Lots More with Matt Levine on MicroStrategy's Infinite Money Machine

Summary

Odd Lots - Lots More with Matt Levine on MicroStrategy's Infinite Money Machine
Release Date: January 31, 2025

Hosts: Joe Weisenthal and Tracy Alloway
Guest: Matt Levine, Author of the Money Stuff column and Co-host of the Money Stuff podcast

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Introduction

In this episode of Odd Lots, Joe Weisenthal and Tracy Alloway welcome Matt Levine to delve deep into the intriguing financial mechanics behind MicroStrategy's strategy, aptly dubbed the "Infinite Money Machine." The conversation explores how MicroStrategy leverages its Bitcoin holdings and convertible bonds to sustain an ever-increasing market valuation, effectively creating a perpetual motion machine in the financial world.

MicroStrategy's Perpetual Motion Machine

Discussion Highlights:

• Matt Levine explains MicroStrategy's unique approach: the company holds a substantial reserve of Bitcoin and issues stock at a valuation approximately twice the value of its Bitcoin holdings. This discrepancy creates a continuous cycle where the company sells more stock to purchase additional Bitcoin, driving up its market capitalization indefinitely.

  "MicroStrategy is a pot of bitcoins that issues stock and the stock trades at, call it, two times the value of the pot of bitcoins. And so if you have that situation, you sell more stock to buy bitcoins because, classically, that's an arbitrage and you close the arbitrage, right?"
  — Matt Levine [03:07]

• Joe Weisenthal probes the sustainability of this model, questioning how MicroStrategy manages to maintain a stock price that significantly exceeds the value of its Bitcoin assets.

  "And so they keep getting more and more valuable."
  — Unknown Speaker 1 [03:55]

Convertible Bonds and Arbitrage Strategies

Convertible Arbitrage Explained:

• Matt Levine delves into convertible bonds, clarifying their role in MicroStrategy's strategy. Convertible bonds allow investors to benefit from the company's stock volatility without directly investing in Bitcoin. These bonds have a conversion premium (e.g., 55%) and are zero-coupon, making them attractive to certain investors despite seeming unattractive metrics at first glance.

  "A convertible arbitrage strategy is like an options trading strategy. Like you're buying call options on MicroStrategy and call options are more valuable the more volatile the company is."
  — Matt Levine [05:47]

• Tracy Alloway highlights the appeal of these bonds to fixed income investors seeking Bitcoin exposure without altering their investment mandates.

  "This is a way to get Bitcoin upside with downside protection."
  — Unknown Speaker 2 [05:37]

The Mechanics of the Infinite Money Loop

Sustaining Valuation Through Volatility:

• Matt Levine elaborates on how convertible bonds contribute to the company's persistent high valuation. By issuing these bonds, MicroStrategy effectively sells volatility to investors, which in turn dampens the stock's volatility due to the hedging activities of convertible bond investors.

  "Selling lots of volatility is very helpful to them... the levered ETF is like jacking up the volatility, which is part of why the stock is so volatile."
  — Matt Levine [08:07]

• The interplay between convertible bonds and levered ETFs creates a unique dynamic where the company's stock remains highly volatile yet perpetually overvalued relative to its Bitcoin holdings.

Risks and Market Implications

Sustainability Concerns:

• Joe Weisenthal raises questions about the long-term viability of MicroStrategy's model, especially considering the historical volatility of Bitcoin.

  "A big crash in Bitcoin would be really bad. Right. And that's very possible because it's crashed many times in its history."
  — Unknown Speaker 1 [09:12]

• Matt Levine acknowledges the precarious nature of the premium MicroStrategy's stock holds over its Bitcoin assets, highlighting the uncertainty surrounding future Bitcoin performance and its impact on the company's valuation.

