Finance

Hedge funds piled into the first-ever junk bond tied to bitcoin to avoid ‘high-yield FOMO’

Summary List PlacementCryptocurrencies are creeping into the traditional financial markets where hard, reserve currencies still rule the roost. MicroStrategy raised the first-ever junk bond that will be used to buy bitcoin this week, as it looks to build a war chest of cryptocurrency. The software company's $500 million bond follows two convertible bond sales the company did in February this year and December 2020, which were both used to fund bitcoin purchases. The transaction represents a certain recognition of cryptocurrency by conventional financial markets, and is a sign that investors are willing to make risky bets on the volatile upstart currency...

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Summary List Placement

Cryptocurrencies are creeping into the traditional financial markets where hard, reserve currencies still rule the roost.

MicroStrategy raised the first-ever junk bond that will be used to buy bitcoin this week, as it looks to build a war chest of cryptocurrency. The software company’s $500 million bond follows two convertible bond sales the company did in February this year and December 2020, which were both used to fund bitcoin purchases.

The transaction represents a certain recognition of cryptocurrency by conventional financial markets, and is a sign that investors are willing to make risky bets on the volatile upstart currency amid a search for greater returns in a world of rock-bottom interest rates. The managers funding the deal won’t directly be invested in crypto, but the ability for MicroStrategy to repay the debt is entirely dependent on bitcoin’s value.

While the deal obtained roughly $1.6 billion in demand, and enough traction to enable MicroStrategy to increase the sale by $100 million to $500 million, it was largely anchored by opportunistic hedge funds, multiple sources familiar with the sale told Insider.

Traditional asset managers or institutional investors, which typically invest heavily in new bond sales, are understood to have shunned the deal for MicroStrategy, sources have said, due to the risky nature of bitcoin.

“The deal was upsized, and oversubscribed, but bitcoin is just too volatile and unpredictable,” said Peter Duffy, chief investment officer at Penn Capital, an investment firm focused on leveraged finance.

Hedge fund managers, bemoaning the dearth of higher returns on offer in bond markets, sense a chance to make some cash by flipping the securities in the secondary market.

“We bought a bit, but just to trade it. We don’t care for the deal much,” one credit manager told Insider. “It’s a sign of the craziness of the high-yield [bond] market.”

Bond managers’ tough ride

Indeed, issuance in the high-yield bond market has surged since the Fed backstopped the market last March as the coronavirus gripped the economy. Companies have binged on cheap debt to stay afloat, while investors have had to assume greater risks for higher returns.

While investors who specialize in distressed securities were licking their chops at the outset of the pandemic, the wave of bankruptcies experienced last year didn’t translate into easy wins for these managers.

Take Hertz for example — the bankrupt car rental company was able to ride a wave of retail investor interest to avoid a bailout from a vulture fund. The rise of SPACs in the latter half of 2020 and the beginning of this year gave companies another avenue for raising capital, with less restrictive terms than high-interest lenders from the hedge-fund world.

This culminated in heavy interest in MicroStrategy’s offering despite the volatile status of bitcoin, with the manager who bought into the deal labeling it as “hedge fund heavy.” This person said the last-minute rush to get in the deal — which pushed from $400 million to $500 million — was “high-yield FOMO.”

All in on bitcoin

Cryptocurrency now makes up more than half of MicroStrategy’s $6 billion enterprise value, according to a report from Reuters Breakingviews. Other bitcoin owners, including car maker Tesla, and payments company Square, hold just enough to account for 1% of their respective worths.

And while the price of a bitcoin token has lost more than $20,000 in value in the last month, it’s not the only risky element of MicroStrategy’s bond sale.

Moody’s Investors Service said in a report Monday that MicroStrategy had “extraordinarily” high leverage. Its debt relative to the company’s earnings was more than 20 times, according to Moody’s calculations, but countered this with MicroStrategy’s “very low” cost of borrowing. 

Jefferies led the transaction, which priced on Tuesday, and it’s now trading in the secondary market.

A spokesperson for MicroStrategy declined to comment and a spokesperson for Jefferies did not respond to a request for comment before press time.

While traders will be fixed on any obscure hedge fund-led fluctuations in the securities, there’s no denying bitcoin’s growing influence.

On Wednesday, El Salvador became the first country to adopt bitcoin as official legal tender, while Warren Buffett invested $500 million in Brazilian fintech Nu Pagamentos, which plans to trade in bitcoin exchange-traded funds.

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