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Lex Letter from New York: bitcoin’s biggest fan



Dear readers,

It is common for a company founder to evangelise a product’s virtues. It is unusual for the founder to champion a product their company does not make.

However, Michael Saylor, chairman and chief executive of MicroStrategy, this summer said the Virginia software company would invest in bitcoin, which is produced by “miners” that perform multiple calculations. The bombshell was delivered perfunctorily. Immediately afterwards, Mr Saylor talked about how much MicroStrategy’s quarterly product licensing revenue had jumped.

Since then, Mr Saylor’s commitment to cryptocurrency has grown. MicroStrategy recently said it had spent $425m buying bitcoin at an average price of $11,111 per coin. Given that bitcoin is now trading at almost $20,000, it has been a canny trade.

Just this week, MicroStrategy went further. It announced a $400m convertible bond whose proceeds will be used to buy the highest profile cryptos.

The principal-agent conundrum has always been at the centre of corporate governance. But a boss obsessed with a controversial, disruptive new financial technology ranks among the most striking C-suite dramas corporate America has seen in a long time.

Line chart showing rising price of bitcoin in $

Mr Saylor, a graduate of MIT, founded MicroStrategy in the early 1990s as a pioneer in data mining, or what it calls “business intelligence”. The company benefited from the dotcom mania, reaching a market capitalisation in 2000 of $24bn. That made Mr Saylor a billionaire several times over on paper.

An accounting scandal, an SEC penalty and the internet bust brought the company back down to earth. Still, it kept plugging along in its niche, starting 2020 with a market capitalisation of $1.5bn.

MicroStrategy’s days as an unassuming software company are over. At a November investor meeting, Mr Saylor, who is now chairman of the company and owns about a fifth of its shares, explained further his “Treasury Reserve Asset” strategy around bitcoin. He said:

“Our decision to move our treasury from cash to Bitcoin came after we first realised that leaving a treasury in cash means taking a straightforward 10% type monetary debasement or more every year. Moving it into a bond or real estate or equity suffers from the same problem. As long as the monetary supply is expanding rapidly, then you’re going to get a negative real yield. 

“None of those are a safe haven. What we’re looking for is a store of value. If you want to find a store of value in aggressively expanding monetary environment, you have to find an asset which doesn’t have its fundamentals based upon fiat cash flows. And that drives you all the way to scarce art, precious metals or crypto assets. 

“Obviously, we can’t find a portfolio of scarce art. And we considered gold, but gold is antiquated and mechanical in the way that it stores value because it’s centralised, you can’t verify how much supply there is and gold miners create more every single year. And so that leaves you with Bitcoin as a crypto asset that’s digital gold.” 

Among crypto zealots, it is all standard stuff. The question for MicroStrategy is this: is it appropriate to pursue this strategy when it could simply pay the money back to shareholders?

Citigroup analysts have already turned sour. Citi this week prepared a likely unprecedented sum-of-the-parts analysis that included the core software business as well as value of bitcoin holdings at various prices.

© Citigroup

Shares of MicroStrategy have more than doubled this year though that trails the rise in bitcoin. Citi went on to downgrade the stock to “sell”, and said: “The issuance of new debt to fund bitcoin purchases is aggressive and may be a deal-breaker for software investors, who may fear they now own a more risky asset management business.”

However, for the millions of speculators in bitcoin, perhaps MicroStrategy shares are now a natural, if unexpected, way to hedge their bets, getting a dull software company as a part of their crypto package.

Enjoy the rest of your week,

Sujeet Indap
Lex writer

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Earnings beats: lukewarm reaction shows prices are stretched




Investors are picking over first-quarter results for signs of economic recovery and proof that record market highs can continue. Stock markets have only been this richly valued twice before — in 1929 and 2000. Bulls hope strong corporate earnings and rising inflation can pull prices higher still. But pricing for perfection means even good results can be met with indifference.

L’Oreal illustrated this trend on Friday. The French cosmetics group stated that sales in the first quarter of the year rose 10.2 per cent. This was a better performance than expected. Yet the announcement sent shares down by around 2 per cent. Weak cosmetics sales were seen as a veiled warning that consumers emerging from lockdowns might not spend as freely as hoped.

Online white goods retailer AO World, a big winner from pandemic home upgrades, also offered a positive update this week. In the quarter that marked the end of its financial year, sales were £30m ahead of forecasts. But even upbeat commentary from boss John Roberts could not stop shares slipping 3 per cent.

Banks are not immune. Their stocks have outperformed the market by 7 per cent in Europe and 12 per cent in the US this year. But stellar Wall Street results were not enough to satisfy investors this week.

JPMorgan Chase, the biggest US bank, smashed expectations for the first quarter. Even adjusting for the release of large loan loss reserves, earnings per share beat expectations by 12 per cent because of higher investment banking revenues. Bank of America earnings also rose thanks to the release of loan loss reserves. Yet shares in both banks ended the week down. Goldman Sachs had to pull out its best quarterly performance since 2006 to hold investor interest.

On multiple metrics, stock valuations look steep. On price to book, banks are now back to the pre-crisis levels recorded at the start of 2020. Living up to the expectation implicit in such valuations is becoming increasingly hard.