  "The thing that I don't understand is the premium of the stock, the volatility. Like, yeah, like, that works, right? The volatility trade is a good trade. The stock. Like, why is the stock worth twice the value of the underlying Bitcoins?"
  — Matt Levine [09:00]

Comparisons and Future Outlook

Potential Replications and Market Trends:

• The hosts discuss whether MicroStrategy's strategy can be replicated by other companies or within different asset classes. Matt Levine references humorous examples like "fartcoin" but emphasizes the unique position of a real corporation like MicroStrategy.

  "One thing that's attractive about MicroStrategy, they're trying to get into the S&P 500, which is fascinating. That turns on a change in the accounting rules that allow for them to account for their bitcoin gains as profits."
  — Matt Levine [12:20]

• The conversation also touches on other companies, such as Mara Holdings, which are considering similar convertible strategies to tap into Bitcoin's volatility, raising questions about the emergence of new asset classes centered around cryptocurrency-based financial instruments.

  "They're really thoughtful about it. And selling lots of volatility is very helpful to them."
  — Matt Levine [08:07]

Conclusion and Final Thoughts

Sustainability and Market Dynamics:

• The episode concludes with reflections on the sustainability of MicroStrategy's model and its broader implications for financial markets. Matt Levine and the hosts acknowledge the innovative yet risky nature of creating a perpetual motion machine through financial engineering, leaving listeners to ponder the future trajectory of such strategies in an ever-evolving economic landscape.

  "No one's like at this scale but like a lot of companies have looked at this and said we should do that."
  — Matt Levine [11:53]

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Notable Quotes:

• Matt Levine [03:07]: "MicroStrategy is a pot of bitcoins that issues stock and the stock trades at, call it, two times the value of the pot of bitcoins."
• Unknown Speaker 1 [05:45]: "Need you to explain convertible arbitrage to me."
• Matt Levine [08:07]: "Selling lots of volatility is very helpful to them... the levered ETF is like jacking up the volatility."

Timestamps Referenced:

• [03:07] – Explanation of MicroStrategy’s Stock and Bitcoin Valuation
• [05:37] – Appeal of Convertible Bonds
• [05:47] – Convertible Arbitrage Strategy
• [08:07] – Impact of Convertible Bonds and Levered ETFs
• [09:00] – Sustainability Concerns of the Business Model
• [12:20] – Accounting Rules and S&P 500 Inclusion

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This episode provides a comprehensive analysis of MicroStrategy's financial strategies, offering listeners a nuanced understanding of how innovative (and speculative) financial mechanisms can create seemingly infinite value underpinned by volatile assets like Bitcoin. Matt Levine's expert insights, combined with the hosts' probing questions, make for an engaging and informative discussion for anyone interested in the intersections of technology, finance, and market dynamics.

Transcript

[Unknown Speaker 1]

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So I went to write one of our.

[Matt Levine]

Thanks for having me.

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I did a dead list.

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I am both the most popular trader and most successful trader at Citadel. Feta's going, uh, barges.

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We do have the perfect guest.

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You're listening to Lots More where we catch up with friends about what's going on right now.

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Because even when the odd lots is over, there's always lots more.

[Unknown Speaker 2]

And we really do have the perfect guest. So I went to write one of our Odd Lots newsletters recently, and I was going to write about MicroStrategy. And I had this idea. I was going to call it MicroStrategy's infinite money loop. And then I was researching on the terminal, and I stumbled on a bunch of Matt Levine columns where you actually titled it Crypto's Perpetual Motion Machine. And then I thought, well, I'm not even going to try to compete with Matt. I'm just gonna ask him to come on the show and explain his name.

[Unknown Speaker 1]

Many such cases, Many such cases. But at least he'll come on the podcast.

[Unknown Speaker 2]

So here we are with Matt Levine, who is of Course, the author of the Money Stuff column, but also the co host of the new Money Stuff podcast.

[Matt Levine]

Sounds that new. It's pretty new year old. I know. I keep thinking it's two months old, but it's almost a year. Yeah, it's like, wow, that's how it flies.

