MicroStrategy Holds Less Bitcoins Than You Think (Q2 Earnings Preview)

Summary

• MicroStrategy is transitioning from a software licensing company to a SaaS company, struggling to reemerge and grow.
• The majority of BTC holdings are under MacroStrategy, a separate entity that shields MicroStrategy from any recourse by investors, leading to fewer shareholder rights and ownership.
• MSTR has raised $6.8b in the capital markets with limited benefits to generating real shareholder value.

MicroStrategy (NASDAQ:MSTR) is in the midst of a major operational transition from operating as a software licensing company to a SaaS company and is struggling to reemerge to growth.

Though MicroStrategy is valued based on their BTC holdings, I believe there may be some structural discrepancies that will result in less BTC exposure than investors are led on to believing, specifically the funneling of BTC to MacroStrategy, a subsidiary of MicroStrategy that is shielded from any recourse of BTC holdings in the instance of MicroStrategy undergoing bankruptcy. Though I do not anticipate imminent bankruptcy MicroStrategy's operations, I do believe the separation of the BTC holdings from equity holders dissociates any risk exposure to the actual holdings of BTC. Despite this factor, I believe MSTR shares are significantly overvalued based on their intelligent leverage model and exposure to BTC. Given the firm's capital structure and series of debt and equity raises, I reiterate my STRONG SELL recommendation for MSTR shares with a price target of $1,026/share at 1.107x their BTC holdings. This multiple is derived by the percentage of net debt in the firm's total enterprise value.

MicroStrategy will be reporting q2'24 earnings on August 1, 2024. The firm has two downward EPS revisions and zero upward revisions within the last 90 days.

MicroStrategy Operations

Looking at consensus estimates for MicroStrategy for eFY24, I believe the analyst community is significantly underestimating the cost of transition the firm will undergo as it converts from a licensing-based software firm to a SaaS company. Analysts are expecting MicroStrategy to realize a significant decline in operating income in eFY24 in the range of $-235.4-189.99mm on the back of $479.61-502.28mm in revenue generation.

MicroStrategy is going through a major shift in operations, migrating customers from on-prem licensing sales to cloud-based SaaS. Management believes this shift will create the appearance of lower revenue on a per-quarter basis as revenue will amortize from deferred to cash over a period as opposed to a one-time payment. This adjustment has offset revenue significantly from period to period; however, the firm's total revenue generation has been on a steady state of decline for the last decade, suggesting that customer churn may be involved in the decline in revenue in recent quarters, not just the transition from licensing to subscription fees.

One factor that struck my attention was the higher costs associated with cloud hosting as the firm transitions more customer features to the cloud environment. I believe this factor will drive further challenges beyond the decline in net revenue, as MicroStrategy's operating strategy essentially calls for a decay in operating margins. Though this is no longer the primary deliverable for MicroStrategy as the firm has transitioned its core focus away from BI applications in favor of BTC holdings, I believe their applications still remain as a key factor as it remains the company's sole cash generation outside of the capital markets.

Management discussed the release of an array of AI-oriented applications that are essentially business intelligence functions with the addition of a copilot. Essentially, their Auto SQL, Auto Answers, and Auto Expert features don't appear to add any additional functionality to the business intelligence process aside from the ability to query information with natural language. The feature most outstanding of the group is their Auto Bot feature, which allows for users to create custom bots to access BI insights. Aside from the name differentiation, the functionality appears to remain relatively rudimentary when compared to Oracle's (ORCL) BI & AI capabilities. I believe that one of the lagging factors of MicroStrategy's applications is that the features stop short of actionable items, meaning that the application will provide all the insights necessary without the cost-saving or revenue-generating benefits other BI/AI applications have to offer. Holistically, I believe this last point is what differentiates traditional business intelligence and BI + AI.
Another negative risk when compared to competitors such as Oracle, Microsoft, and Google is that MicroStrategy uses 3rd party hosting for their cloud features. Though this can be seen as a benefit as it allows for the application to be utilized in a multi-cloud or hybrid environment, the barriers across hyperscalers have been broken down in recent years, allowing for applications run on OCI to be used in Microsoft Azure (MSFT), Google Cloud Platform (GOOGL, GOOG), or Amazon AWS (AMZN).↳

One factor that comes to mind that might make MicroStrategy's application more appealing to competitors is pricing; however, Microsoft Power BI, which resides in the top-right corner of the Gartner Magic Quadrant, is scalable, offers the same features, and starts at $10/month for a single user of Power BI Pro.

