In-depth analysis of the opportunities and risks of MicroStrategy: profit and loss come from the same source, Davis double-click and double-kill

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马里奥看Web32024/11/27 09:53

By:马里奥看Web3

In-depth analysis of the opportunities and risks of MicroStrategy: profit and loss come from the same source, Davis double-click and double-kill

Last week we discussed the potential of Lido to benefit from changes in regulatory environments, hoping to help everyone seize this Buy the rumor trading opportunity. This week, there is a very interesting theme, which is the popularity of MicroStrategy. Many predecessors have commented on the company's operation mode. After digesting and studying it in depth, I have some of my own opinions and hope to share them with you. I think the reason for the rise in MicroStrategy's stock price is due to the "Davis Double Click" business design of financing the purchase of BTC, which binds the appreciation of BTC to the company's profits. The innovative design of combining traditional Financial Marekt financing channels to obtain capital leverage has enabled the company to have the ability to exceed the profit growth brought by the appreciation of BTC held by itself. At the same time, as the position expands, the company has a certain degree of BTC pricing power, further strengthening this profit growth expectation. The risk lies in the fact that when the BTC market experiences fluctuations or reversal risks, the profit growth of BTC will stagnate. At the same time, due to the company's operating expenses and debt pressure, MicroStrategy's financing ability will be greatly reduced, which will affect profit growth expectations. Unless there is new support to further push up the BTC price, the positive premium of MSTR stock price relative to BTC holdings will quickly converge. This process is also known as the "Davis Double Kill".

What is Davis Double Click and Double Kill?

Those who are familiar with me should know that I am committed to helping more non-financial professionals understand these dynamics, so I will replay my own thinking logic. Therefore, first of all, I will supplement some basic knowledge, what is "Davis double click" and "double kill".

The so-called "Davis Double Play" was proposed by investment guru Clifford Davis and is usually used to describe the phenomenon of a company's stock price rising sharply due to two factors in a good economic environment. These two factors are:

Company profit growth: The company has achieved strong profit growth or optimized its business model, management, and other aspects, resulting in an increase in profits.

Valuation expansion: Due to the market's more optimistic outlook on the company's prospects, investors are willing to pay higher prices for it, thereby driving up the stock valuation. In other words, the stock's Price-To-Earnings Ratio (P/E Ratio) and other valuation multiples are expanding.

The specific logic that drives the "Davis Double Click" is as follows. Firstly, the company's performance exceeds expectations, and both revenue and profits are increasing. For example, good product sales, market share expansion, or successful cost control will directly lead to the company's profit growth. This growth will also increase the market's confidence in the company's future prospects, leading investors to accept a higher Price-To-Earnings Ratio P/E, pay higher prices for the stock, and the valuation begins to expand. This linear and exponential positive feedback effect usually leads to an accelerated rise in stock prices, which is called the "Davis Double Click".

For example, to illustrate this process, suppose a company's current Price-To-Earnings Ratio is 15 times, and its future profits are expected to increase by 30%. If investors are willing to pay 18 times the Price-To-Earnings Ratio due to the company's profit growth and changes in market sentiment, even if the profit growth rate remains unchanged, the increase in valuation will push the stock price up significantly, for example:

Current stock price: 100 dollars

Earnings increased by 30%, meaning earnings per share (EPS) increased from 5 dollars to 6.5 dollars.

Price-To-Earnings Ratio increased from 15 to 18.

New share price: 6.5 dollars × 18 = 117 dollars

The stock price rose from 100 dollars to 117 dollars, reflecting the dual role of profit growth and valuation improvement.

The "Davis Double Kill" is the opposite, usually used to describe the rapid decline in stock prices caused by the combined action of two negative factors. These two negative factors are:

Company profit decline: The company's profitability may decline due to factors such as reduced revenue, rising costs, and management errors, resulting in lower profits than market expectations.

Valuation contraction: Due to declining profits or deteriorating market prospects, investors' confidence in the company's future decreases, resulting in a decrease in its valuation multiple (such as Price-To-Earnings Ratio) and a drop in stock price.