[Unknown Speaker 1]

I always think 2020 was two years ago.

[Matt Levine]

Same, same, same.

[Unknown Speaker 2]

Yeah. Time is a flat circle. Matt, what is MicroStrategy's perpetual motion machine?

[Matt Levine]

Microstrategy, I keep saying perpetual motion machine. I think I'm kidding. I think I'm kidding. I keep hoping that I'm kidding. So MicroStrategy is a pot of bitcoins that issues stock and the stock trades at call it two times the value of the pot of bitcoins. And so if you have that situation, you sell more stock to buy bitcoins because like classically that's an arbitrage and you close the arbitrage, right? You sell stock, that brings down the price of your stock. You buy bitcoins, that brings up the price of bitcoin. Eventually you get to the point where your stock and the value of the underlying bitcoins is the same. MicroStrategy, it never gets any closer. So they keep selling more stock and buying more bitcoins and it keeps driving the value of the company up. And so they keep getting more and more valuable.

[Unknown Speaker 1]

They have an asset, so to speak, that's not bitcoin. And that asset is the ability to get like non margin callable leverage, right?

[Matt Levine]

So I mean like, like if I.

[Unknown Speaker 1]

Wanted to borrow bitcoin or borrow money to buy bitcoin, I could. But there is a chance that bitcoin goes down tomorrow. They ask for my money back and I'm homeless.

[Matt Levine]

So this is a thing that they say and that has some truth to it, but this is not a levered way to buy bitcoin. And the way you know that is that the market cap of the company is 2x the value of its bitcoins, right? So it's like a, it's like an anti leverage way to buy bitcoin, right? Like if you put $2 into MicroStrategy you get back $1 of Bitcoin, which is the opposite of leverage. Now it's true that like, and they do, and by the way also like they do have the ability to like, they're right. Like they've sort of touted this as their strategy. Like we are mousetrap for buying bitcoin because you can get leverage. They do a lot of convertible bonds. I Don't think have a ton of just sort of regular non marginal leverage other than the converts. But yeah, that's a theoretical case. It's just like, it's just not true. As a matter of pricing, Wait.

[Unknown Speaker 2]

The convertible bonds are actually what initially caught my eye because I think they issued at one of the recent ones, 0% with a conversion premium of 55%. And that's already when the stock is trading at this massive premium to the value of its assets. And so usually the higher the conversion premium and the lower the coupon, the less attractive that would be for investors. But clearly people are buying this stuff because they keep doing it.

[Matt Levine]

Yeah, a convert is just like a convert, you just plug into a model. Sorry, taking a step back, I actually.

[Unknown Speaker 2]

Need you to explain convertible arbitrage to me.

[Matt Levine]

So there's two things here. There's convertible arbitrage, but there's also a lot of fundamental investors. You think about the MicroStrategy convertible, nevermind convertible arbitrage. There are people in the world who run, I don't know, fixed income funds, who run convertible fundamental funds, who run various sorts of funds who wake up in the morning thinking, I want to buy some Bitcoin. And they can't because their mandate doesn't include Bitcoin. It might not even include MicroStrategy stock. Or MicroStrategy stock might be too rich for them, but they can buy a fixed income product that has some Bitcoin upside. They're like, yeah, that's great, right? So part of the investment thesis for these bonds and there's like a lot of these bonds is something like that. It's like this is a way to get Bitcoin upside with downside protection. But the convert arbitrage strategy is this is the way to get MicroStrategy volatility. And MicroStrategy is so volatile in part because it's crazy, but in part because of like technical factors involving their ETFs. And so a convert arbit is just an options trading strategy. Like you're buying call options on MicroStrategy and call options are more valuable, the more volatile the company is, more volatile the stock is. And this is a very, has like 100% annualized volatility. What you're doing is you buy a convertible, you sell some stock to hedge and you adjust your hedge over time as the convertible gets more or less in the money. And the way you do that is basically every time the stock goes up, you're selling more stock to get shorter. And every time the Stock goes down, you buy back stock to. To reduce your hedge. And if the stock is constantly bouncing around, you're constantly buying low and selling high and making a lot of money. So it's a good volatility trade. And those convertible terms, it's like zeros up. 55 is like, that sounds outrageous. But you plug it into the model and you put in 100% volatility. And that's cheap, and so people want to buy it.