Looking at MicroStrategy from a financial standpoint, the firm appears to be continuing its operational decline despite the transition from licensing revenue to subscription-based revenue. Given the additional costs associated with cloud hosting services through this transition, I anticipate MicroStrategy to experience a continued decline in their adjusted operating margin.

Given the limited cash flow generation, I do not anticipate MicroStrategy to allocate nearly as much free cash flow to BTC acquisition, especially as the firm transitions to the new subscription model despite it being a higher margin business. Perhaps margin compression will be a near-term headwind; however, if the firm continues to experience a decline in total revenue, I believe this downward trend may continue.

Corporate Reports

This leads me to believe that the firm will continue to depend on the capital markets to pay down debt in order to both sustain operations and acquire BTC. In total, MicroStrategy has raised $3.2b in equity and $3.6b in debt to purchase BTC.

Corporate Reports

MicroStrategy & MacroStrategy

Management at MicroStrategy may refer to themselves as a Bitcoin Development company over a BI/AI company, which is well within their rights given that every cent of cash generated, whether through operations and debt & equity raises, goes straight to buying BTC.

The factor that makes me think twice about investing in MicroStrategy as a so-called intelligence-leveraged BTC company is that the firm funnels the majority of its BTC holdings into MacroStrategy, a wholly owned subsidiary that is shielded from recourse in the event of a MicroStrategy bankruptcy. This means that equity holders of MSTR own nothing more than the assets held by MicroStrategy and none of those held by MacroStrategy.

SEC Filing

In addition to this, MicroStrategy is no stranger to shelf equity offerings in order to build their BTC holdings, which management believes is accretive to shareholder value. Though this may be true when comparing the fundamental value of MSTR shares to BTC, I believe this strategy only harms those seeking BTC exposure as MSTR shareholders aren't solely exposed to BTC risk. Other risks include further dilution of their equity value, operational risk, macroeconomic risks, and market risks as the price of BTC is relatively correlated with the NASDAQ (QQQ). Aside from the buying volume of MSTR shares in February post-q4'23 earnings release, MSTR remains significantly correlated to BTC.

The chart below correlates BTC & QQQ and includes MSTR for reference.

As for being a leveraged approach to BTC, ProShares Ultra Bitcoin ETF (BITU) offers a 2x leveraged approach to trading BTC without the operational risk as experienced with MSTR. The niche that management calls for in holding MSTR is that investors receive a leveraged approach to investing in BTC. One of management's strategies for culling in investors is the expense ratio factor, which MSTR shares have no exposure to. BITU has a 95bps expense ratio. iShares Bitcoin Trust ETF (IBIT), which has direct exposure to BTC with no leverage, has an expense ratio of 12bps. Though MSTR shares having no management fees certainly is a good perk to holding shares, I believe the operational risks involved with holding MSTR shares significantly outweighs the management fees of the managed and passive ETFs.

The biggest differentiator is that investors of MSTR don't actually own direct exposure to BTC, as the BTC assets are primarily held in MacroStrategy. Given this factor, I believe MicroStrategy is nothing more than a capital-raising vehicle used to bolster BTC holdings at MacroStrategy. This is essentially a reverse SPE where investors are directly investing in equity dilution and debt with limited-to-no benefits from MacroStrategy's BTC holdings.↳

In addition to this, MicroStrategy does not generate value by holding BTC. BTC is very similar to a commodity or a security in which BTC can be mined, bought, and sold to generate value. By only buying BTC with no mandate for selling, BTC's sole purpose is to act as a placeholder to potentially accrue value over time. Unlike the miners, such as Marathon Digital Holdings (MARA) or CleanSpark (CLSK), MicroStrategy does not generate value by creating BTC. Similar to these miners, MicroStrategy holds BTC with the expectation of BTC being an appreciating asset.

My last point is Michael Saylor's recent stock sales. Management's argument for this was that the sales were automated and premeditated, which is common for executives to do. What baffles me is that the management team spent a good proportion of their q1'24 earnings call selling listeners on why they should own MSTR shares while their founder is selling millions of dollars of stock. Automated or not, Mr. Saylor elected to sell his shares in the open market.

Valuation & Shareholder Value

Corporate Reports

As of q1'24, MacroStrategy holds 175,721 BTC and MicroStrategy holds 38,679 BTC for a total holding of 214,400 BTC. As of July 29, 2024, BTC was valued at $67,340/BTC, providing a total value of $14.4b.↳

Based on MicroStrategy's current BTC holdings and their EV/Market cap of 1.107x, I believe MSTR shares are significantly overvalued when priced to their BTC holdings. I reiterate my STRONG SELL rating with a price target of $1,026/share.