In the cryptocurrency market, MicroStrategy's investment strategy has drawn significant attention. This company, originally focused on business intelligence software, has become Wall Street's focal point due to its bold Bitcoin investment strategy. What makes MicroStrategy's stock performance so distinctive? What's the investment logic behind it? Let's delve into the reasons behind this company's stock price fluctuations and potential risks.
What are Davis Double Play and Double Kill?
In the investment field, there are two interesting phenomena called "Davis Double Play" and "Davis Double Kill," both proposed by renowned investor Clifton Davis. Let me explain these concepts in simple terms.
Imagine when a company performs exceptionally well, its stock price often gets driven by two positive factors. First is the company's improved profitability, such as strong product sales or successful cost control, all of which increase company profits. Meanwhile, because of this excellent performance, investors become more confident in the company's future and are willing to pay higher prices for its stock. This creates a virtuous cycle: good company performance leads to higher valuations from investors, causing stock prices to rise acceleratingly. This phenomenon is called "Davis Double Play." For example, if a company currently earns $10 per share and the market gives it a 15x multiple, the stock price would be $150. If company performance improves by 10%, earning $11 per share, and simultaneously due to excellent performance, the market gives it an 18x multiple, the new stock price would rise to $198. This price increase includes both improved performance and higher market valuation factors.
Conversely, "Davis Double Kill" is the opposite process. When a company encounters operational issues, such as poor product sales or rising costs, leading to decreased profitability, investors begin to worry about the company's future. At this time, not only is company profit declining, but investor confidence also wavers, unwilling to maintain high valuations. Using the previous example, if company performance declines by 20%, earning only $8 per share, and simultaneously due to lost market confidence, the valuation drops from 15x to 12x, the stock price would fall to $96. This double impact often causes stock prices to fall rapidly.
MSTR's Core Business Model
Understanding the concept of "Davis Double Play," let's examine why MicroStrategy's stock is so popular, with its total stock value even exceeding the value of its Bitcoin holdings.
The company made a bold transformation: from a traditional software company to one that primarily makes money by borrowing to buy Bitcoin. Their main revenue source comes from raising funds through issuing new stocks or bonds, then using these funds to purchase Bitcoin and profit from its appreciation. At first glance, this seems no different from a Bitcoin ETF.
However, MicroStrategy's true distinction lies in the leverage effect created by its financing capability. Let's calculate with specific numbers: assume the company currently holds $40 billion worth of Bitcoin, has issued X shares of stock, and has a total market value of Y dollars. Thus, each share's equity equals $40 billion divided by X. If the company now wants to raise funds by issuing new shares at a ratio of 'a', the total shares would become (1+a) times the original, or X×(1+a). At current stock prices, this would raise a×Y dollars.
After using these newly raised funds to buy Bitcoin, the company's Bitcoin holdings would increase from $40 billion to ($40 billion + a×Y). Thus, the new equity per share becomes ($40 billion + a×Y)÷[X×(1+a)]. To determine if this financing benefits shareholders, we calculate the difference between new and old equity per share: [($40 billion + a×Y)÷(X×(1+a))] - ($40 billion÷X).
This calculation reveals an interesting phenomenon: as long as the company's market value Y exceeds its Bitcoin holdings value ($40 billion), meaning there's a "positive premium," each financing round to purchase Bitcoin will inevitably increase per-share equity. Moreover, the larger the positive premium, the greater the equity growth, showing a proportional relationship. As for the impact of issuance ratio 'a', smaller issuance ratios actually lead to greater equity growth.
This explains why company leader Michael Saylor places such importance on maintaining the stock's "positive premium" status. As long as this status is maintained, each financing round to buy Bitcoin creates more value for shareholders. This further strengthens investor confidence, encouraging them to maintain high valuations, creating a virtuous cycle. Additionally, as Bitcoin holdings increase, the company's influence in the Bitcoin market strengthens, further reinforcing investor confidence.
Industry Risks of MSTR's Model
Let's discuss the potential risks that MicroStrategy's business model poses to the industry. The primary risk lies in how it acts as an "amplifier," intensifying Bitcoin price volatility. To understand this, we need to examine what happens when Bitcoin enters a high-level consolidation period.
