that I completely get the bull thesis behind Bitcoin. Fed x Treasury is currently stuck between a rock and a hard place, and the easy way for them to have their stimulus cake and eat debt-to-GDP too is to allow the dollar to depreciate through inflation. Nobody has to feel excess pain except the value of goods and services — which is hedged to real assets like gold. And if the future of fiat is digital, then the future of gold is Bitcoin.

Sounds good. That still does not make MSTR 0.00%↑ make any sense. But I’m getting ahead of myself.

Perhaps the poster child (pariah?) for such irrational exuberance is MSTR 0.00%↑. Not only is MSTR’s valuation only potentially justifiable if you treat it as a Bitcoin ETF proxy (i.e. ex-business), it somehow manages to raise capital by issuing convertibles paying 0% interest when the stated use of those funds is to buy even more alt assets².

Mark Meldrum of CFA fame made this highly enlightening video describing the pyramid scheme that MSTR 0.00%↑ is propping up. Essentially, he is tearing apart their so-called ‘Intelligent Leverage’ process which purportedly exploits the spread between share dilution and asset values raised.

The math of MSTR’s Ponzyramid scheme goes something like this: For every $1 of overvalued stock (or stock equivalent, e.g. convertibles) they issue, shareholders are diluted by significantly less³. This purportedly creates operating leverage in MSTR’s business model, since this process can be rinsed-and-repeated. The obvious question that Mark raises is, if it’s possible to create value out of thin air like this, why doesn’t everyone else do it?

The lynchpin of this flywheel is identified as the new incoming investors, who are effectively buying out earlier investors when they contribute new capital at ever-higher prices. This is because unlike Bitcoin’s value (which is constrained by scarcity), MSTR is a corporate shell and thus is not constrained by being an isolated system — it can issue shares to attract capital from “outside the box” to add value. However, this illusory spread between shareholder dilution and asset accumulation falls apart once new investors stop contributing outside capital — which implies the functional equivalent of a Ponzi scheme.

There’s a palpable irony in MSTR’s setup since it lauds itself as a champion of Bitcoin — whose merits lie wholly and exclusively in its scarcity protecting investors from reckless fiat inflation. However, MSTR itself appears to be contributing to that very same inflationary value destruction by issuing new capital to promote an illusory spread which can only be propped up by persistently diluting shareholders.

This is made worse by the fact that MSTR’s ‘intelligent leverage’ strategy is faced with an uphill battle to accrete value. MSTR currently owns $37.6B worth of Bitcoin while its market cap is $80B — implying a 2x premium to their underlying Bitcoin holdings. Even if their intelligent leverage process wasn’t the sham as described, no amount of operating leverage could reasonably offset a 200% premium vs. simply buying vanilla Bitcoin.

Lest we forget, much of MSTR’s recent share price pump has been due to the rise of Bitcoin’s price itself — which is up a whopping +50% in two months (!!). Since Bitcoin’s public float is about 15-30% of all total Bitcoin outstanding⁴, it conservatively implies that MSTR owns 1.8% of all Bitcoin in existence — which amounts to 6% of the public float.

And given that MSTR increased their Bitcoin holdings by nearly 40% in November alone, that would mean that they had singlehandedly acquired 1.6% of the public float in November alone. Any wonder then that Bitcoin is straddling $100,000 today? Incentives, incentives.

What if Bitcoin’s price falls? Saylor makes the believable case that anyone who is long MSTR is going to be long Bitcoin anyway — but I just don’t see how the math makes sense in spite of that. If Buffett is right about the underlying value of Bitcoin being anywhere removed from prevailing stratospheric heights, they have a bigger problem than their non-existent 0.5x leveraged Bitcoin ETF.

The only more offensive thing than MSTR 0.00%↑ to fundamental investors is that it represents a symbol of the irrational exuberance pervading markets today. Barely 2 months ago, I wrote about how a crash might not be imminent since the wall of worry still stood strong — well it has since collapsed entirely. I just don’t see how peak market conditions get any clearer than this — this environment is reminiscent of the one when Mark Cuban bought puts with his Yahoo stock as collateral in 1999; or perhaps Druckenmiller missing the peak of the dotcom bubble by an hour.

This is especially relevant in light of prevailing hyper-extended US valuations across the board. The Fed’s higher-for-longer stance on interest rates in conjunction with fiscal overstimulus (new debt ceiling every year) has led to the usual inverse correlation between stocks and bonds breaking down⁵; leading to melt-your-face-off valuations across all asset classes. Alt assets like Bitcoin are pumping to all-time highs, and markets are euphoric over incremental stimulus despite fiscal dominance leading to pushing-on-a-string. To be clear, Einhorn has said that artificial conditions can persist for a long time despite rationality; but few portfolio managers would say that we’re still in Kansas anymore.

One reason why I appreciate value investing as an investment methodology is because there’s a natural hedge built into each individual position. By virtue of dumpster-diving in share prices, it automatically limits our maximum drawdown (much less actual losses) amidst broader volatility. Doing this might not make you the cool kid until it’s no longer relevant, but it sure as heck helps you sleep at night. Unlike say $MSTR’s investors.

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1. Costco is literally back at 50x P/E, its prior peak attained during the dotcom bubble

2. To be clear, investors in MSTR’s convertibles are probably paying for gamma exposure, rather than strictly being interested in interest exposure or to exposure of the underlying Bitcoin collateral.

3. In his example, Mark uses 100% for the former and 2% for the latter, so the spread sounds pretty substantial.

4. depending on who you ask

5. until recently