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Source:BitMEX Research;Compiled by: Bitchain Vision
Key points of this article
We analyze Stretch ($STRC), an extremely novel MSTR (Strategy) debt instrument designed to maintain price stability by adjusting the dividend rate monthly based on the bond market price.Therefore, the product is promoted as low-risk and compared to short-term U.S. Treasury bonds.This is yet another attempt by Mr. Michael Saylor to hack into the financial system, and its purpose is still to accumulate more Bitcoins.We read the SEC filing and it is our understanding that MSTR could abandon the price stability target and reduce the dividend by up to 25 basis points per month, meaning the dividend rate could fall to zero in a little over three years.Therefore, we believe that this product is positive for MSTR and from an investment perspective, its risk is much higher than short-term Treasury bonds.
Overview
In November 2024, we published an article about MSTR titled “We worked out the math behind Ponzi schemes“.
This method is relatively simple and only focuses on the stock itself.In addition to stocks, MSTR offers a range of other financial products for investors to choose from.In particular, the company has launched a relatively new series of senior perpetual bonds:
This article will focus on what we consider to be the most interesting of the four products – STRC.In particular, following our November 2024 article,STRC is the product we receive the most questions about.For example:What happens when the music stops and new money flowing into MSTR dries up?How will MSTR pay STRC’s dividends at that time?Will MSTR be forced to sell Bitcoin?Is STRC a Ponzi scheme?In light of these issues, we decided to write this short article outlining our basic views on STRC.
What is STRC?
STRC is promoted as the lowest risk segment of the MSTR family of investment products.In fact, its risk is low enough to be comparable to U.S. Treasuries or stablecoins.However, its yield is much higher than these low-risk alternatives.The chart below is from MSTR’s recent investor presentation, where STRC is compared to “Treasury Credit.”
Source:Strategy document
The price of STRC has recently increased to a face value of $100.This shows that it has achieved some success and the price is relatively stable.
How is the interest rate determined?
STRC appears to be targeting a trading price around $100.Dividends are generally paid monthly and the amount may be adjusted at the company’s discretion.The idea is that if STRC trades below $100, dividend payments can be increased, pushing the price of MSTR higher.Conversely, if STRC trades above $100, the dividend could be reduced, which should theoretically bring the price back down to around $100.Therefore, the instrument should be very stable, always trading around $100.This makes STRC a cash-like instrument and an alternative investment option to short-term Treasury bills.A key difference with Treasury bonds is that the funds raised by issuing STRC are used to purchase Bitcoin.This is yet another attempt to hack into the financial system in order to buy more Bitcoin.
As far as we know,STRC is a completely new product.There are currently no other similar debt instruments on the market.Debt instruments typically have fixed or floating coupons, with interest rates that change based on other interest rates in the economy, such as the federal funds rate.We are not aware of any other debt instrument that adjusts interest rates to maintain stability in its market price.MSTR appears to have been buoyed by their previous success in exploiting a vulnerability in the financial system—selling its own stock at a premium to buy Bitcoin—and they have come up with an even more brazen trick: issuing bonds to buy Bitcoin.Thanks to some novel trick, the bonds appear to have the same risks as short-term Treasuries.
At first glance, this new model of debt issuance may seem unsustainable for the company.If a company has a fixed coupon, its liabilities will not change even if it gets into trouble.However, if a company adopts a floating coupon, which is floated to maintain debt price stability, then once the company gets into trouble and credit risk increases, the coupon payment will need to be increased to maintain debt price stability.This means that as a company encounters difficulties, its liabilities increase.As a result, a company can become trapped in a vicious cycle, with its credit rating declining until it goes bankrupt.So, these new tools may exacerbate corporate instability.Taking MSTR as an example, a drop in the price of Bitcoin may lead to a drop in the value of STRC, which in turn increases MSTR’s monthly payment liabilities, ultimately leading to a vicious cycle.
What are the interest rate rules?
Given the above mechanism, it is worth paying attention to the setting rules for monthly dividend payments, not just the target of STRC share price stability.In particular, we need to pay attention to the rules related to the reduction of coupon rates.The rules are detailed below, but may be difficult to understand due to the obscure wording.