[Unknown Speaker 2]

Joe, I didn't realize this until recently, but if you go and look at some of MicroStrategy's earning presentations for Q1.

[Unknown Speaker 1]

Q4, I should check that. I should check those out.

[Unknown Speaker 2]

They actually have slides on there that are basically like. Like boasting about how volatile the stock is. Have you seen these, Matt?

[Matt Levine]

I think so, yeah.

[Unknown Speaker 2]

Yeah. It's like MSTR is more volatile than any other s and P500 stock. There's another one they're marketing to convert investors. Yeah, they're clearly marketing the volatility as a selling point.

[Matt Levine]

They know what they're doing.

[Unknown Speaker 1]

This is important.

[Matt Levine]

This is like they're sort of using every part of this strategy to raise money, which is they're really thoughtful about it. And selling lots of volatility is very helpful to them. And the point about the ETFs, like, converted investor buys low, sells high. Every time the stock goes down, you have to buy back some stock. Every time the stock goes up, you have to sell some stock. You're profiting from volatility, but you're also dampening volatility, because when the stock goes down, you're buying. So if you issue a lot of convertibles, you dampen the volatility in your stock. MicroStrategy doesn't have this problem because they also have these levered ETFs, which so much increase the volatility of the stock. Because a levered etf, every time the stock goes up, they have to buy more stock. Every time the stock goes down, they have to sell stock. And so the levered ETF is like jacking up the volatility, which is part of why the stock is so volatile.

[Unknown Speaker 1]

So it is a perpetual motion machine. It's solid. No, I don't care.

[Matt Levine]

The thing that I don't understand is the premium of the stock, the volatility. Like, yeah, like, that works, right? The volatility trade is a good trade. The stock. Like, why is the stock worth twice the value of the underlying Bitcoins?

[Unknown Speaker 1]

Yeah, that's weird. A big crash in Bitcoin would be really bad. Right. And that's very possible because it's crashed many times in its history.

[Matt Levine]

Yeah, you know, like your guess is as good as mine about like what that does to the premium. Like if Bitcoin goes down by 50%, does this stock go down by 50% because it go down by 90%, who knows?

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[Unknown Speaker 2]

Could I start my own perpetual money making machine where I just have a pot of something and then I try to make my stock as volatile as possible. Like maybe I just say stuff on the Internet constantly.

[Matt Levine]

Please do it like companies are trying. No one's like at this scale but like a lot of companies have looked at this and said we should do that. And so some of them just do it. Some of them do it like dogecoin, you know, like you can have other.

[Unknown Speaker 1]

Who is. There's like random like kind of questions.

[Matt Levine]

Yeah, yeah. I wrote about a half joking crypto thing that's doing it called, you know, there's like a crypto called fartcoin and.

[Unknown Speaker 1]

There'S a fart coin strategy, right?

[Matt Levine]

Yeah. But it's not a company, right?

[Unknown Speaker 1]

Oh, yeah. So this can be replicated on chain. So yeah, sure.

[Matt Levine]

Yeah, yeah. Well, it can. The mechanics can be replicated. Can the premium be replicated on chain? I don't know. I mean you can sort of sell anything. But I think part of the premium here comes from it being a real corporation. One thing that's attractive about MicroStrategy, they're trying to get into the S&P 500, which is a fascinating. That turns on a change in the accounting rules that allow for them to account for their bitcoin gains as profits.

[Unknown Speaker 1]

I didn't know that.

