Initiating Coverage on Strategy (MSTR US: Model Available)

Date of Initiation: 4/14/2025

Current Price: $311.45

Price Target: $279.43

Conviction: 8/10

Holding Period: 3 Year Hold

Model: Strategy.xlsx

This idea may feel unconventional, especially if you're used to long-only investing like I am. But I believe the rational is sound and the trade is anything but speculative. Nonetheless, I think if you read this with an open mind you'll understand the trade I'm making is rational and not speculative. You might disagree with the trade, but I hope you'll walk away understanding why I'm making it. I pitched the pair trade short Strategy/long Bitcoin in Silver Fund on Monday, April 14th as a personal passion project. Frankly, I thought I would be laughed out of the room but by the end of the pitch I had convinced enough of the fund of my reasoning that we voted to take the position.

What is Strategy?

Strategy, formerly MicroStrategy, is the world's largest "Bitcoin Treasury Company". They buy Bitcoin with capital raised through internal and external financing and plan to hold this Bitcoin for the foreseeable future. The following pie chart breaks out how Bitcoin purchases have been financed as of April 11th.

You can see that a vast majority of these purchases have been enabled by external financing. Strategy has some legacy enterprise software operations which fund a small portion of bitcoin purchases and help them cover interest and dividend payments.

The MSTR Premium

When you buy Strategy stock you are paying a 104.73% premium on the underlying Bitcoin. Your dollar is getting you less BTC than you would otherwise be able to purchase through an ETF or digital wallet.

Some will say this premium is warranted because Strategy is a great way for institutional investors to gain access to Bitcoin when they can’t buy spot BTC. But the advent of Bitcoin ETFs and other BTC exposed products has allowed institutional investors the access that Strategy once provided. Others will say you’re paying for the “Saylor Premium”, named after Strategy’s chairman Michael Saylor. Saylor is seen as a visionary in the crypto community and has a cultlike following. However, I would posit this “Saylor Premium” could very easily disappear if signs of trouble begin brewing within MSTR. These signs of trouble are beginning to appear. On Friday, MSTR announced it may have to begin selling BTC to cover debt payments and dividends after Saylor promised investors this would never happen.

By far the most potent argument to pay the MSTR premium is Strategy’s usage of “Intelligent Leverage”. Strategy will claim that they intelligently lever existing Bitcoin by conducting new and larger capital raises consecutively. If you buy a share of MSTR today, that same share could own 50% more BTC by the end of next year.

Intelligent Leverage: Praying for a Greater Fool

The catch with MSTR’s Intelligent Leverage is that it has some very real practical limits and is completely fixed on Strategy’s ability to take advantage of capital markets. Strategy laid out their 21/21 plan in November of 2024. They told investors they plan to raise $21 billion in fixed income and $21 billion in equity products through FY2027. In Q4 of 2024, MSTR raised $16.7 billion of the $21 billion in equity allotted meaning that future capital raises will be heavily tilted toward fixed income products. MSTR is already within their 20-30% leverage target (metric used is (Debt + Pref)/Bitcoin NAV) and interest and dividend payments will become increasingly burdensome as they raise more preferred stock and convertible debt. In the model I am VERY generous with the underlying software business which would be used to pay dividends and interest. I project their interest coverage for FY25 will be close to 0.21x, which spells trouble.

More importantly the logic behind intelligent leverage has some blatant flaws. If I buy a share of MSTR today I am expecting the NAV of the Bitcoin for my share to increase over the coming years. This increase can only happen if new investors fund the purchase of more Bitcoin. Without new investors, MSTR has limited funding and the Bitcoin NAV decreases relative to the dilution of shares. To intelligently lever Bitcoin, you need to have successful capital raises so new investors can increase the BTC NAV for earlier investors.

Making Money on Premium Compression

The flaws of intelligent leverage, introduction of new ETFs and BTC products, and the flimsiness of the Saylor Premium lead me to believe that the MSTR premium is likely to compress over the coming years. It currently sits at 104.73%, which is relatively elevated when compared with past levels.

