(Bloomberg) — To sate his multibillion dollar rampant appetite for Bitcoin, Michael Saylor has tapped demand from retail investors transfixed by MicroStrategy Inc.’s more than 500% rally this year. He’s also benefitted from hedge funds who care far less where the stock trades.
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Calamos Advisors LLC co-Chief Investment Officer Eli Pars has been among the buyers for more than $6 billion of convertible notes sold by MicroStrategy this year to finance the purchase of his ever-expanding cryptocurrency hoard. Like many other managers, Pars uses the notes in market-neutral arbitrage bets that exploit the surging volatility of the underlying asset.
“Convertibles are a way for issuers to monetize the volatility of their stocks, and MicroStrategy is an extreme example,” said Pars, whose firm owns more than $130 million of MicroStrategy notes in both long and arbitrage strategies.
Co-founder Saylor has accumulated Bitcoin now worth around $40 billion over the past four years after deciding that the tiny enterprise software maker needed to embark on 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 split combination of equity and fixed-income securities. Since Oct. 31 alone, MicroStrategy has bought about $13.5 billion in Bitcoin and issued $3 billion in zero-interest convertible notes, the firm’s fifth bond offering this year.
Convertible Arbitrage
These low-interest, long-term notes, with more than $7 billion now outstanding, can be exchanged for equity if the stock price rises above certain levels. Hedge funds are buying them to deploy their own version of a convertible arbitrage tactic already being done elsewhere by the likes of AQR Capital Management and Man Group. It has been one of the hottest strategies on Wall Street this year.
While flavors of the tactic vary, convertible arbitrage traders generally use hedges to isolate the exchange feature of the notes and treat it as an equity option whose value is tied to the stock’s volatility. The more the stock swings, the more profitable the trade 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 with 0.6% for the S&P 500 Index.
The shares jumped 8.7% on Wednesday in New York, as Bitcoin approached a record high of almost $100,000.
Saylor touted volatility as a selling point while presenting his capital raising plan during an earnings conference call in October with investors and analysts, noting that its stock is more volatile than any member of the S&P 500. The dynamic is driven in part by the wild fluctuations of Bitcoin’s price, which has more than doubled this year. Plus, MicroStrategy traded at a more than 200% premium to the value of the Bitcoin it owns, a level that could also add to volatility.
Another appeal to Wall Street pros is the pricing of MicroStrategy’s convertible bonds, which are at relatively cheap levels that would allow them to lock in potentially juicy arbitrage profits. MicroStrategy is the largest issuer of convertible bonds this year globally.
“The trade is attractive because the implied vol of the converts is way below realized vol or option implied vol,” said Pars. Even across the convertible universe, MicroStrategy is a “very rare opportunity” especially considering the size and number of issues, 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’
Near-endless demand from price-agnostic speculators is a key leg of what some have jokingly termed Saylor’s perpetual-motion money machine, allowing MicroStrategy repeatedly to raise money, to help keep Bitcoin aloft by buying it in droves, and thereby plump the value of its shares. The danger is the possibility crypto’s massive year-long rally reverses, in which case an ever-more leveraged bet on its value could have severe consequences for its owners.
“It could be a giant house of cards that will crush many shareholders when it crashes,” said David Trainer, CEO of market research firm New Constructs LLC. “There is no fundamental benefit here. It has become a game of musical chairs, you play until the music stops and you just hope you can get out before the crash.”
MicroStrategy is selling stock through an at-the-market offering program, which allows its investment banks to create shares and sell them at market prices, with the proceeds added to its balance sheet.
“Our job is to bridge the traditional capital markets that want bonds or they want fixed income or they want equity or they want options, and we plug that into the crypto economy and we use Bitcoin to do that,” Saylor said during a Dec. 3 interview on CNBC. MicroStrategy did not respond to a request for comment from Bloomberg.
While the convertible arbitrage community is relatively shielded from the wild price swings because their positions are hedged, a key risk to their trade is the firm’s credit profile, which is tied to one of the riskiest asset classes and Saylor’s unprecedented strategy.
“If Bitcoin does correct and the premium of MicroStrategy’s Bitcoin holdings to indebtedness compresses, it will start to affect the credit of the converts,” said David Clott, portfolio manager at convertible bond specialist Wellesley Asset Management. “The trade seems like a bit asymmetric on the downside now.”
That said, as long as volatility remains high and Bitcoin trades in a reasonable price range, the arbitrage opportunity may prove to be too alluring to resist.
–With assistance from Dan Wilchins and David Marino.
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