A new corporate accounting rule for crypto holdings could make the firm eligible for inclusion in the S&P 500.
Posted April 26, 2024 at 10:41 am EST.
Software firm MicroStrategy (MSTR) has been borrowing billions since August 2020 — roughly $7.53 billion so far, according to its founder and Executive Chairman Michael Saylor — to buy bitcoin (BTC) as part of its long-term investment strategy.
That approach, coupled with a new public accounting rule announced in December 2023, may end up helping the company to become eligible for inclusion in the S&P 500. That step that would likely boost MSTR’s stock price, liquidity, and prestige, as being included in the S&P 500 would require funds that track the widely-used index to purchase shares of MSTR.
But that’s only if the firm decides to adopt the new rule, a decision that will most likely be revealed in MicroStrategy’s first quarter report on April 29, according to a research document by Mark Palmer, managing director and senior research analyst at investment firm Benchmark.
MicroStrategy holds the world’s largest bitcoin corporate treasury, with 214,246 BTC worth almost $14 billion at today’s price, making MSTR an ideal proxy for investors who are unable or reluctant to hold the cryptocurrency outright.
MSTR’s status as a bitcoin proxy has allowed it to trade at a premium in the past and some analysts predicted a drop in that premium after the historic approval of eleven bitcoin spot ETFs in January. Analysts argue that low-fee, high-volume ETFs from prestigious firms such as BlackRock and Fidelity are better options.
Despite doubts about the company’s viability as a BTC alternative and concerns around the sustainability of Saylor’s investment strategy of issuing cheap debt to buy bitcoin, MicroStrategy has continued to borrow large sums of cash to bolster its BTC holdings. And now, that strategy may pay off if the company ends up in the S&P 500, assuming it adopts the new accounting rule and is approved for inclusion.
Read more: MicroStrategy Purchases 12,000 More Bitcoins for $822 Million
“The company could put itself on a path to the four straight quarters of GAAP [generally accepted accounting principles] profitability it would require to be eligible for inclusion in the S&P 500,” Palmer said.
“However, we also believe that the tax implications associated with adoption could cause MSTR to hold off on electing that option,” he added.
Saylor’s Strategy
Saylor founded MicroStrategy in 1989 as a business intelligence firm and took it public in 1998. The company began acquiring bitcoin in 2020 when it found itself with a cushy $500 million in uninvested cash and credit but no viable investment options, at a time when the U.S. Federal Reserve had essentially cut interest rates to zero.
In a corporate video published that year, Saylor explained that strong price appreciation and the convenience of being completely digital made bitcoin a much more attractive investment than traditional assets such as gold.
Read more: How Japan’s Metaplanet Successfully Ripped a Page Out of MicroStrategy’s BTC Playbook
Data from BitcoinTreasuries.com shows that MicroStrategy has made close to forty public purchases of bitcoin since 2020. The purchases are typically made every few months and average roughly $1.5 billion per year.
In 2022, Saylor handed over the CEO reins to Phong Le and took on the role of Executive Chairman.
“As Executive Chairman I will be able to focus more on our bitcoin acquisition strategy and related bitcoin advocacy initiatives, while Phong will be empowered as CEO to manage overall corporate operations,” Saylor said in a statement at the time.
Saylor’s acquisition strategy involves issuing cheap convertible bonds to fund bitcoin purchases for his firm. Convertible bonds, as the name suggests, can be exchanged for a company’s shares. The bonds are typically issued at interest rates lower than those of standard bonds because bondholders can benefit from an increase in the value of the underlying shares.
The sustainability of this approach has been questioned by some, but Palmer says MicroStrategy’s wager on bitcoin is not only sustainable, but also that it has been well-executed.
“The company’s timing for tapping the capital markets to raise proceeds for bitcoin purchases has been remarkable,” Palmer told Unchained. “We believe MicroStrategy has demonstrated that its unique strategy is sustainable, especially inasmuch as the company has taken bitcoin’s volatility into account,” he added.
Palmers said one way the firm’s strategy mitigates bitcoin’s volatility is by ensuring it has a long timeline for repaying its debt, with some of MicroStrategy’s most recent notes set to mature in 2030.
Accounting Changes
Current US accounting rules require companies to record decreases in the value of their bitcoin holdings as losses that cannot be offset by subsequent increases in the BTC price.
This gives the false impression of an unprofitable business and indeed, despite a ten-fold increase in the price of bitcoin, MicroStrategy has been forced to record $2.27 billion in cumulative losses on its crypto holdings, according to Palmer’s report.
ASU 2023-08, FASB’s new rule that goes into effect on January 1, 2025 but can be adopted early, will take MSTR’s earnings from a loss to a significant profit.
“While the Street estimates that MSTR will report a 1Q24 loss per share of $0.55 (our estimate calls for a loss per share of $0.46), we estimate that the company by electing early adoption of the standard could report a gain of more than $300 per share during the quarter,” Palmer said.
MicroStrategy already meets all other eligibility criteria for S&P 500 inclusion. The company is based in the U.S., its shares are highly liquid, at least 50% of its outstanding shares are available for public trading, and its market capitalization exceeds $18 billion. The final hurdle – demonstrating positive earnings in its most recent quarter and ensuring the sum of its earnings in the previous four quarters are positive – can finally be cleared if the firm decides to adopt the new rule come April 29.
However, the resultant capital gains could have unfavorable tax consequences, meaning MicroStrategy might continue with the status quo and not adopt the new rule. But Palmer says that wouldn’t be a prudent decision.
“After weighing the pros and cons of MSTR opting for early adoption of ASU 2023-08, we believe it would be in the best interest of the company’s shareholders if it were to announce that it has adopted the new guidance on April 29 when it reports its 1Q24 results,” Palmer said.
MSTR was trading at $1,258 at the time of reporting, up nearly 172% year-to-date.
