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What they’ve found has been something of a gold mine of cheap funding in the roughly $300 billion U.S. convertible-bond market by burrowing deep enough to make their presence difficult to avoid.
“There was a lot of issuance in the fourth quarter from the crypto space,” said James Dinsmore, a portfolio manager focused on convertibles at Gabelli Funds. “It doesn’t seem like that’s going to stop anytime soon.”
Despite lingering skepticism on Wall Street about bitcoin BTCUSD, convertible bonds have been busy writing a new chapter tethered to the digital asset — with the lead character being MicroStrategy Inc. MSTR, among the world’s largest corporate owners of bitcoin.
MicroStrategy’s mega $2.6 billion convertible issuance at a 0% coupon in November can be thought of as a loan with no interest. With it, MicroStrategy plans to buy more bitcoin, and to keep using convertible bonds and other financing to purchase even more of the cryptocurrency.
If MicroStrategy shares climb high enough for its convertible bonds to be eligible for exchange into equity, that makes the bonds more valuable.
A bond investor might sell those bonds before they mature and reap significant upside, particularly if a company’s stock has been doing well. The debt also can be held to maturity, when an investor receives their investment back in full, plus any upside in stock or cash.
On the flip side, if a company’s stock doesn’t work out, they can be asked to buy back their convertible bonds before they mature, making those investors whole.
Shares of MicroStrategy, a legacy software company, were up more than 600% over the last 12 months as of Tuesday, according to FactSet. This comes despite it spending more than $18 billion in the past few months to bulk up its bitcoin holdings at prices above current levels and at the expense of shareholders, as MarketWatch’s Tomi Kilgore has reported.
Even so, MicroStrategy’s roaring stock has been a major recent driver of gains for U.S. convertible bonds, with a fourth-quarter crypto frenzy helping fuel the sector’s 11.1% return last year.
That led convertibles to trounce the 0.5% return on U.S. government debt for 2024, the 8.2% yearly gain for high-yield bonds and the 10% advance for the small-cap Russell 2000 index RUT, according to BofA Global Research.
Convertible bonds traditionally have been a go-to funding source for small and midcap companies as well as promising tech names, with AI darling Nvidia Corp. NVDA and electric-vehicle giant Tesla Inc. TSLA among the notable issuers of the past decade.
“They often were [used] in a phase of building up a platform or a new drug,” said Yan Jin, lead manager in convertible bonds at Columbia Threadneedle Investments. “[Companies] were burning cash and needed to raise money, and a quick way to do that was through issuing convertibles.”
Borrowing rates typically come much cheaper than in the high-yield market, with the upside potential of a stock going to the moon designed to offset lower bond interest income. The strategy in recent years produced big ups and downs.
In 2020, convertibles returned 46% to investors, but then delivered an almost a 20% loss in 2022. The past few years, however, have seen double-digit returns.
MicroStrategy’s gamble on bitcoin adds a new layer of risk to the convertible market. Its pile of outstanding debt represent about 4% of the main U.S. benchmark convertible-bond index, while crypto-related issuers overall comprise about 7% of the total U.S. market.
Recent issuers include MARA Holdings Inc. MARA, Core Scientific Inc. CORZ and Bitdeer Technologies Group BTDR, all part of $14.3 billion of total crypto-related issuance last year, according to BofA Global data.
“We still favor things we can do some fundamental analysis on,” said Jin at Columbia Threadneedle. “When we look at leveraged bitcoin plays, we regard that as a risk factor we have to manage.”
MicroStrategy didn’t respond to requests for comment.
Convertible bonds were designed to be less risky than owning a company’s stock or bitcoin outright, because bonds rank senior in payment priority if a company does go bankrupt, whereas the worst-case scenario for the other two asset classes would be a total loss.
The value of convertibles comes from a combination of principal plus any interest payments, as well as significant upside potential with the option to convert to stock.
For long-only investors like Columbia Threadneedle’s Jin, it’s about having some downside protection in a name like MicroStrategy from the bond portion, as well as upside potential from the conversion option.
He gave the example of owning MicroStrategy’s earlier convertible bonds, issued in 2021 with zero coupon and a 50% conversion premium. While its stock has been on a wild ride since the company’s big pivot to buying bitcoin in 2020, its bonds have been offering downside protection during rough patches for the stock.
The 2021 bonds mature in 2027. Assuming the stock is unchanged from now until then, Jin said bondholders would get 6.981 shares of MicroStrategy multiplied by its current price, which has been trading well above $300 so far in January — or roughly $2,200 for every $1,000 invested in each bond.
But that isn’t the entire story. The new crop of crypto-linked convertibles also give bond investors a way to take longer-term views on the asset class, without risking a complete wipeout if it crashes.
The strategy could gain more appeal with individual investors — with exchange-traded funds looking to get into the action, including an actively managed strategy called REX Bitcoin Corporate Treasury Convertible Bond ETF. It seeks to earn a total return by investing in convertible bonds issued by companies that hold bitcoin in their corporate treasury account.
Bitcoin has been prone to violent price swings along its path from a novel idea in 2008 for payments to becoming the world’s largest cryptocurrency.
Hopes for a more crypto-friendly regulatory environment under the second Trump administration helped push bitcoin above $100,000 in December for the first time in history.
Yet bitcoin briefly fell below $90,000 on Monday, raising alarms that another bear market could lurk on the horizon. Stocks and other risk assets have come under pressure from a surge in longer Treasury yields BX:TMUBMUSD10Y that lifted the 30-year yield BX:TMUBMUSD30Y recently to the 5% threshold.
Fears that Trump’s agenda could rekindle inflation and prevent the Federal Reserve from cutting rates much more in 2025 have been working against stocks SPX DJIA COMP, bond prices and crypto assets.
While MicroStrategy holds about 2.2% of bitcoin outstanding, its three-year plan to buy more while issuing $21 billion of equity and another $21 billion in debt won’t necessarily mean it has a big enough footprint to act as an anchor investor.
Jin at Columbia Threadneedle said bitcoin definitely affects MicroStrategy, but not vice versa.
Dinsmore at Gabelli Funds said bitcoin itself wouldn’t be something he would rush to invest in outside of a convertible-bond format. But he also isn’t worried about bitcoin and issuers of convertible bonds if the crypto’s price surges to $200,000.
“If bitcoin goes to $20,000, we are having a much different conversation, including if issuers are able to repay their bonds,” he said.
“I keep telling people this is going to be a Harvard Business School case study,” Dinsmore said. “One way or the other, we are going to see this coming to an interesting end.”
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