[Matt Levine]

Yeah, they may not get into the S and P anyway, but they've not been profitable enough to get into the S and P. But the bitcoin gains, they have had bitcoin gains most of the time and that will become accounting profit for them.

[Unknown Speaker 1]

I want to ask a question that touches on one of Tracy's favorite topics and it's actually a little bit adjacent here. What would be the problem of just having an index that's just these are the 500 biggest companies. What's better about having an S and P that sometimes has some discretion versus just like here are the 500 biggest companies in the world, in the US whatever.

[Matt Levine]

In this immediate case, like, what is a company? Like, is spy a company?

[Unknown Speaker 1]

Oh, interesting.

[Matt Levine]

Because like this is. This is an etf, right? I mean, like arguably this is an etf, right. It's in the trappings of a, of a tech company. But like if you said the biggest company as well, you know, like is an S&P 500 fund. Yeah, a company. But away from that. No, I mean like people definitely have very rule driven indices. I think part of the appeal of the S and P is, you know, it's a product that's sold to fund managers. Right. And like if, if every fund manager says I don't want to own, you know, for a while the S and P was. Or for a while a lot of indexes were excluding dual class stocks because like fund managers would call the index providers and say, we don't want to own dual class stocks. We're bound to buy the index. So take them out of the index. And then like they changed their mind because all the dual class stocks were doing well and so they had to put them back in index. But it's, it's just like, it's just a market driven thing, right? Like if people want a certain index, they get that index. There's nothing wrong with having the top 500 companies be the index.

[Unknown Speaker 2]

Like nowadays everyone has started custom indexing as well. Right. So like if you don't like the s and P500, you can just ask for your own index. And that's why there's a billion indexes. Now the other thing I saw was there was a bitcoin miner, I think it was called Mara or something, Mara Holdings. And they said they were going to issue converts basically to do the same thing as Microstrategy. So it's almost like is this going to be like an asset class? A thing that stays with us?

[Matt Levine]

Yeah. You know the people in the convert market talk about being saturated with, with like crypto converts. Right. Like if you like grew up as a convert investor, like you like suddenly you're my portfolio in crypto. Right. In part because like you think about like the volatility and like the, the technical aspect of making money on the, on trading the volatility that depends on the credit being good. And no one really knows the credit here. Right. If there's a big crypto crash, all of these credits in a very correlated way become terrible and so your whole asset class falls apart.

[Unknown Speaker 1]

Prior to all this, what was the canonical use case of who and why issue converts?

[Unknown Speaker 2]

Oh, I seem to remember energy companies.

[Matt Levine]

Energy did a lot. I mean the canonical case is like tech, biotech, but a lot of energy too. It's like companies that are volatile, companies that often don't want to get credit ratings, companies that what you're selling is in some sense equity upside and in some other sense equity volatility and that's more attractive to convert. There are companies that have attractive equity volatility and not such attractive credit to traditional credit investors. And so they can do that trade rather than issuing bonds.

[Unknown Speaker 1]

You have a deep SEQ take?

[Unknown Speaker 2]

Oh yeah, deep sea.

[Matt Levine]

Yeah, I have various takes. My main take was I wrote today like your old take. I saw mine about, you know, the way to monetize Deepseek was short and video.

[Unknown Speaker 2]

It's just like all three of us.

[Unknown Speaker 1]

We'Re all complimenting each other. I would say my old blog@the stalwart.com in like 2000. This was when. You know what I thought about this. When Google introduced Sheets or when they came out with their Excel competitor, I was like, some companies should start doing this when they short Microsoft. For some reason, Sheets never really took off and became an Excel competitor on a real level. But back when there was so much free Web 2.0 software, I thought, give out free software and short your competitor anyway.

[Matt Levine]

Yeah, I mean, there's no evidence that Deep SEQ did it, but it'd be cool if they did.

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Lots More is produced by Carmen Rodriguez and Dashiell Bennett with help from Moses Andam and Cale Brooks.

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