Strategy, the bitcoin-hoarding company led by Chairman Michael Saylor, has fallen into a mathematical trap of its own making.
Saylor has trained investors to believe that the strategy’s model for acquiring Bitcoin will work as long as the market values the company at a higher value than the value of its Bitcoin holdings. Effectively, the company’s overvalued stock became the currency to buy Bitcoin.
The strategy also created a special metric called mNAV to track premiums. It did this while building more than $50 billion worth of Bitcoin reserves, financed by the sale of equity and debt securities.
The problem that has emerged recently is that metrics have started to show that the market is valuing the strategy at a discount to its Bitcoin value. The roll-up strategy was beginning to come undone, and roll-ups generally do not work well in reverse.
Adding to the stress: The metric is artificially inflated because it ignores the sharp decline in the value of some of the company’s securities. Although the metric is essentially a made-up measurement, it does matter to strategy investors and the crypto market.
According to the strategy’s own logic, if the metric is at a discount rather than a premium, the company should sell some Bitcoin to buy back its securities. Investors are keeping a careful eye on any signs that the strategy could start doing so in larger numbers.
The stakes are high. The strategy’s holdings represent 4% of the total Bitcoins that will ever exist. Some selling could cause a further decline in Strategy’s stock as well as Bitcoin’s already poor price. A short sale of the strategy in May had this effect, even though it sold only 32 bitcoins for $2.5 million.
That’s why strategic investors look at mNAV. then what is it?
The strategy says MNAV shows its enterprise value as a multiple of its Bitcoin holdings, and it regularly showed huge premiums to its Bitcoins. In its heyday, this allowed the strategy to regularly sell stock to buy more Bitcoin. It worked like a traditional roll-up company using increased shares as currency to fund an acquisition spree.
For now, that game is over. Strategy’s stock is down 75% over the last year. And MNAV has declined sharply, falling below 1 last month.
This set the stage for Strategy’s announcement last Monday that it would abandon the Dear Life philosophy. It said its board had authorized the sale of up to $1.25 billion of its bitcoin to buy back shares and cover interest payments and preferred-stock dividends.
But the plight of the strategy is worse than it appears. There is a flaw in the MNAV metric that has intensified as the prices of the strategy’s bonds and preferred shares have declined along with its stock.
To calculate enterprise value, the strategy adds the market value of its common stock to the principal amount of its loan and the par value of its preferred stock, then subtracts the cash. Generally, this formula works well if the debt and preferred shares are trading at or near par.
The problem now is that MNAV overstates the enterprise value – the numerator of the ratio – of the strategy by using the face value rather than the market value of its debt and preferred stock.. This makes the metric artificially high. It also defeats the purpose of showing the extent to which the market is valuing the strategy at a premium or discount.
On June 26, when the strategy said the MNAV was less than 0.99, using the market value of its debt and preferred stock it would have been 0.89.
For enterprise value, the strategy included $6.75 billion of debt and $15.46 billion of preferred stock. They were par value, not market value. At the time, Strategy’s debt was trading at a 7% discount, and its various series of preferred shares, combined, were trading at a 28% discount.
Since then, MNAV has bounced back along with the strategy’s share price. As of 4pm Thursday, the strategy’s website showed mNAV at 1.09. But using market values for its debt and preferred stock it would have been 1.04, only a modest premium.
To stem the bleeding, on June 29 the strategy increased the dividend on its largest preferred series, called STRC or “stretch”, to 12%. This was expected to attract buyers and bring the price closer to par value.
The move showed that the strategy cares deeply about the market prices of its preferred stocks, despite it not using them in its MNAV metric for investors.
The company estimates that its $2.55 billion cash buffer gives it about 17 months of leeway to pay interest and preferred dividends without selling crypto. But if the market starts valuing the strategy at a discount again, and it sticks, the strategy faces the possibility of running out of cash and has no choice but to tap its Bitcoin stash.
The strategy may have bought itself some time. It cannot be said how much is left.
Write to Jonathan Weil at jonathan.weil@wsj.com
