Greeting from the Edge,
I’m writing another short-form update this week. Many growth stocks have trended up significantly since the onset of the pandemic until recent days. Are cryptocurrencies just following this trend up or are they in a more speculative bubble? Are they a real asset or an unproven technology? Those are great questions, but they are not the focus of this update where we will focus on only one question. Why would a corporation buy bitcoin?
Background
The last 12-months have been a roller coaster ride for many small businesses, individuals, families, non-profits and corporations. But companies like Zoom, Peloton, Tesla, Square, PayPal and MicroStrategy have done well. Zoom and Peloton provide needed services while more people have worked from home during the pandemic. Square was initially negatively impacted with many small businesses and restaurants closing during the early phase of the pandemic until their digital wallet became a favored tool to receive direct payments and PPP loans and buy stocks. PayPal is another option for digital payments. During 2020 Square and PayPal also added the ability to buy, hold and sell bitcoin. Buying bitcoin for these two companies makes sense since it is now a part of their corporate strategies for transactions between their customers.
But bitcoin makes less sense for Tesla and MicroStrategy because these companies do not currently transact business in bitcoin although Elon Musk, CEO, Tesla has stated in the future they will accept bitcoin as payment towards their electric vehicles and energy services. Michael Saylor, CEO, MicroStrategy has recently stated “The Company remains focused on our two corporate strategies of growing our enterprise analytics software business and acquiring and holding bitcoin.” To understand these companies strategies you need to look a little deeper into potential corporate strategies.
Microstrategy reported as of February 24, 2021 that it held 90,531 bitcoins acquired at an aggregate purchase price of $2.171 billion and at an average purchase price of $23,985, inclusive of fees and expenses. Michael Saylor has been very vocal about his company’s bitcoin purchases. MicroStrategy only has a current revenue of $480 million, total cash balance of $60 million, and total debt of $581 million. 15.95% of shares outstanding are held as short positions. This seems to be a rather speculative cryptocurrency bet.
On February 8, Tesla said it had acquired bitcoin with a reported aggregate purchase price of $1.5 billion. Elon was negative on bitcoin when asked about it by the media until just recently. What changed? Tesla’s bitcoin holdings are now worth approximately $2.5 billion with a gain of $1 billion. But Elon’s changing opinion on bitcoin could be tied to new insights into corporate strategy. He has been leader in vertical integration, sustainable energy and autonomous navigation. Maybe he sees what we do not on bitcoin as well.
Factors impacting corporate strategies for bitcoin
Bitcoin valuation relative to USD - The aggregate value of bitcoin recently surpassed $1T with its rapid appreciation in price per bitcoin with a peak around $58,330 in late February 2021. This is highly dependent on the trust, reliability and security of bitcoin as a store of value.
Corporate Tax Treatment - the IRS treats cryptocurrencies like property on the balance sheet. If a bitcoin position loses value compared to the purchase price, the loss must be recognized as a loss on the income statement and reduces corporate taxes. If a bitcoin position increases in value, the gain must be recognized as a gain on earnings and increases corporate taxes until the original purchase price is reached. At this point, the bitcoin holding is re-established on the balance sheet and can gain without tax consequences until disposed of in the future with a capital gain.
HyperInflation - If we experience hyperinflation, real assets would increase significantly in value relative to cash. The purchasing power of cash would decay over time until hyperinflation ends. Stocks would sell off significantly due to assets moving towards lower-risk, interest-bearing investments. Bonds would sell off, too, with higher interest rates elsewhere. Bitcoin should appreciate in value if it remains a trusted asset and store of value like gold. Debt at a fixed interest rate is easier to pay off if pricing power allows revenue to increase while debt payments stay fixed. Interest rates on new debt would increase during hyperinflation.
Deflation - If we experience deflation, real assets would decrease significantly in value relative to cash. The purchasing power of cash would increase over time. Cash is king. Stocks would sell off significantly due to assets moving towards lower-risk, treasury bonds. Debt would likely get restructured through bankruptcies. The loss of pricing power reduces revenue and customers would likely postpone purchases to buy something cheaper in the future.
The probability of 2 or 3 is higher today than a year ago due to much government stimulus due to the pandemic. When stimulus loses effectiveness, debt just increases without the desire effect. At some point smart money might pursue predatory shorting strategies to take down the value of more speculative asset holdings. That could then lead more asset sales to switch to less risk-taking. If a company’s leaders are convinced the long-term prospects of the company are solid, they would want to strengthen the company along the way and take advantage of any circumstance that allow stock buy-backs, capital investments on better terms and advantaged reduction of debt.
Conclusion
During hyperinflation, a company’s bitcoin investment would increase in value without tax consequences as property on the balance sheet until sold. As the company’s stock value decreases, so does the spread between the price of bitcoin and the company stock. Debt would also become easier to pay off with appreciating bitcoin assets. Using bitcoin, a company can take advantage of an extreme condition to double down on the company.
During deflation, a company with adequate cash can leverage the negative tax consequences of a massive bitcoin loss to accelerate the selloff of the companies stock to buy back shares with cash. This also assumes they can weather a storm that will lead to significant bankruptcies. Bitcoin is less strategic here in that it just accelerates the destruction of share value in a planned maneuver, but it does play a role.
As long as bitcoin remains a sustainable and reliable technology and leverages its finite number of units to maintain value relative to fiat currencies, it becomes the perfect complement to cash to protect the long-term prospects of a company in these extreme cases of hyperinflation and deflation. During more normal and contained 2% inflation, bitcoin is just pure speculation on its future value which also looks bright.
Look for Apple to also move in the direction of bitcoin to protect its significant cash position during extreme conditions. And if it works for Tesla, Microstrategy, Square, PayPal and others, maybe bitcoin also helps retail investors hold more cash as a hedge against riskier investments into other disruptive innovations. In the extreme scenarios mentioned above, you could double down on your stock portfolio with proceeds from bitcoin sales and cash depending on the scenario.
Best,
Stephen
Nothing in this post is intended to serve as financial advice. Do your own research.