Before addressing anything else, let’s get the most important thing out of the way, STRC’s supposed price stability mechanism. Most of the units of the dividend-paying product were issued at around $100 and there is a stability mechanism in place to push the price towards $100. The idea is that if STRC trades below $100, the dividend payment can be increased, which should push up the price. In the other scenario, if STRC trades above $100, the dividend amount can be decreased, which should in theory push the price down. It is critical to understand that this design is fundamentally unstable. If investors perceive that the credit risk of the company is increasing, the price of STRC should fall, then the company would need to increase the dividend rate, which could further deteriorate the creditworthiness of the company, potentially resulting in a downward death spiral.
The other point to note is that this coupon is determined at the company’s discretion, it’s not an automatic stability system. This choice available to the company is not normal and it creates considerable uncertainty for investors in evaluating STRC. The choice creates a dilemma, legal ambiguity and is therefore a problem. A problem which in the long term requires a solution, in our view.
Understanding this potential instability and uncertainty is critical before addressing the other key questions such as:
- Can MSTR afford the dividends?
- Should one invest in STRC?
- Will STRC go back to Par?
- What MSTR should do now?
Should one borrow at 11.5% to buy Bitcoin?
Before even thinking about STRC, it is worth attempting to use basic financial logic to look at the trade. MSTR issued the perpetual debt instrument for $100, with a yield of 11.5% and then purchased Bitcoin with the proceeds. Even though the debt is perpetual and never needs to be repaid, in our view, on the face of it, this is a bad deal. If someone offered us an 11.5% perpetual loan, to purchase Bitcoin, we would reject it. The rate, 11.5% is simply too high.
Bitcoin could for example increase in value at an average annual rate of 10%. Inflation over the long term could be 5%. This would still mean Bitcoin could be a tremendous success, perhaps even on the way to hyperbitcoinization, but still fail to achieve the 11.5% annual growth rate. Therefore, issuing the perpetual instrument could have a negative impact on the issuer’s balance sheet in the long run. Although, of course, Bitcoin growing at 10% a year is compound growth and the liability is fixed at 11.5% of the initial loan value, therefore eventually Bitcoin will break away if the 10% growth persists.
However, the price of Bitcoin is not going to appreciate in a straight line. In the long term the price of Bitcoin could appreciate by over 11.5% per year on average, however there could be periods when the price declines. In order to service the interest payments, Bitcoin may need to be sold at these lower prices. This could again result in net losses for the issuer, even though the debt never needs to be re-paid.
We have produced a very basic “STRC Fair Value Calculator” tool, which is available here:
Using a discount rate of 8% and assuming the dividend payment stays flat at 11.5%, this values STRC at $144, significantly above the $100 issue price.
Therefore, in our view, assuming the coupon stays flat at 11.5% or assuming the 11.5% is an obligation for the issuer (it isn’t), issuing STRC was a very bad trade. In contrast, investing in STRC would probably be a good investment. In short no, one should not borrow at 11.5% to buy Bitcoin, that is a very bad trade, in our view.
Should one borrow at 11.5%, with the right to gradually lower the rate to SOFR, to buy Bitcoin?
STRC is a lot more complex than a fixed-rate 11.5% perpetual bond. There is a price stability mechanism and MSTR can change the coupon rate at their discretion. Although the company appears to have indicated that it will use this discretionary power to target a $100 price, from reading the issuing documents, it appears as if the company has no obligation to do so. The company has the right to lower the coupon by 25 bps each month all the way down to the SOFR rate, which is currently around 3.6%. The company can do this, without incurring any penalties.
Using the Farside calculator again, when taking this into consideration and calculating the net present value of future cashflow, we value the instrument at $55.
$55 is significantly below $100. Therefore, borrowing money on these terms to buy Bitcoin is an excellent deal for the borrower and a bad deal for the lender, in our view.
Inherent Contradictions
The issuance of STRC did not happen at $55. It also did not happen at $144. Most of the units were issued at around $100. This price therefore had built into it considerable uncertainty over the price stability mechanism and the direction of future coupon payments. STRC is a product of contradictions. It’s a novel and fantastical product that can be looked at from a number of angles.
The price stability mechanism is currently not working. STRC is trading at around $75, 25% below the $100 target. The company is not expected to respond by increasing the coupon, perhaps because they are worried about the downward death spiral or because they already think 11.5% is high enough. Indeed, assuming a reasonable discount rate and that the company remains solvent, at a fixed 11.5% coupon, the instrument should trade not at $100 but well over $100. The company should annouce the next coupon rate decision at the end of June 2026. This is a key decision to watch.
