Hedge Funds Make MicroStrategy Wall Street’s Hottest Trade

By Investor Empires On Dec 5, 2024

(Bloomberg) — To satiate his rampant, multibillion-dollar appetite for bitcoin, Michael Saylor tapped into demand from retail investors stunned by MicroStrategy Inc.’s rise. By more than 500% this year. It has also benefited from hedge funds that don’t care much where stocks trade.

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Eli Bars, co-head of investment at Calamos Advisors LLC, was among buyers of more than $6 billion in convertible securities sold by MicroStrategy this year to fund purchases of its ever-expanding cryptocurrency inventory. Like many other managers, Pars uses notes in market-neutral arbitrage bets that exploit the increased 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,” said Baars, whose firm holds more than $130 million of MicroStrategy securities in both long and arbitrage strategies.

Co-founder Saylor has amassed Bitcoin now worth about $40 billion over the past four years after deciding that the small enterprise software maker needed to embark on a different path to survive. He accelerated the strategic shift in October by announcing plans to raise $42 billion over the next three years through an evenly split mix between stocks and fixed-income securities. Since October 31 alone, MicroStrategy has bought about $13.5 billion in bitcoin and issued $3 billion in interest-free convertible bonds, the company’s fifth bond offering this year.

Transferable arbitration

These long-term, low-interest bonds, now worth more than $7 billion, can be exchanged for stocks if the stock price rises above certain levels. Hedge funds are buying them to deploy their own version of the convertible arbitrage tactic already being implemented 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 note exchange feature and treat it as a stock option whose value is tied to the stock’s volatility. The more a stock fluctuates, the more profitable the trade becomes — and MicroStrategy has been nothing if not turbulent. This year MicroStrategy posted an average daily move of 5.2% in either direction, compared to 0.6% for the S&P 500.

Shares jumped 8.7% on Wednesday in New York, as bitcoin approached a record high of about $100,000.

Saylor described volatility as a selling point while presenting his plan to raise capital during an October earnings conference call with investors and analysts, noting that his shares are more volatile than any member of the Standard & Poor’s 500. The dynamism is due in part to wild volatility. of the price of Bitcoin, which has more than doubled this year. Additionally, MicroStrategy has been trading at a premium of more than 200% to the value of the Bitcoin it holds, a level that can also increase volatility.

Another appeal for Wall Street professionals is the pricing of MicroStrategy’s convertible bonds, which are at relatively cheap levels that would allow them to capture potential arbitrage profits. MicroStrategy is the largest issuer of convertible bonds this year globally.

“The trade is attractive because the implied volume of the converter is much lower than the realized or implied volume of the option,” Baars said. Even across the convertible world, MicroStrategy is “a very rare opportunity,” especially given the size and number of issuances, he said.

In addition to Calamos Partners, top MicroStrategy bondholders are Linden Advisors, Context Capital, Graham Capital and Millennium Management, according to data compiled by Bloomberg.

“Musical chairs”

The almost endless demand from price-agnostic speculators is a key component of what some have jokingly called Saylor’s perpetual motion money machine, allowing MicroStrategy to repeatedly raise money, to help keep Bitcoin high by buying it in large numbers, thus increasing the value of Bitcoin. Currency. Its shares. The danger lies in the possibility of a reversal of the huge rise witnessed by cryptocurrencies over the course of a year, in which case increased betting on their value could have serious consequences for their owners.

“It could be a giant house of cards that will crush many shareholders when it collapses,” said David Trainer, CEO of market research firm New Constructs LLC. “There’s no fundamental benefit 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 collision.”

MicroStrategy sells shares through a put-to-market program, which allows its investment banks to create shares and sell them at market prices, with the proceeds added to its balance sheet.

“Our mission is to bridge the traditional capital markets that want bonds or want fixed income or want stocks or want options, and we bring that into the cryptocurrency economy and we use bitcoin to do that,” Saylor said during a conference 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 wild price fluctuations because its positions are hedged, the main risk to its trading is the company’s credit profile, which is linked to one of the riskiest asset classes and Saylor’s unprecedented strategy.

“If bitcoin corrects and the premium for MicroStrategy’s holdings of Bitcoin declines relative to leverage, that will start to impact the credit of converts,” said David Clute, a portfolio manager at Wellesley Asset Management, which specializes in convertible bonds. “The trade looks a bit asymmetric to the downside now.”

However, as long as volatility remains high and Bitcoin is trading in a reasonable price range, the arbitrage opportunity may be too tempting to resist.

-With assistance from Dan Wilchins and David Marino.

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