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Good morning.

Welcome to Deep Flow: our weekly analysis of the biggest stories in digital assets.

This week, we break down MicroStrategy’s Bitcoin Playbook.

First, a reminder that this edition of Deep Flow is free to all Flow State subscribers, but it will go behind a paywall for members on June 17.

If you’d like to support us and upgrade your membership today, you’ll receive a 25% discount.

Thanks, and let’s dive in.…🌊🌊🌊

Introduction

Since September 2020, MicroStrategy (MSTR) has accumulated more than 214k BTC ($14.7b) under Michael Saylor’s leadership.

Anyone involved with Bitcoin is familiar with the story. Michael Saylor is one of Bitcoin’s biggest advocates and most famous faces.

But how exactly did he pull it off?

Understanding MicroStrategy’s Bitcoin plan means answering three questions:

1. What is their Bitcoin strategy?

2. Why did they pursue it?

3. Should other companies do it, and if so how?

The first question is relatively straightforward, and can be seen on the slide below taken from their Q1 Earnings report.

Leaving aside the software development side of things, the strategy can be basically summed as with “Increase Bitcoin Holdings and Shareholder Value.”

How do they do that? In two ways.

First, by using excess cash to acquire BTC.

And second, through capital market activities (equity and debt).

The focus of this newsletter, however, is on the remaining questions from above.

Why is MicroStrategy is doing this, how is it relevant for other companies, and what must corporations do in order to start pursuing a Bitcoin strategy of their own?

MicroStrategy’s Bitcoin Philosophy

How does Michael Saylor, and MicroStrategy, think about Bitcoin? Why did they pursue their Bitcoin strategy, and what is their general point of view concerning Bitcoin adoption by other companies?

These questions were all answered in some form at MicroStrategy’s recent conference, Bitcoin for Corporations.

Below, I’ve clipped relevant parts of two presentations from that event. I’ve summarized the videos here, and linked them too.

Bitcoin is the Best Treasury Asset

• Corporate Finance Implications:

  • Traditional treasury assets like cash and credit are dilutive.

  • Holding cash or investing in T-bills yields low returns (3% after tax) compared to the 12% cost of capital, leading to shareholder value destruction.

  • Example: Holding $100 billion in cash can destroy $9 billion in shareholder value annually.

• Bitcoin's Accretive Nature:

  • Bitcoin is the first accretive treasury asset.

  • Holding $100 billion in Bitcoin, appreciating at 40% annually, results in $40 billion of accretion instead of $9 billion of dilution.

  • This changes the rules of modern corporate finance.

• Modern Corporate Finance Practices:

  • Traditional finance encourages stripping volatility from the P&L and returning capital to shareholders through buybacks or dividends, despite tax inefficiencies.

  • Companies often borrow to buy back equity, leading to negative working capital and financial fragility.

• Fragility of Conventional Treasury Assets:

  • Holding positive capital (bonds) can be toxic, while negative capital (borrowed funds) makes companies fragile and susceptible to bankruptcy during bad quarters.

  • The average corporate life expectancy is reduced due to the toxic nature of conventional treasury assets.

• MicroStrategy's Bitcoin Strategy:

  • Since adopting Bitcoin, Microstrategy has seen significant benefits, outperforming many traditional tech companies.

  • Companies like SAP, IBM, Salesforce, and Oracle struggle to beat the cost of capital.

  • In contrast, MicroStrategy leveraged cheap debt to buy Bitcoin, resulting in superior performance.

• Corporate Health and Longevity:

  • Companies injecting toxic assets into their balance sheets are shortening their lifespan.

  • By adopting Bitcoin, companies can stop "bleeding the patient," leading to improved corporate health and longevity.

Why MicroStrategy Bought Bitcoin

• Context of the Decision

  • The decision to adopt a Bitcoin strategy began in the first quarter of 2020.

  • This period marked the start of what Saylor refers to as the "crazy years."

• Economic and Market Conditions

  • The world experienced lockdowns, office closures, and market crashes.

  • Interest rates dropped to zero, causing significant market confusion and volatility.

• Business Concerns

  • Initially focused on the core business and how to navigate the new economic landscape.

  • Concerns arose about employee satisfaction and retention, especially with remote work making it easier for competitors like Microsoft, Google, and Amazon to poach talent without requiring relocation.

• Asset Management

  • Realized that their substantial cash reserves ($500 million) would yield zero returns for the foreseeable future, as indicated by the Federal Reserve.

• Pressure from Shareholders

  • Shareholders were unhappy with the cash reserves yielding no interest.

  • The cost of capital typically being 12% highlighted the inefficiency of holding cash.

• Need for Action

  • Faced with low yields on cash, shareholder pressure, and the need to support employees, MicroStrategy felt compelled to take action.

  • This open-minded approach led them to explore Bitcoin as a potential solution to these challenges.

The Evolution of Microstrategy’s Bitcoin Plan

• Initial Stage: Defensive

  • In December 2020, MicroStrategy launched its first convertible bond to protect the company.

  • This move was primarily defensive, aimed at safeguarding the company during uncertain times.

• Second stage: Opportunistic

  • By the time of the bond issue, MicroStrategy's stock had doubled or tripled.

  • This provided an opportunity to raise money, leading to an opportunistic approach.

• Strategic Shift in Early 2021

  • In the first half of 2021, the company's approach became more strategic.

  • The second convertible bond issue marked a shift from opportunistic to programmatic, indicating a more systematic approach.