However, what this does mean is that the price stability mechanism is already dead. It might not be 100% dead, because the company could argue there is a ceiling to the mechanism. It could be that the company will increase the coupon, to target a $100 price, but only if the yield is below 11.5%. This of course was not explained by the company beforehand, as far as we can recollect. And if this is the case, that 11.5% is the top of the range, then this further indicates that this rate was too high to issue the product. Surely if there is a ceiling to the rate, the company should only issue new STRC if there is a large buffer between the ceiling and the current rate, perhaps at least 2%.
Anyway, it now looks like the price stability mechanism is mostly dead. In our view, this means there is no particular reason that the product will trade back up to $100. With the price stability mechanism dead and no redemption mechanism, there is really not much special going forwards about $100. The people claiming that the instrument will move back to this price are perhaps being overoptimistic.
Another potential consequence of the failure of the price stability mechanism, is that it increases the level of uncertainty over the future coupon policy. Now that it has failed, this could be an argument for lowering the coupon by 25 bps a month until it reaches SOFR. If the market expects MSTR to do this, STRC should trade at around $55, as we have shown above. Doing this would also solve two additional problems. Firstly, the company’s coupon payments are now quite easily affordable, in our view and the perception that they have a cashflow problem should go away. The other problem, that the company might not be willing to admit, the inherent unstable nature of the price stability mechanism, also disappears, as this unstable mechanism would be fully abandoned.
What should MSTR do now?
The easiest option and the most likely option in the short term is to do nothing. The company could keep the coupon at 11.5% and not worry about the fact that the instrument is trading well below $100. The company could attempt to finance the coupon payments for as long as possible, by issuing new equity or selling Bitcoin. Even if the Bitcoin price is significantly below average buy price or the equity is sold at a steep discount to mNAV. The trouble with this approach is that it is essentially kicking the can down the road. The company claims it has a large cash buffer now, but when this runs out, we are back to where we were without the buffer. The trouble is that the 11.5% rate on a $10.5bn outstanding issuance is a significant cash burn relative to the current balance sheet size. The STRC product has an inherently unstable price stability mechanism and there is considerable uncertainty about the direction of coupon policy. Addressing this uncertainty now and fixing the issue as soon as possible is probably the best thing to do for the company and Bitcoin. However, the temptation is to follow the path of least resistance, not admit one was wrong and keep the scheme going on for longer, if the company can get away with it.
Before going on to how to solve the problem. There is perhaps one more thing the company could attempt to do. The company could just announce a coupon cut, without a clear policy or guidance around it. MSTR could indicate that the 11.5% rate is simply too high, but that they want to be fair to investors and that therefore they will target more a compromise rate, say 8% ish. This kind of rate could be more affordable to the company, but also fairer to investors, who could avoid seeing their investment fall to c$55. This kind of arrangement could be reached perhaps as part of a discussion between the company and owners of STRC. However, if it isn’t enforced legally it would leave the potential uncertainty over the coupon rates as a problem for the longer term.
If the company does want to fully solve the problem, the way we see it is there are essentially two realistic choices:
1. Start buying back STRC
2. Fully abandon the price stability mechanism and move the rate down to SOFR
In the long run, in our view, ultimately the company will end up going down one of the above paths, or perhaps buying some back and then eventually lowering the coupon to the SOFR rate, if the company does not succeed in buying back all of the outstanding.
It is probably challenging for the company to justify buying back STRC now, since it was just issued and this would mark a reversal in policy. Of course, buying it back could also raise legal questions. Since the price of the debt is heavily influenced by the perception and indications coupon policy, which the company can control without doing anything, merely by giving indications, one could argue that it might be a bit unfair for the company to buy back at a discount. However, whichever path the company takes it may face legal challenges, given for example the AI bikini lady advert, which is the image at the top of this article. Buying back may be the best way out of this situation, at a price determined by the ability to sell Bitcoin or sell equity and also at a price designed to be a compromise between mitigating legal risks and enhancing shareholder value.
Speculation about a possible buyback could be propping up the price now, as the instrument trades well above $55. We think a buy back is the most likely outcome. It is just that one may need to wait a while for this, before the company eventually gives in to the pressure and faces reality.
Disclosure: The Farside Equity Fund does not have any positions in MSTR or STRC. This material should not be the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions
