History doesn’t repeat itself, but it often rhymes with Wall Street — and that’s terrible news for MicroStrategy

Social media message boards may call this strategy “MicroStrategy’s never-ending money problem.” Selling convertible notes allows the company to buy more Bitcoin, which in turn increases the price of the world’s largest cryptocurrency and allows the company to issue more convertible notes. It’s a repeating cycle that has undeniably played a role in bringing Bitcoin close to the psychologically important $100,000 per token level.

While there’s no doubt that MicroStrategy has proven the skeptics wrong, history so far has a way of rhyming with Wall Street. Similar leverage-driven scenarios like this have always been the case possibly (key word!) ended in pain for the companies and shareholders behind it.

Perhaps the most striking example of a seemingly undeniable leverage scenario blowing up in Wall Street’s face occurred less than twenty years ago.

As early as the 1970s, banks began packaging mortgages into more complex products known as mortgage-backed securities (MBSs) that our nation’s major financial institutions could buy and sell.

About twenty years ago, banks began applying this highly profitable securitization of loans to subprime mortgages (that is, mortgages offered to borrowers with poor credit). Although subprime MBSs offered tempting returns, they required subprime borrowers to pay their bills and keep home prices rising.

Compared to house price inflation data from the last century, the rise in house prices in the mid-2000s was simply not sustainable. The other critical problem is that subprime borrowers were often forced into adjustable-rate loans that offered low initial payments but eventually reset and made their payments unaffordable, at least for some subprime borrowers.

Once these subprime MBSs failed, it created a cascading effect for many of America’s largest financial institutions.

To be clear, what happens at MicroStrategy will not topple the US financial system, as the subprime MBSs threatened to do during the financial crisis. But it is the next in a series of examples of using leverage in (what, in retrospect, will be) a disastrous way.

For MicroStrategy’s ‘infinity glitch’ to work, the company needs buying interest in Bitcoin to remain frothy, and for Bitcoin’s price to move higher. However, history shows conclusively that this is not sustainable.

Since Bitcoin began trading fifteen years ago, the world’s largest digital currency has suffered seven peak-to-trough declines of at least 50%, including three that exceeded 82%. Crypto bear markets are no small feat and have historically proven inevitable. If Bitcoin’s price falls by 50% or more, pressure to pay back lenders could increase.

To make matters worse, hoarding Bitcoin as a reserve will only make the world’s most popular cryptocurrency less liquid. In other words, if MicroStrategy ever has to sell some of its Bitcoin to meet its debt obligations, it could lead to a situation that drives down the price of the world’s most prominent digital currency.

But the most glaring negative of all is the premium placed on MicroStrategy’s Bitcoin assets. Based on a price of $92,754 per Bitcoin, MicroStrategy’s Bitcoin portfolio of 386,700 tokens is worth $35.87 billion at the time of writing. But as of the closing bell on November 26, MicroStrategy had a market cap of $81.5 billion.

Assigning a very generous $1 billion market value to the shrinking business analytics software segment – ​​MicroStrategy’s AI software segment is losing money and has seen revenue decline 14% over the past decade – leads to investors paying a 124% premium for the company’s Bitcoin. assets.

Mind you, this premium does not take into account the rapidly growing debt obligations, nor does it take into account the possibility of a fully diluted share count of 266.5 million shares (as opposed to the 230.5 million base shares outstanding, the market cap of $81 .5 billion based on). On a fully diluted basis, this premium for its Bitcoin assets is even more egregious.

If an investor were optimistic about Bitcoin’s future, they could purchase tokens on a reputable exchange for $92,754 at the time of writing. Meanwhile, investors purchasing MicroStrategy shares will pay over $208,000 per token based on the current 124% premium, or nearly $244,000 per token on a fully diluted basis with 266.51 million shares outstanding.

While it’s impossible to pinpoint exactly when a bubble will burst, the tea leaves couldn’t be clearer that this premium, and MicroStrategy’s use of leverage, is not sustainable.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool holds and recommends positions in Bitcoin. The Motley Fool has a disclosure policy.

History doesn’t repeat itself, but it often rhymes with Wall Street — and that’s terrible news for MicroStrategy was originally published by The Motley Fool