(Bloomberg) — To feed his rampant billion-dollar appetite for Bitcoin, Michael Saylor has tapped into demand from retail investors captivated by MicroStrategy Inc.’s more than 500% rally. this year. He has also benefited from hedge funds that care much less about where the stock trades.
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Eli Pars, co-Chief Investment Officer of Calamos Advisors LLC, was among the buyers of more than $6 billion in convertible notes sold by MicroStrategy this year to finance the purchase of its ever-growing cryptocurrency treasure trove. Like many other managers, Pars uses the notes in market-neutral arbitrage bets that take advantage of the rising volatility of the underlying asset.
“Convertible bonds are a way for issuers to monetize the volatility of their stocks, and MicroStrategy is an extreme example,” says Pars, whose firm owns more than $130 million of MicroStrategy bonds in both long and arbitrage strategies.
Co-founder Saylor has amassed Bitcoin worth about $40 billion over the past four years after deciding that the small software maker needed to take a different path to survive. He accelerated the strategy shift in October by announcing plans to raise $42 billion over the next three years through an evenly distributed mix of equities and fixed income. Since October 31 alone, MicroStrategy has purchased approximately $13.5 billion worth of Bitcoin and issued $3 billion in zero-interest convertible notes, the company’s fifth bond offering this year.
These long-term, low-interest bonds, now with more than $7 billion outstanding, can be exchanged for stocks if the stock price rises above certain levels. Hedge funds are buying them up to deploy their own version of a convertible arbitrage tactic already used elsewhere by AQR Capital Management and Man Group, among others. It was one of the most popular strategies on Wall Street this year.
Although flavors of the tactic vary, convertible arbitrage traders generally use hedges to isolate the exchange feature of the notes and treat it like a stock option whose value is tied to the stock’s volatility. The more stock prices fluctuate, the more profitable trading becomes – and MicroStrategy has been nothing if not turbulent. This year, MicroStrategy has posted an average daily move of 5.2% in either direction, compared to 0.6% for the S&P 500 Index.
Shares rose 8.7% in New York on Wednesday as Bitcoin neared an all-time high of nearly $100,000.
Saylor touted volatility as a selling point when he presented his capital raising plan during an October earnings conference call with investors and analysts, noting that the stock is more volatile than any member of the S&P 500. The momentum is driven in part by the wild swings in the price of Bitcoin, which has more than doubled this year. Furthermore, MicroStrategy was trading at a premium of more than 200% to the value of the Bitcoin it owns, a level that could also increase volatility.
Another appeal to Wall Street professionals is the pricing of MicroStrategy’s convertible bonds, which are at a relatively cheap level, potentially allowing them to rake in juicy arbitrage profits. MicroStrategy is the largest issuer of convertible bonds worldwide this year.
“The trade is attractive because the implied volume of the converts is well below realized volume or implied option volume,” Pars said. Even in the convertible universe, MicroStrategy is a “very rare opportunity,” especially given its size and number of problems, he said.
In addition to Calamos Partners, top holders of MicroStrategy’s bonds include Linden Advisors, Context Capital, Graham Capital and Millennium Management, according to data compiled by Bloomberg.
‘Musical chairs’
The near-endless demand from price-agnostic speculators is a key part of what some have jokingly called Saylor’s perpetual motion money machine, allowing MicroStrategy to repeatedly raise money, help keep Bitcoin up by buying it in bulk, and thus increase the value of the currency can rise. its shares. The danger is that cryptocurrency’s massive, years-long rally may reverse, in which case ever-increasing bets on its value could have dire consequences for its owners.
“It could be a giant house of cards that will crush many shareholders if it collapses,” said David Trainer, CEO of market research firm New Constructs LLC. “There is no fundamental advantage here. It’s become a game of musical chairs, you play until the music stops and you just hope you can get out before the crash happens.
MicroStrategy sells shares through an at-the-market offering program, which allows its investment banks to create shares and sell them at market prices, with the proceeds being added to the balance sheet.
“Our job is to bridge the gap between the traditional capital markets that want bonds, or fixed income, equities or options, and we plug that into the crypto economy and we use Bitcoin to do that,” Saylor said during a meeting in December. 3 interview on CNBC. MicroStrategy did not respond to a request for comment from Bloomberg.
While the convertible arbitrage community is relatively protected from the wild price swings because their positions are hedged, a key risk to their trading is the company’s credit profile, which is tied to one of the riskiest asset classes and Saylor’s unprecedented strategy.
“If Bitcoin corrects this and MicroStrategy’s Bitcoin equity premium to debt narrows, this will start to hurt the creditworthiness of the converts,” said David Clott, portfolio manager at convertible bond specialist Wellesley Asset Management. “Trading now seems a bit asymmetrical on the downside.”
That said, as long as volatility remains high and Bitcoin trades within a reasonable price range, the arbitrage opportunity may prove too attractive to resist.
