MicroStrategy: Sum-Of-The-Parts Analysis Suggests Material Overvaluation

Thesis

MicroStrategy (NASDAQ:MSTR) is a legacy software business which is in slow decline. Management has successfully pivoted the business into crypto through their accumulation of Bitcoin. While this has raised brand awareness, the share price momentum has been carried away, creating a grossly overvalued stock.

Company Overview

Most people on this forum are already familiar with MicroStrategy. For those that aren't, there are two segments to consider. The legacy of the business is software. MicroStrategy got started in 1989 as a business intelligence software provider. The company went public in 1998 and largely matched the stereotype of the dot com boom.

Shares rocketed from $7 in 1999 to in excess of $300, at the peak in 2000. It all came crashing down when the dot com bubble burst and MicroStrategy came under investigation by the SEC. While the stock price never recovered, the core software business continued to chug along, showing annual revenue growth from 2003 forward.

Despite this steady compounding in the business, valuation (as measured by price to sales) showed a steady compression. Falling from a dot com peak of 70x+ and finishing 2014 around 3x sales.

At this point, the software company started to take a turn for the worse. Following a decade of steady growth, revenue growth turned negative in 2015 and went on to contract for the next six years in a row. One can speculate on the cause of the change - did they fail to invest prudently in R&D to maintain relevance? Were new entrants attracted to their previous success and started to take share? Regardless the cause, this was a major turning point for the business. Steady growth became steady declines.

Faced with this new reality of a business in decline, management started to seek out new growth initiatives. First by attempting to innovate within their core domain, enterprise software, and then by entering a brand-new field.

Now we arrive at segment number two. In August 2020, MicroStrategy announced that they had purchased their first Bitcoin, specifically 21,454 for approximately $250 million. Over the coming years they would make many more purchases, sometimes with straight cash and other times through creative structures like Bitcoin backed debt offerings.

This brings us up to today. One stock, two segments (software and Bitcoin) and the question we seek to answer - "what is it all worth?"

The software business continues to be a slow decliner. In the August earnings report, they showed $111.4 million of total revenue, a decline of 7% y/y. In the same report they shared that the total Bitcoin holdings had increased to 226,500. As with any company, the narrative and the public shareholders are focused on the segment that's growing, not the segment that's shrinking.

While Bitcoin itself has been fairly stagnant of late (relatively to normal Bitcoin price velocity), shares of MicroStrategy have been able to maintain their momentum, recently reaching new all-time highs. For MicroStrategy, this feels like the story has come full circle. Once again, shares are trading north of 70x sales.

SoTP Valuation

MicroStrategy should be a pretty straightforward sum-of-the-parts story. If it was a standalone business, what is the software company worth? How many Bitcoin do they have? And what other puts and takes need adjusting (e.g., cash, debt, other balance sheet items).

Let's start with the software company. As mentioned above, recent quarter results were a little in excess of $100 million of revenue. Let's take that quarter and annualize it: that gives us $445.6 million of annual revenue.

Looking at a peer group of software companies, low growth software companies are currently being valued at 4x revenue. Not that dissimilar from the 3x revenue MicroStrategy was trading at before the pivot into Bitcoin.

$445.6 x 4.2 = $1.87 billion of value for the software company. This is a quick, back of the envelope number. In my opinion, it's probably overstating the valuation. 4.2x is labeled here as "low growth" while MicroStrategy's software business is no growth at the moment. Regardless, this gets us close enough.

Let's turn to the Bitcoin holdings. Q2 results showed 226,500. That's already stale information. As of September, that number has been revised up to 252,220. Bitcoin can be a volatile asset, by the time I write a value, it will already be wrong. For the sake of argument, I'm going to round up and use $70,000 as the Bitcoin price. That would make the Bitcoin holdings worth $17.7 billion.

Now for the puts and takes. The Q2 financials showed $67 million of cash and $3.8 billion of debt. Since announcing results, they have come back to the market twice, issuing an additional $1.875 million of convertible notes in September. $500 million of this was intended to retire existing debt, so we'll use $5.2 billion as our outstanding debt number.