However, we may not reduce the annual monthly periodic dividend rate applicable to any periodic dividend period: (i) by more than: (1) 25 basis points; and (2) (x) the sum of (x) the lowest value of the annual monthly SOFR rate (as defined in this prospectus supplement) on the first business day of the preceding periodic dividend period, if any, and (y) the lowest value of the annual monthly SOFR rate on each business day between the first business day and the last business day of the preceding periodic dividend period; oror (ii) decrease to a level below the annual monthly SOFR rate in effect on the business day immediately preceding our next periodic dividend rate notice.
Source:SEC
Note: SOFR is the U.S. market-based overnight interest rate benchmark.It was set up to replace LIBOR, which was more susceptible to manipulation by certain banks.
Our understanding of the foregoing is that MSTR has the right, at its sole discretion, to reduce the dividend rate by up to 25 basis points per month, regardless of other circumstances.Regardless of STRC’s share price or overall market conditions, the dividend yield can be reduced by 25 basis points per month.This equates to 300 basis points or 3 percentage points per year.Therefore, based on the current dividend yield of 10%, it would take three years and four months to reduce the dividend yield to zero, subject to the maximum reduction allowed.In some cases, companies can lower their dividend rates more quickly each month if market interest rates in the overall economy are also falling.For example, if overnight market rates fall by 100 basis points in a month (from the beginning of the month to the end of the month), then STRC’s dividend rate may fall by 100 basis points + 25 basis points = 125 basis points in any month.It seems reasonable that if the base rate falls then the STRC should be able to adjust.
If MSTR fails to pay declared dividends, there are complex consequences.In this case, unpaid dividends will continue to accumulate.Our understanding is that MSTR cannot pay dividends on “any class or series of dividend-parity stocks” until all unpaid cumulative dividends have been paid, unless it also pays STRC dividends and the proportion of STRC dividends to the cumulative unpaid dividends is no less than the same proportion of other dividend-paying stock classes.That is, the higher the cumulative unpaid dividends, the more difficult it is to pay significant dividends on other classes of stocks.So if MSTR starts accumulating STRC’s unpaid dividends, it becomes more difficult to pay dividends on any other stock.However,There is still no guarantee or bankruptcy risk of any kind, and it is entirely possible not to pay dividends to STRC holders if the company does not want to pay.
Is STRC a Ponzi scheme?
Now that we understand how STRC works, we can explore whether it has any similarities to a Ponzi scheme.Of course, it is not strictly a Ponzi scheme because it is not based on lies or fraud.However, if a model has much in common with a Ponzi scheme, such as providing investors with seemingly strong and stable returns, but the maintenance of these returns relies on a steady flow of new money flowing in, and once the money stops flowing in, the entire system collapses, then it is reasonable to compare it to a Ponzi scheme.
STRC is quite costly from a cash flow perspective.Its offering size is approximately $3 billion, with annual dividend payments of up to $300 million based on a 10% yield.MSTR cannot afford such a high dividend without raising new funds or selling Bitcoin, so in a sense, STRC is a bit like a Ponzi scheme.However, it doesn’t really look like a Ponzi scheme, given that the company has complete autonomy to gradually reduce its dividend payout to keep it affordable.Therefore,Overall, we believe STRC does not look like a Ponzi scheme.However, we believe that investing $100 in STRC does not reflect superior investment insight.In our view, STRCs are far more risky than short-dated U.S. Treasuries.
Conclusion
If the music stops and MSTR faces challenges, instead of selling Bitcoin, MSTR can abandon STRC’s strategy of achieving stability.The company can choose any easier option.MSTR can reduce STRC’s dividend rate by 25 basis points per month.At the current dividend yield of 10.5%, it would take three and a half years to drop to zero.As dividend yields fall, the cost of paying dividends also becomes cheaper.We believe this is very positive for MSTR and therefore the current dividend payments are sustainable and affordable.certainly,This means that the price of STRC could plummet, possibly by as much as 87%,to the present value of cash flows over the next three and a half years.
MSTR’s story may not be what some skeptics expected.We think,MSTR’s debt may not necessarily cause Bitcoin to be forced to sell off, triggering a downward price spiral and eventually leading to MSTR’s bankruptcy.We need to understand that Strategy’s debt instruments are extremely innovative and are not ordinary debt instruments, but are specially designed for its own needs.Saylor is no ordinary person!He is a genius of our time, often using some exotic mechanism, whether debt or equity, to raise billions of dollars for their companies.Regardless of Bitcoin prices or capital flows, MSTR will not be affected.Conversely, investors may be dissatisfied when everything comes to a screeching halt.We believe that STRC is a perfect example of this phenomenon.