The whole logic is as follows. Firstly, the company failed to achieve the expected profit target or faced operational difficulties, resulting in poor performance and decreased profits. This will further worsen the market's expectations for its future, causing investors to lack confidence and unwilling to accept the current overvalued Price-To-Earnings Ratio, only willing to pay a lower price for the stock, resulting in a decrease in valuation multiples and further decline in stock prices.

Using the same example to illustrate this process, assuming a company's current Price-To-Earnings Ratio is 15 times, its future profits are expected to decrease by 20%. Due to the decline in profits, the market begins to doubt the company's prospects, and investors begin to lower their Price-To-Earnings Ratio. For example, lowering the Price-To-Earnings Ratio from 15 to 12. The stock price may therefore fall sharply, for example:

Current stock price: 100 dollars

Earnings fell 20%, meaning earnings per share (EPS) fell from 5 dollars to 4 dollars.

Price-To-Earnings Ratio decreased from 15 to 12.

New share price: 4 dollars × 12 = 48 dollars

The stock price fell from 100 dollars to 48 dollars, reflecting the dual effect of declining profits and valuation contraction.

This resonance effect usually occurs in high-growth stocks, especially in many technology stocks, because investors are usually willing to give higher expectations for the future growth of these companies' businesses. However, these expectations are usually supported by relatively large subjective factors, so the corresponding volatility is also very high.

How is the high premium of MSTR caused and why has it become the core of its business model?

After supplementing this background knowledge, I think everyone should be able to roughly understand how the high premium of MSTR relative to its BTC holdings is generated. Firstly, MicroStrategy switched its business from traditional software business to financing the purchase of BTC, and of course, there may be corresponding asset management revenue in the future. This means that the profit of this company comes from the capital gains from the appreciation of BTC purchased by diluting equity stakes and issuing bonds. With the appreciation of BTC, the Shareholders' Equity of all investors will correspondingly increase, and investors will benefit from it. In this regard, MSTR is no different from other BTC ETFs.

The difference lies in the leverage effect brought by its financing ability, because MSTR investors' expectations for the company's future profit growth come from the leverage income obtained from its financing ability growth. Considering that the total market value of MSTR's stocks is in a positive premium state relative to the total value of BTC it holds, that is to say, the total market value of MSTR is higher than the total value of BTC it holds. As long as it is in this positive premium state, whether it is equity stake financing or its convertible bond financing, with the funds obtained to purchase BTC, it will further increase its equity per share. This gives MSTR a different profit growth ability from BTC ETFs.

For example, suppose the current BTC held by MSTR is $40 billion, and the total outstanding shares X have a total market value of Y. At this time, the equity per share is 40 billion/X. If financing is carried out with the most unfavorable equity stake dilution, assuming the ratio of new shares issued is a, this means that the total outstanding shares become X * (a + 1), and financing is completed at the current valuation, raising a total of a * Y billion US dollars. Converting all these funds into BTC, the BTC position becomes 40 billion + a * Y billion, which means that the equity per share becomes:

In-depth analysis of the opportunities and risks of MicroStrategy: profit and loss come from the same source, Davis double-click and double-kill

We subtract it from the original equity per share to calculate the growth of diluted equity per share, as follows:

This means that when Y is greater than 40 billion, that is, the value of BTC it holds, that is, when there is a positive premium, the growth of equity per share brought by financing the purchase of BTC is greater than 0, and the larger the positive premium, the higher the growth of equity per share, which is called a linear relationship. As for the impact of dilution ratio a, it presents an inverse proportion feature in the first quadrant, which means that the fewer additional stocks issued, the higher the growth rate of equity.

Therefore, for Michael Saylor, the positive premium between the MSTR market value and the BTC value he holds is the core factor in establishing his business model. Therefore, his optimal choice is to maintain this premium while continuously financing, increasing his market share, and gaining more pricing power over BTC. The continuous enhancement of pricing power will also enhance investors' confidence in future growth under high Price-To-Earnings Ratio, enabling them to complete fundraising.

To sum up, the secret of MicroStrategy's business model lies in the fact that the appreciation of BTC drives up the company's profits, and the positive trend of BTC growth means that the trend of corporate profit growth is good. With the support of this "Davis Double Click", the positive premium of MSTR begins to expand. Therefore, the market is gambling on how high the positive premium valuation of MicroStrategy can complete subsequent financing.