Let's put the pieces together:

+$1.87 billion for the software company

+$17.7 billion for the Bitcoin

+$0.07 cash

-$5.2 billion for debt

=$14.44 net asset value

To put that number in context, the current market cap of the equity (@$201.67/share) is $40.8 billion. Investors are paying a 180% premium relative to this estimate of fair value.

Even if you agree with the puts and takes, and how to value the software business. Investors are paying a 130% premium to the simple value of the underlying Bitcoin holdings. That's a lot of faith and confidence in management.

Now, I can hear the objections already - I'm only looking at the current price of Bitcoin, I'm missing the fact that it will be worth significantly more in the future. Ok, an investor in MSTR would need to see Bitcoin increase to $174,000 to justify the current price of MicroStrategy. That's what is already built into the valuation.

To help you check that math, take the current market cap of $40.8 billion. Subtract the value of the software company, cash and add back the debt

$40.8 - $1.87 (software) - $0.07 (cash) + $5.2 (debt) = $44.1 billion remaining value. Divide that by 252,220 Bitcoin and you get a per coin implied value of $174,688.

If you think Bitcoin is going up, why buy an intermediary at an embedded premium when you can access Bitcoin directly through one of the main ETFs - the iShares Bitcoin Trust ETF (IBIT), for example? This reminds me of the time when everyone was enamored with Grayscale (GBTC). Back in 2020, investors were willing to pay a premium to buy Bitcoin through the Grayscale Trust.

As time went along, Bitcoin became easier to access through more platforms and at lower fees. The premium completely disappeared. An investor could have been completely correct about the future direction of Bitcoin, but they underperformed in GBTC because they paid a premium to enter. The same phenomenon is unfolding in MSTR.

Second objection, MicroStrategy is different because they can accumulate more Bitcoin, it's not just a passive holding vehicle. This is true, but the vast majority of the Bitcoin they are buying is funded through debt issuance, not from operating cash flow of the business. You yourself can take out the margin or get a loan to buy Bitcoin. Using debt isn't unique or all that value accretive. Debt issuance to buy more Bitcoin makes MSTR larger, but it's not necessarily shareholder accretive.

If you look at the most recent statement of cash flows, net cash provided by operating activities amounted to $5.3 million for the 6 months ending June. Over that same time period, they purchased $2.4 billion worth of Bitcoin through the issuance of notes and shares (equity dilution). So, operating cash flow funded 0.2% of new Bitcoin purchases. While it makes for a good narrative that they can use the operating cash flow to increase their Bitcoin stake, in reality, operating cash flow is insignificant to the actual results. MSTR is offering investors levered Bitcoin exposure, with investors paying a greater than 100% premium to the price of the underlying Bitcoin. If you're looking for levered Bitcoin exposure, why not just buy a 2x ETF like BITX or BITU, at a 0% premium to the underlying Bitcoin price?

The last point I want to make is watch what insiders are doing. In theory, there should be no one better informed than company management teams. In the last 12 months, there have been 165 insider sells and no insider buys.

Michael Saylor himself, the mastermind behind the Bitcoin strategy, has started selling shares this year, dumping hundreds of thousands of shares worth hundreds of millions of dollars. Now people may choose to sell for a variety of reasons - rebalance their portfolio, tax planning, etc. What's interesting about Saylor's transactions is this is the first time he sold shares since 2012. If he were one to rebalance his portfolio or trim his winners, you would have expected to see some sales during the first share price boom in 2021. The lack of historical activity makes these sales seem more substantial.

While a lot has changed in 25 years, maybe the simple idea of avoiding stocks at large premiums remains the same. The last time MSTR traded at these valuations, investors went on to lose 97% of their money over the next year. While that sounds like an extreme forecast, it seems reasonable that shares could decline by 60-70% to get back to current fair value, assuming a constant Bitcoin price.

What could go wrong?

Well, overvalued stocks can always become more overvalued. Just think back to the peak of GameStop (GME) mania. Once a security price is unencumbered by fundamentals, the sky's the limit. If you believe in fundamental analysis, it looks like a compelling short. If you're looking at short-term momentum, it could be a very dangerous proposition.