• Third stage: Transformational

  • Ultimately, MicroStrategy's engagement with Bitcoin became transformational.

  • The company rebranded itself as a Bitcoin development company, fundamentally changing its business model and strategy.

Why Companies Should Buy Bitcoin

Exchanges and custodians

• Customer Confidence

  • By holding Bitcoin, exchanges and custodians show confidence in the asset they are recommending to their customers.

  • It’s important for these institutions to put their money where their mouth is, validating the safety and potential of Bitcoin to their clients.

• Public Company Advantages

  • Public exchanges like Coinbase can easily issue equity and convertible debt to acquire Bitcoin.

  • This strategy not only enhances their balance sheet but also aligns with their business model of convincing others to buy and hold Bitcoin.

Private companies in general

• Raising Capital with Bitcoin

  • Instead of raising $50 million for operating losses, raise $200 million in capital, putting $150 million into Bitcoin and $50 million into operations.

  • This strategy leverages Bitcoin’s potential growth and demonstrates belief in Bitcoin’s future.

• Moral Standing and Commitment

  • If a company does not believe in Bitcoin’s future, it should exit the business.

  • Companies must support the asset they are promoting to maintain moral standing and credibility in the industry.

• Participating Preferred Stock

  • Private companies can issue participating preferred stock, which behaves like a debt instrument without marking to market.

  • Investors can gain Bitcoin’s upside without the downside risk, appealing to those with investment portfolios.

Zombie companies

• Definition of Zombie Companies

  • Zombie companies are those with stagnant revenue growth (0-5% annually) and minimal stock trading activity.

  • These companies often have significant cash reserves but lack growth potential, making their stock unattractive.

  • These companies struggle to raise capital at reasonable rates, often paying high interest for junk bonds.

• Transformational Deals

  • Investment bankers typically advise zombie companies to pursue transformational deals, such as mergers or acquisitions of high-growth companies.

  • However, finding suitable acquisition targets that ensure integration and consistent growth is challenging.

• Bitcoin as a Universal Merger Partner

  • Bitcoin can serve as a universal merger partner for zombie companies.

  • By investing in Bitcoin, these companies can attract market attention, increase stock trading volume, and revitalize employee stock options.

• Benefits of Adopting Bitcoin

  • Investing in Bitcoin introduces volatility, which can increase the company’s stock value and market capitalization.

  • The cost of capital decreases as the company's stock becomes more attractive to investors, making it easier to raise funds.

• Example of MicroStrategy

  • Saylor highlights MicroStrategy's transformation from a stagnant company to a high-performing one through its Bitcoin strategy.

  • This approach can serve as a model for other zombie companies seeking to rejuvenate their business and enhance shareholder value.

MicroStrategy’s Bitcoin Playbook

1. Key Considerations

The first document MicroStrategy has published as part of their open-source corporate Bitcoin strategy, is a breakdown of key high level considerations.

I. Business Strategy & Governance

• Rationale for investing in BTC

• Business and strategy narrative, which will impact customer, investor, and employee perception.

• Potential negative impacts on stock price and increased stock price volatility

• Risk of theft/fraud losses greater due to irreversibility and near-anonymity of BTC transactions

• Tax impacts

II. Risk Management

• BTC investment management policy (e.g. mitigating risk of conducting regulated activity; approval of thresholds for transactions)

• Hedging of BTC investment exposure through derivative instruments

• Insurance to protect against loss of BTC

• Treatment of BTC under the Uniform Commercial Code

III. Disclosure Matters

• Financial statement impacts

• Critical accounting policies (e.g. determination of fair value; revaluation of BTC investment)

• Discussion of impact of BTC valuation on quarterly results

• Quantitative and Qualitative Disclosures About Market Risk

• Other risk factors (e.g. regulatory, volatility, theft and fraud)

IV. Execution of BTC Investments

• Establish custody and storage solutions (i.e. engage US qualified custodian)

• Establish partnership with broker for executing BTC transactions

• Determine method(s) of BTC storage and allocation between methods (i.e. hot vs cold wallets)

• Negotiate fees

• Negotiate contractual protections and ancillary services

More detail can be found in the attached document here:

2. Accounting Treatment and Tax Considerations

Note: As of December last year FASB has issued new standards that change fair value accounting for digital assets like Bitcoin held on the balance sheets of public companies like MicroStrategy.

However, MicroStrategy did not implement the change for 2024. As such, their current accounting methodology that set out in the attached document. This will change for 2025, when they adopt the new standards.

3. Legal and Contractual Considerations

MicroStrategy has also published a list of legal and contractual considerations for prospective custodians, brokers, and payment processors.

It’s a detailed document with specific considerations for each institution type, so the best way to read it is in full:

4. Bitcoin Roadmap

Finally, MicroStrategy has published a roadmap document for any company looking to implement a corporate Bitcoin strategy.

A brief overview is below, followed by the full document attached where you can get all the details.

I. Planning Phase

• Strategy and Team

• Corporate Governance

• Finance and IT

• Vendors and Partners

II. Execution Phase

• Prepare Treasury Reserve Policy

• Prepare BTC Trading Policy

• Set up brokerage, custodial, and/or fund accounts

• Obtain insurance

• Prepare SEC disclosures

III. Post-execution Phase

• Determine amount, timing, frequency, source of funds, and method for subsequent BTC purchases

• Determine the need and method of external communications regarding subsequent BTC purchases

• Conduct subsequent BTC purchases, as appropriate

That’s the Deep Flow for this week.

I’ll see you back here next Monday.

— Julian