Justifying the Value of 'MSTR' Premium Subscription

Strategy (NASDAQ: MSTR), the business intelligence firm that operates on a SaaS basis and is known for pioneering a bitcoin treasury strategy, is currently trading at a market cap of $73 billion, which is approximately 1.6 times the value of its underlying bitcoin holdings. This "MSTR premium" has led to misunderstandings, skepticism, and even concern. However, based on a decade of experience in equities, we believe that there are three reasons why the MSTR premium is justified, especially during periods of rising bitcoin price expectations like the current one.

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CHART: MSTR’s premium to NAV

Source: MSTR-Tracker.com, GSR

Firstly, Strategy leverages its position by issuing equity and debt to invest the proceeds in bitcoin, earning the difference between the return on bitcoin and its cost of capital, also known as "carry." Importantly, this carry is not just earned in the current year, but also in future years, and investors calculate the present value of this expected future carry and add it to MSTR's market cap.

In fact, this is a major reason why MSTR's premium fluctuates with market expectations of future bitcoin returns. However, the first reason MSTR trades at a premium to its BTC holdings is that investors calculate the future BTC carry in the present.

Secondly, Strategy capitalizes on intelligent capital markets issuance to benefit shareholders. It creates value through convertible debt issuance, where it not only receives payment for offering bitcoin-like returns to the bond market, but also for the volatility inherent in its stock as convertible bond arbitrageurs make more money with a more volatile underlying asset. Additionally, MSTR issues equity, mostly through at-the-money equity issuance programs, at a premium to book value, which is accretive to shareholders by definition. In fact, issuing equity at twice book value is equivalent to selling $1 for $2, or conversely, buying BTC at 50% off. This is how Strategy was able to generate a 74% increase in the amount of its bitcoin held per share last year, equivalent to 140,630 BTC, or $14 billion of value for shareholders.

Lastly, the entire structure takes advantage of the nascency of bitcoin and cryptocurrencies, their secular expansion, and the tendency of bitcoin's price to rise over time.

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For those who are not yet convinced, consider this thought experiment: If I had a magic bank account with $100 USD in it that paid you a 69% interest rate, how much money would you pay me for that? While the answer may vary from person to person, it is likely much more than $100, meaning that the bank account would trade at a premium to its underlying USD (i.e. NAV).

This is exactly what is happening with MSTR, as it has increased its BTC per share at a 69% annual rate since it began investing in bitcoin in August 2020. This increase in BTC per share (i.e. in-kind yield) is higher during bull markets and lower during bear markets, but it has generally risen over time. And while there is no guarantee that Strategy will continue to increase its BTC per share in the future, MSTR is guiding for a 15%+ increase this year and 6-10% in each of the following two years.

Of course, risks abound - MSTR investors take on basis risk to the price of BTC and the stock tends to move more than bitcoin in both directions. Relatedly, the premium may move up or down in the future, and the stock will likely trade at a discount (i.e., below the value of its bitcoin holdings) during bear markets. However, the premium exists because investors believe MSTR will continue to increase the amount of its bitcoin per share in the future, and they are willing to pay up for that now.

CHART: MSTR’s increase in bitcoin per share (i.e. bitcoin yield)

Source: MSTR-Tracker.com, GSR

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