Strategy Stock Is Scary. Its Preferred Might Be Worth a Look. — Barrons.com
By Andrew BaryBitcoin is backsliding and that's bad news for Strategy stock. But it may be an opportunity for investors willing to bet on the company's preferred securities.Since its early October peak, Bitcoin has fallen about 30% to $85,000, one of its sharpest selloffs in recent years. The decline has been caused by a combination of a more hawkish-than-expected Federal Reserve and a shift toward more risk-averse market dynamics, with the drop ultimately leading to liquidation of leveraged positions and sales of Bitcoin exchange-traded funds.While the decline has been uncomfortable for Bitcoin "HODLers," it has been particularly painful for the company formerly known as MicroStrategy. The term HODL originally resulted from a typo involving the word "holder" from a crypto enthusiast. Fans of the asset class have since embraced it as meaning, "Hold on for Dear Life."Strategy's strategy has been to sell common stock, preferred, and debt to buy Bitcoin. The company has accumulated some $55 billion worth of Bitcoin, about 3% of 20 million Bitcoins now outstanding, in the process.Strategy's common stock, however, has slumped more than 50%, to $177, since late July, leaving it way below its high of $543 set a year ago. The company is now valued at close to net asset value where it once commanded a large premium. Strategy has about $8 billion of convertible debt outstanding, and those bonds have also come under pressure, particularly a $3 billion issue that yields almost 8% and can be redeemed by holders in 2028. The convertibles are more appealing than the risky common stock.For investors comfortable with the risks, the best bets are Strategy preferred issues. Preferred stock is a senior form of equity long popular with individuals for its high fixed dividend rates similar to a bond, and favored by issuers, who can miss a dividend without triggering a default. Strategy has issued some $8 billion of preferred this year in five separate issues. Like most preferred, the Strategy issues are perpetual, meaning they don't need to be paid back. The four U.S. preferred issues are actively traded on the Nasdaq and known by their tickers and nicknames: STRC, known as Stretch; STRD, dubbed Stride; STRF, as in Strife; and STRK, or Strike.The Strategy preferred, like the common stock and convertible, have been hit in the recent selloff. Their yields, already elevated before the selloff, are up one to two percentage points over the past six weeks. (The common has no dividend.) The result is that $8 billion of Strategy preferred now carry dividend yields of 10% to 15%, some of the highest yields in the $300 billion preferred stock market. By contrast, preferreds issued by big banks like JPMorgan, Wells Fargo, and Bank of America yield about 6%.While Barron's was bearish on Strategy common a year ago at double the current price, the preferred actually looks like a good deal for investors comfortable with crypto risk. Capital Group, the big Los Angeles-based money manager, is a believer, holding over $1 billion of preferred. So is Bill Miller, whose Miller Income fund holds the highest yielding Strategy preferred, STRD, now around 15%. "Saylor has figured out a way to create debt and preferred structures that appeal to different investors' risk/reward" tolerances, Miller says, referring to Strategy chairman and controlling shareholder Michael SaylorThe risk is certainly there. S&P Global Ratings gave the company a low-junk B-minus credit rating, indicating concern about the company's debt. It didn't rate the preferred issues, but they likely would have an even lower rating. S&P cited Strategy's "narrow business focus, high Bitcoin concentration, and low U.S. dollar liquidity" as risks.The company needs to make about $700 million annually in preferred dividend payments and has minimal income to do so. The company's smallish software business operates at close to breakeven and the Bitcoin holdings yield nothing.Investor Peter Schiff, one of Strategy's biggest detractors, tweeted recently that the company's business model "relied on income-oriented funds buying 'high-yield' preferred shares. But those yields will never actually be paid. Once fund managers realize this, they'll dump the preferreds and MSTR won't be able to issue any more, setting off a death spiral."This critique seems unfair. While the company has been paying the preferred dividends using proceeds from equity sales and has been reluctant to sell any of its Bitcoin, there's no reason it can't. With $55 billion in Bitcoin, Strategy could make preferred dividends for years and pay off its $8 billion of convertible debt if needed. CEO Phong Le said as much on the company's third-quarter earnings conference call. "We could sell high-basis Bitcoin to cover our dividend needs on our preferred stock," he said. In a tweet this past Thursday, Strategy said that "at current Bitcoin levels, we have 71 years of dividend coverage assuming the price stay flat." Le and other Strategy insiders have bought several of the preferred issues.A risk is a collapse in Bitcoin prices, but even then Strategy might be able to make preferred dividend payments. It's in Strategy's interest to pay preferred dividends even if it has to sell Bitcoin so that it can retain access to what has become an important funding source. The preferred also have tax benefits for their holders due to Strategy's lack of conventional profits. The dividends are considered a return of capital, meaning that taxes are deferred until the investor sells the securities. Strategy hopes to maintain the return-of-capital dividend status for a decade or more.The four Strategy preferred issues have different characteristics. The largest deal, the $3 billion variable-rate Stretch, now trades around $93, below its face value of $100, and yields 11%. Strategy's goal is for the Stretch issue to trade close to $100 and it adjusts the monthly dividend rate to try to achieve that.Strike has an 8% dividend rate and trades at a steep discount to face value at 75 cents on the dollar, for a current yield of 11%. It's convertible into a tenth of a share of Strategy equity — an option that is now way out of the money but has some value.Strife, which carries a 10% dividend rate, trades around $94 and yields 10.5%. It's probably the most secure preferred because the dividend increases if a payment is missed. The most junior — and riskiest — preferred is Stride, which has a 10% rate and trades around $67 for a yield of almost 15%. Stride is the only one of the four that is noncumulative, meaning that the issuer doesn't need to make up for missed dividends. Given its huge Bitcoin holdings, there is no reason for Strategy to skip a payment.Bitcoin isn't for everyone — nor are Strategy's preferred. But for investors comfortable with the cryptocurrency, the Strategy securities offer a high-yield play with a lot of assets behind them.They may even be worth HODLing.Write to Andrew Bary at [email protected] content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.