What are the risks that MicroStrategy brings to the industry?

Next, let's talk about the risks that MicroStrategy brings to the industry. I think its core lies in the fact that this business model will significantly increase the volatility of BTC prices and act as an amplifier of volatility. The reason is the "Davis Double Kill", and BTC entering a high-level oscillation period is the beginning of the entire domino effect.

Let's imagine that when the rise of BTC slows down and enters a period of volatility, MicroStrategy's profits inevitably begin to decline. Here, I want to elaborate on it. I have seen some friends attach great importance to its holding cost and floating profit scale. This is meaningless because in MicroStrategy's business model, profits are transparent and equivalent to real-time settlement. In the traditional stock market, we know that the real factor causing stock price fluctuations is financial reports. Only when quarterly financial reports are released, the true profit level will be confirmed by the market. During this period, investors only estimate changes in financial situation based on some external information. That is to say, most of the time, the reaction of the stock price lags behind the true changes in the company's revenue, and this lag relationship will be corrected when the quarterly financial report is released. However, in MicroStrategy's business model, because its position size and BTC price are public information, investors can understand its true profit level in real time, and there is no lag effect, because the equity per share changes dynamically, which is equivalent to real-time settlement of profits. Therefore, the stock price has already truly reflected all its profits, and there is no lag effect, so it is meaningless to focus on its position cost.

Bringing the topic back, let's take a look at how the "Davis Double Kill" unfolded. When the growth of BTC slows down and enters an oscillation phase, MicroStrategy's profits will continue to decrease, even to zero. At this time, fixed operating costs and financing costs will further reduce the company's profits, even in a state of loss. At this time, this oscillation will continue to erode the market's confidence in the future development of BTC prices. This will translate into doubts about MicroStrategy's financing ability, further hitting expectations for its profit growth. Under the resonance of these two, the positive premium of MSTR will quickly converge. In order to maintain the establishment of its business model, Michael Saylor must maintain the positive premium state. Therefore, it is necessary to sell BTC to buy back stocks, and this is the moment when MicroStrategy started selling its first BTC.

Some friends may ask, why not just hold BTC and let the stock price fall naturally? My answer is no. To be more precise, it is not allowed when the BTC price reverses, but it can be tolerated during fluctuations due to MicroStrategy's current equity structure and what is the optimal solution for Michael Saylor.

According to the current shareholding ratio of MicroStrategy, there are some top consortia, such as Jane Street and BlackRock, and Michael Saylor, the founder, only accounts for less than 10%. Of course, through the design of dual equity stakes, Michael Saylor has an absolute advantage in voting rights because he holds more shares in Class B Common Stock, and the voting rights of Class B Common Stock are 10:1 compared to Class A. Therefore, this company is still under the strong control of Michael Saylor, but its equity stake ratio is not high.

This means that for Michael Saylor, the long-term value of the company is much higher than the value of the BTC he holds, because if the company faces bankruptcy liquidation, the BTC he can obtain is not much.

So what are the benefits of selling BTC and repurchasing stocks to maintain the premium during the oscillation phase? The answer is also obvious. When the premium converges, assuming Michael Saylor judges that the Price-To-Earnings Ratio of MSTR is undervalued due to panic, selling BTC to exchange for funds and repurchasing MSTR from the market is a cost-effective operation. Therefore, the effect of repurchasing on reducing circulation and amplifying equity per share will be higher than the effect of reducing BTC reserves and reducing equity per share. When the panic ends and the stock price pulls back, equity per share will become higher, which is beneficial for future development. This effect is easier to understand in extreme cases of BTC trend reversal and negative premium of MSTR.

Considering Michael Saylor's current position and the fact that liquidity usually tightens during fluctuations or downturns, the price decline of BTC will accelerate when it starts to sell. The acceleration of the decline will further worsen investors' expectations for MicroStrategy's profit growth, causing the premium rate to further decrease, which forces it to sell BTC and repurchase MSTR. At this point, the "Davis Double Kill" begins.

