MicroStrategy issued convertible bonds with low interest rates and high stock conversion prices. What is the operating principle behind this?

The software development company MicroStrategy, MSTR, which focuses on Bitcoin as its core business, has issued convertible bonds for the first time in three years. The conversion price offers a premium of up to 20% compared to the current stock price. What incentives are attracting investors to subscribe to this convertible bond with a maturity of six years and a coupon rate of only 0.625%? And what is MicroStrategy's strategy?

MicroStrategy has issued $700 million in corporate bonds to invest in Bitcoin.

MicroStrategy Issues Convertible Bonds Again After Three Years

MicroStrategy announced that it will issue $700 million of 2030 Convertible Senior Notes to qualified institutional buyers in a private offering, with the following terms:

• Maturity Date: March 15, 2030
• Interest Rate: 0.625%
• Interest Payment Dates: Semi-annually on March 15 and September 15 each year
• Conversion Price: $1,498
• Conversion Period: July 1, 2024, to March 13, 2030
• Put Option: Investors can sell back the notes at par value of 100 after September 15, 2028

Convertible bonds have a clause that allows the bond to be converted into stock at a predetermined price when the stock price exceeds a certain level. The pricing principle is a combination of the company bond and the call option to buy stock.

With MicroStrategy's stock price at $1,246 on the pricing date and a conversion price of $1,498, the premium is as high as 20%. The interest rate is only 0.625%, almost negligible compared to the risk-free 4.1% yield of the U.S. ten-year Treasury bond. Why would investors be willing to purchase it?

Timing of MicroStrategy's Convertible Bond Issuance

Let's review the three convertible bonds currently issued by MicroStrategy, all with extremely low or zero coupon rates and premiums of over 20% compared to the pricing date. The list is as follows:

MicroStrategy started buying Bitcoin in September 2020. Based on this starting period, we compare MicroStrategy's stock price with the Bitcoin price as shown in the table below. The three purple arrows indicate the times when MicroStrategy issued convertible bonds. We found that the issuance timing was when MicroStrategy's stock price was significantly higher than the Bitcoin price, leading us to speculate:

Using option pricing at high stock prices can set the conversion price at a relatively high point. In a market with enthusiastic sentiment, option prices also rise. This way, funds can be obtained at almost no cost.

Considerations for Investors Buying Convertible Bonds

Why would investors spend money on a product that offers little interest and a 20% premium on the conversion price compared to the current price? If they are so bullish on MicroStrategy, why not just buy in at the current price? We analyze the reasons below:

• Low risk: Even if there is no conversion after six years, investors can still get back their principal unless MicroStrategy goes bankrupt
• Own a six-year call option: Once MicroStrategy's stock price rises above $1,498, the conversion can be executed, making the call option very cheap in the market's view
• Early redemption mechanism: The unique redemption feature of this convertible bond allows it to be sold back at par value of 100 after September 15, 2028

Investors who purchase MicroStrategy's convertible bonds likely have a strong belief in the company's stock price but are unwilling to take on too much risk, hence choosing this method to invest their funds.

Although the liquidity of these convertible bonds is uncertain, according to Bloomberg's current quote, the price of the new convertible bond is $109, still at a premium issuance! The previous 2025 Convertible Bond with a conversion price of $398 has surged to $258, demonstrating MicroStrategy's clever fundraising tactics.