Implementation in a manner that exposes us only to the premium would mean shorting a share of MSTR and longing the same amount of BTC as the underlying Bitcoin NAV on the MSTR share. So, if I short one share of MSTR at $299.98 (April 11th close price) I should long $146.52 in BTC or some type of BTC ETF. This exposes the trade to the full premium and periodic rebalancing on my part would allow me to make money on the premium compression regardless of BTC’s performance over time.

Why the Premium will Compress

Catalysts will be particularly important with this trade. I rank the following 4 catalysts from most to least likely.

Inability to cover Interest/Dividends: This seems incredibly likely, and it would force MSTR to liquidate some Bitcoin. When MSTR is forced to liquidate Bitcoin, the market should take it as a sign that they’ve expanded their Bitcoin NAV as much as possible using outside capital. The premium should fall as investors realize Strategy has exhausted their potential to efficiently bring in external capital. There are already rumors of this occurring, and Saylor is starting to prepare investors mentally for the event.

Difficulty with new capital raises: I think a tougher macro environment and growing red flags with Strategy’s plans and balance sheet will make investors less keen to finance their Bitcoin operations. No new capital raises would mean no more intelligent leverage and the potential collapse of the MSTR premium.

Debtholders calling MSTR’s debt: This would be catastrophic for the company but is not at all outside the realm of possibilities. If MSTR’s Bitcoin NAV drops below the principal + interest payments that debtholders are expecting, they may call on MSTR to liquidate Bitcoin (much of the debt is collateralized by BTC) to make the creditors whole. This would start a nasty downward spiral of Bitcoin selling with no floor in sight.

Volatility Disappears: Mark Meldrum has a great video on YouTube about why trading shops buy MSTR’s convertible debt. His thesis is that the moment the volatility in MSTR’s stock disappears these debtholders will not have an appetite for MSTR’s products. This will leave them unable to intelligently lever, which is obviously a problem. I've tracked the volatility and while there's no real trend yet, it's something I'll keep my eyes on.

How I Could be Wrong

The premium growing is the most foreseeable path I can see to losing this trade. Saylor is a great salesman of BTC. He paints a beautiful picture of a world where BTC is widely adopted and is considered a mainstream store of value. While I think MSTR’s strategy is certainly doomed in the long term (business model is reliant on new capital and trees can’t grow to the sky) being early could be the same as being wrong.

I also believe there is implementation risk if the long Bitcoin hedge isn't correctly calculated and adjusted regularly. While this is something I can closely monitor in my paper portfolio, it was a concern I was very cognizant to bring up with Silver Fund as we will be unable to touch the portfolio over the summer.

Modeling

I modeled an expected return for this trade by trailing down the Bitcoin premium over the coming years under different assumptions for overall BTC performance. I also stress tested the trade under different assumptions for how the MSTR premium moves. Feel free to explore the model and test these assumptions if you’d like (on the sheet Return Scenarios). What I view as a base case is the premium shrinking to about 33.73% by the end of our 3-year holding period. This would result in a 48.3% return for us across three years with relatively low overall risk if the hedge is implemented well.

Strategy and the Macro Environment

Strategy will have a really hard time in a tough macro environment competing with spot BTC because spot BTC doesn’t have to worry about making debt payments or selling off because they are in the NASDAQ 100. A bad macro will be very helpful in getting us to our catalysts quicker while a good macro will allow MSTR to conduct capital raises much easier.

Conclusion

In conclusion, I propose we short MSTR and long BTC to hedge out bitcoin risk in the trade. This will give us direct exposure to MSTR’s premium over Bitcoin NAV, which I believe is likely to contract because of the increased prevalence of institutional bitcoin products, the pitfalls of intelligent leverage, and missteps by Michael Saylor and Strategy’s management. There are several catalysts that could accelerate the process and allow us to achieve great risk adjusted returns.