This report highlights MicroStrategy’s (MSTR) chosen accounting treatment of its Bitcoin assets and how it impacted GAAP net income in 2020. Similar to what we saw with Tesla’s recent Bitcoin purchase, MicroStrategy’s Bitcoin assets can be tools for earnings management.
Bitcoin Treatment and Its Impact on Fundamentals
While analyzing MicroStrategy’s 2020 10-K, analyst Devyn DeLange found that MicroStrategy accounts for its Bitcoin assets, which make up 72% of the firm’s total assets, as indefinite-lived intangible assets instead of as short-term cash equivalents. This distinction means MicroStrategy will record write-downs on unrealized losses related to its Bitcoin assets as they fall in value. On the flip side, MicroStrategy can also record large, realized gains should it sell those assets after an increase in value. This accounting treatment is in contrast to how unrealized gains/losses are recorded for equity securities.
In 2020, MicroStrategy recorded a $71 million impairment charge (nearly 2x MicroStrategy’s 2020 Core Earnings) related to the firm’s Bitcoin assets. In other words MicroStrategy’s reported GAAP net income is massively understated due to its Bitcoin loss rather than any change in the firm’s underlying operations. See disclosure of the firm’s Bitcoin on its 2020 balance sheet here.
Companies already use numerous accounting loopholes to manage earnings, and it appears Bitcoin investing is a new loophole.
Understanding Accounting Treatment to Better Manage Risk/Reward
Both equity and debt investors need to consider accounting details, which impact reported fundamentals, and how stakeholder capital is allocated.
In 2020, MicroStrategy’s Bitcoin purchases were funded by sales of short-term investments and the issuance of convertible bonds. On February 16, 2021, the firm announced its intentions to issue an additional $600 million in 0% senior convertible notes, of which the proceeds will be used to purchase more Bitcoin. Just a day later, the firm announced it would increase the issuance to $900 million.
It appears debtholders are willing to fund the firm’s increased exposure to Bitcoin and will even do so at the low interest rate of 0%. However, shareholders appear more skeptical. MSTR fell 8% on February 16 (S&P fell >1%) after the initial announcement, which could indicate skepticism of the firm’s plan to issue debt to purchase such a highly volatile and non-core asset, which can distort earnings.
We think investors’ skepticism is warranted given that MicroStrategy, and its current CEO Michael Saylor, previously settled with SEC after it alleged the firm overstated its revenue and earnings in 1998 and 1999.
No Substitute for Diligence
We adjust for all unusual items, both hidden and reported, to calculate a more accurate measure of a firm’s profitability. Going forward, we will remove any gains/losses firms realize when they sell Bitcoin from our calculations of profits, as these gains/losses represent non-operating income/losses.
Without this diligence, investors could make misinformed investment decisions.
Only our “novel dataset”, which leverages our Robo-Analyst technology, enables investors to overcome flaws with legacy fundamental datasets to apply reliable fundamental data in their research. Core Earnings: New Data & Evidence, accepted for publication by The Journal of Financial Economics also proves the superiority of our fundamental data, Core Earnings models, and securities research.
This article originally published on February 18, 2021.
Disclosure: David Trainer, Devyn DeLange, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.
 A study forthcoming in The Journal of Financial Economics shows that most analysts and fundamental data firms do not pay enough attention to accounting details and footnotes disclosures when modeling earnings.