When Bitcoin's price growth slows and enters a consolidation phase, MicroStrategy's profits inevitably become affected. It's worth noting that while many people focus on MicroStrategy's Bitcoin cost basis and floating profits, these aren't the most crucial factors. This is because MicroStrategy's business model is unique: its profit status is completely transparent, as both its Bitcoin holdings and Bitcoin market prices are real-time public information. Unlike traditional companies where true profits are only confirmed through quarterly reports, MicroStrategy's profit levels can be calculated in real-time, and stock prices reflect this information immediately.
So how does the "Davis Double Kill" effect manifest in this situation? When Bitcoin enters a consolidation period, MicroStrategy's profits begin to decline, potentially even resulting in losses, as the company still needs to pay operational and financing costs. This situation erodes market confidence in Bitcoin's future prospects and raises doubts about MicroStrategy's future financing ability. These two factors combined lead the market to withdraw its high valuation, causing the company's stock premium relative to its Bitcoin holdings to rapidly contract. To maintain his business model, founder Michael Saylor must protect this premium status. This means he might have to sell Bitcoin to buyback company stock. Some might ask, why not simply hold Bitcoin and let the stock price naturally fall? The answer is that this approach is too risky, especially when Bitcoin prices show a downward trend.
This relates to MicroStrategy's shareholding structure. Although Michael Saylor maintains control through a special share structure (Class B shares having 10 times the voting rights of Class A shares), his actual shareholding is less than 10%. Major shareholders include top financial institutions like Jane Street and BlackRock. This means for Saylor, maintaining the company's long-term value is more important than simply holding Bitcoin, because even in liquidation, his Bitcoin share would be limited.
During market panic, if the company's stock shows significant discount, selling some Bitcoin to buyback stock might be wise. This is because the increase in per-share equity from reducing float might exceed the decrease from selling Bitcoin. Especially when market sentiment recovers, this operation could provide greater development space for the company.
However, the problem is that given MicroStrategy's large Bitcoin holdings, once they start selling, it could accelerate Bitcoin's price decline. Bitcoin's price decline would further hurt market confidence in the company, leading to continued premium contraction, creating a vicious cycle. This is a typical "Davis Double Kill" effect.
More importantly, the institutional investors behind the company are powerful financial giants who won't remain passive while watching the stock price collapse. They will inevitably pressure management to maintain stock prices. Moreover, with continuous equity dilution, Saylor's voting rights might have fallen below 50%, forcing him to pay more attention to these institutional investors' demands.
Conclusion
Through our deep analysis of MicroStrategy's business model, we can better understand this company's unique role in the cryptocurrency market. First, we learned about the important concepts of "Davis Double Play" and "Davis Double Kill." Simply put, when a company's performance improves while simultaneously receiving higher market valuations, stock prices accelerate upward - that's the "Double Play"; conversely, when performance declines coupled with loss of market confidence, stock prices accelerate downward - that's the "Double Kill."
MicroStrategy designed its unique business model based on this mechanism. The company continuously raises funds to purchase Bitcoin, using market premiums to expand its operations. When Bitcoin prices rise, this model works well: Bitcoin appreciation brings basic returns, while the company's financing ability amplifies these returns through leverage, creating a typical "Davis Double Play" effect. More importantly, as long as the market maintains a premium on the company relative to its Bitcoin holdings value, the company can continue to expand through financing, creating more value for shareholders.
However, this business model also brings potential systemic risks. When Bitcoin prices enter a consolidation period or decline, the situation becomes complicated. Because the company's profit status is completely transparent and markets can calculate its value in real-time, the stock price becomes particularly sensitive to Bitcoin price fluctuations. If Bitcoin prices fall, the company might be forced to sell Bitcoin to maintain stock prices, which in turn could further accelerate Bitcoin's decline, creating a "Davis Double Kill" effect.
Particularly noteworthy is the company's shareholding structure. Although Michael Saylor maintains control through a special share structure, his actual shareholding percentage is low, while major shareholders are financial giants like BlackRock. This means during severe market fluctuations, the company might be forced to take short-term actions to maintain stock prices, which could further amplify market volatility.
In conclusion, MicroStrategy's case demonstrates the dual nature of financial innovation. During upward cycles, it can amplify returns through leverage effects, creating considerable wealth; but during market adjustments, the same mechanism can amplify risks and even affect the stability of the entire cryptocurrency market. This reminds us that while focusing on the benefits of innovation, we must also be vigilant about potential systemic risks it may bring.