Lex recommends the FT’s Due Diligence newsletter, a curated briefing on the world of mergers and acquisitions. Click here to sign up.

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Barclays criticised for underwriting US private prison deal




Barclays has attracted criticism for underwriting a bond offering by the US company CoreCivic to fund the building of two new private prisons, in a new dispute over Wall Street’s relationship with the controversial sector.

The UK-based bank said two years ago that it would stop financing private prison companies, but the commitment did not extend to helping them obtain financing from public and private markets.

About 30 activists and investors, among them managers at AllianceBernstein and Pax World Funds, have signed a letter opposing the $840m fundraising for two new prisons in Alabama, which was due to be priced on Thursday.

The signatories said the bond sale brings financial and reputational risk to those involved and urged “banks and investors to refuse to purchase securities . . . whose purpose is to perpetuate mass incarceration”.

Activists and investors who pay attention to environmental, social and governance issues have sought to cut off companies that profit from a US criminal justice system that disproportionately incarcerates people of colour. As well as raising ethical issues, many also say such financing may be a bad investment because legislators are increasingly calling for an end to the use of private players in the prison system.

While Barclays is not lending to CoreCivic, activists and investors attacked its decision to underwrite the deal, which is split between private placements and public issuance of taxable municipal bonds. The arrangement is “in direct conflict with statements made two years ago” when the bank announced it would no longer finance private prison operators, according to the letter.

Barclays said its commitment to not finance private prisons “remains in place”, adding it had worked alongside representatives from the state of Alabama to finance prisons “that will be leased and operated by the Alabama Department of Corrections for the entire term of the financing”.

CoreCivic said the Alabama facilities will be “managed and operated by the state — not CoreCivic. These are not private prisons. Frankly, we believe it is reckless and irresponsible that activists who claim to represent the interests of incarcerated people are in effect advocating for outdated facilities, less rehabilitation space, and potentially dangerous conditions for correctional staff and inmates alike.”

Barclays’ 2019 commitment to limit its work with private prison companies came as other banks, including Wells Fargo, JPMorgan Chase and Bank of America, also said they would stop financing the sector.

Critics said they were not sure why Barclays is differentiating between lending and underwriting.

“You’ve already taken the stance, the right stance, that private prisons and profiting from a legacy of slavery is bad,” said Renee Morgan, a social justice strategist with asset manager Adasina Social Capital, one of the signatories of the letter. “But then you’re finding this odd loophole in which to give a platform to a company to continue to do business.”

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Hedge funds post best start to year since before financial crisis




Hedge funds have navigated the GameStop short squeeze and the collapse of family office Archegos Capital to post their best first quarter of performance since before the global financial crisis.

Funds generated returns of just under 1 per cent last month to take gains in the first three months of the year to 4.8 per cent, the best first quarter since 2006, according to data group Eurekahedge. Recent data from HFR, meanwhile, show funds made 6.1 per cent in the first three months of the year, the strongest first-quarter gain since 2000.

Hedge fund managers, who often bet on rising and falling prices of individual securities rather than following broader indices, have profited this year from a rebound in the cheap, beaten-down so-called “value” stocks and areas of the credit market that many of them favour. Some have also been able to profit from bouts of volatility, such as the surge in GameStop shares, which turbocharged some of their holdings and provided opportunities to bet against overpriced stocks.

“We’re going into a market environment that is going to be more fertile for most active trading strategies, whereas for most of the past decade buying and holding the index was the best thing to do,” said Aaron Smith, founder of hedge fund Pecora Capital, whose Liquid Equity Alpha strategy has gained around 10.8 per cent this year.

The gains are a marked contrast to the first three months of 2020, when funds slumped by around 11.6 per cent as the onset of the pandemic sent equity and other risky markets tumbling. However, funds later recovered strongly to post their best year of returns since 2009.

This year, managers have been helped by a tailwind in stocks and, despite high-profile losses at Melvin Capital and family office Archegos Capital, have largely survived short bursts of market volatility.

It’s a “good market for active management”, said Pictet Wealth Management chief investment officer César Perez Ruiz, pointing to a fall in correlations between stocks. When stocks move in tandem, it makes it more difficult for money managers to pick winners and losers.

Among some of the biggest winners is technology specialist Lee Ainslie’s Maverick Capital, which late last year switched into value stocks. Maverick has also profited from a longstanding holding in SoftBank-backed ecommerce firm Coupang, which floated last month, and a timely position in GameStop. It has gained around 36 per cent. New York-based Senvest, which began buying GameStop shares in September, has gained 67 per cent.

Also profiting is Crispin Odey’s Odey European fund, which rose nearly 60 per cent, having lost around 30 per cent last year, according to numbers sent to investors.

Odey’s James Hanbury has gained 7.3 per cent in his LF Brook Absolute Return fund, helped by positions in stocks such as pub group JD Wetherspoon and Wagamama owner The Restaurant Group. Such stocks have been helped by the UK’s progress on the rollout of the coronavirus vaccine, which has raised hopes of an economic rebound.

“We continue to believe that growth and inflation will come through higher than expectations,” wrote Hanbury, whose fund is betting on value and cyclical stocks, in a letter to investors seen by the Financial Times.

Additional reporting by Katie Martin

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