Of course, there is also a reason that forces it to sell BTC to maintain its stock price. The investors behind it are a group of deep states with deep eyes, who cannot watch the stock price go to zero and remain indifferent. This will inevitably put pressure on Michael Saylor and force him to take responsibility for his market value management. Moreover, according to recent information, with the continuous dilution of equity stakes, Michael Saylor's voting rights have dropped below 50%. Of course, specific sources of information have not been found. But this trend seems inevitable.

Is MicroStrategy's convertible bond really risk-free before maturity?

After the above discussion, I think I have fully explained my logic. I also hope to discuss a topic: whether MicroStrategy has no debt risk in the short term. Some predecessors have already introduced the nature of MicroStrategy's convertible bonds, so I will not discuss it here. Indeed, its debt duration is quite long. There is indeed no repayment risk before the maturity date. But my opinion is that its debt risk may still be reflected in advance through the stock price.

MicroStrategy's convertible bonds are essentially bonds that are stacked with free bullish options. When they mature, creditors can request MicroStrategy to redeem them at the previously agreed conversion rate equivalent to stocks. However, there is also protection for MicroStrategy. MicroStrategy can actively choose the redemption method, using cash, stocks, or a combination of the two, which is relatively flexible. If there is sufficient funds, more cash can be repaid to avoid dilution of the equity stake. If there is insufficient funds, more stocks can be invested. Moreover, this convertible bond is unsecured, so the risk of debt repayment is not significant. There is also a protection for MicroStrategy here, that is, if the premium rate exceeds 130%, MicroStrategy can also choose to redeem directly at the original cash value, which creates conditions for loan renewal negotiations.

Therefore, the creditor of this bond will only have capital gains if the stock price is higher than the conversion price and lower than 130% of the conversion price. In addition, there is only principal plus low interest. Of course, after Mindao's reminder, the investors of this bond are mainly hedge funds used for Delta hedging to earn volatility returns. Therefore, the logic behind it has been carefully considered.

The specific operation of Delta hedging through convertible bonds is mainly to buy MSTR convertible bonds and sell short equal amounts of MSTR stocks to hedging the risks brought by stock price fluctuations. Moreover, with the subsequent price development, hedge funds need to constantly adjust their positioning dynamic hedging. Dynamic hedging usually has the following two scenarios:

When the MSTR stock price falls, the Delta value of convertible bonds decreases because the conversion rights of the bonds become less valuable (closer to "out-of-the-money"). At this time, more MSTR stocks need to be sold short to match the new Delta value.

When the MSTR stock price rises, the Delta value of convertible bonds increases because the conversion rights of the bonds become more valuable (closer to the "real value"). At this time, by buying back some previously sold short MSTR stocks to match the new Delta value, the hedging of the portfolio can be maintained.

Dynamic hedging requires frequent adjustments in the following situations:

Significant fluctuations in the target stock price: such as the significant change in the price of Bitcoin causing significant fluctuations in the stock price of MSTR.

Changes in market conditions, such as volatility, interest rates, or other external factors, affect convertible bond pricing models.

Usually hedge funds trigger operations based on the magnitude of Delta changes (such as every 0.01 change) to maintain the precise hedging of the portfolio.

Let's take a specific scenario to illustrate, assuming the initial position of a hedge fund is as follows

Buy $10 million worth of MSTR convertible bonds (Delta = 0.6).

Sell short $6 million worth of MSTR stock.

When the stock price rises from 100 dollars to 110 dollars and the Delta value of the convertible bond becomes 0.65, the stock position needs to be adjusted. The number of stocks to be covered is calculated as (0.65 − 0.6) × 10 million = 500,000. The specific operation is to buy back stocks worth 500,000 dollars.

When the stock price falls from 100 dollars to 95 dollars, the new Delta value of the convertible bond becomes 0.55, and the stock position needs to be adjusted. The calculation requires adding short stocks as (0.6 − 0.55) × 10 million = 500,000. The specific operation is to sell short stocks 500,000 dollars.

This means that when the MSTR price falls, the hedge fund behind its convertible bonds will sell short more MSTR stocks in order to dynamically hedging Delta, further hitting the MSTR stock price. This will have a negative impact on the positive premium and affect the entire business model. Therefore, the risk on the bond side will be fed back in advance through the stock price. Of course, in the upward trend of MSTR, hedge funds will buy more MSTR, which is also a double-edged sword.

Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.

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