Bitcoin, We Have a Problem

I have tried my best for years to avoid this subject, but the time has come at last. Compliance officers, we need to talk about bitcoin.

Specifically, we need to talk about certain operating businesses in the world that now purchase and hold bitcoin as a corporate strategy. Because some companies are doing exactly that, and turning their financial reporting and corporate governance into a stinky mess along the way.

Our foremost example of this phenomenon is Tesla ($TSLA), which published its Q1 2021 earnings release on Monday. The headline numbers all look fair. Total revenue was $10.39 billion, up 74 percent from one year ago; net income was $438 million, up more than twenty-fold from a piddling $16 million one year ago.

Except, that $438 million in profits isn’t entirely due to the sale of Tesla cars and related products. More than $100 million of that amount came from bitcoin speculation.

As you might have heard, in February Tesla announced that the company had purchased $1.5 billion worth of bitcoin as an investment vehicle for surplus cash. In its earnings release on Monday, Tesla said it had subsequently sold $272 million of that investment, and pocketed $101 million in profit. That amount fell straight into the net income line. Without its bitcoin play in Q1, Tesla’s net income would only have been about $338 million.

To be clear, Tesla made no inaccurate financial statements with this maneuver. But it did play fast and loose with a highly volatile asset (bitcoin) that gave the company a nice boost to the bottom line. Cynics would say Tesla came close to earnings management: it could see the value of bitcoin appreciating, and knew how much the company could sell to make up for any shortfalls that might exist on the operating side. 

Even if the price of bitcoin fell, Tesla still could have dumped the asset, and then booked the loss for a credit on tax liability. Heads it wins one way; tails it wins another. 

Is all this permissible under current U.S. accounting rules? Yes. Is it an honest representation to the investing public about Tesla’s value as an operating company? You tell me.

But Wait, There’s More

Aside from the eye-rolling accounting maneuvers, Tesla may have a more pressing problem with the corporate governance dimension to this maneuver. Consider this apparent sequence of events:

• Tesla CEO Elon Musk muses about the promise of bitcoin as a currency
• Tesla buys bitcoin, announces purchase to the world
• Musk fanboys swoon; price of bitcoin soars
• Tesla sells bitcoin holdings, and Q1 numbers hit market expectations

If I were the Securities and Exchange Commission, I would want to know precisely when all these decisions and statements were made. 

Indeed, let’s recall that the SEC already tussled with Musk in 2018, when he sent that notoriously nutty tweet announcing that he planned to take Tesla private at $420 per share, “funding secured.” There was no such funding, and Tesla never did go private. Instead, the SEC ended up imposing $20 million civil fines against both the company and Musk personally, and Tesla’s board had to hire a corporate lawyer whose sole purpose is to vet Musk tweets in case of more social media chicanery.

Perhaps that lawyer could tell us what Musk and the executive team was thinking as they embarked on the bitcoin gambit and announced it to the world. At the least, the SEC should be asking.

And the Bitcoin Concerns Keep Rising

As much as Tesla is the example of the day for bitcoin questions, other examples are worth noting as well. 

We also have the case of MicroStrategy ($MSTR), a business intelligence software firm based in Virginia. MicroStrategy had been plodding along for several years, with annual revenue drifting downward from $504 million in 2017 to $480 million in 2020. In the third quarter of 2020, however, MicroStrategy started buying bitcoin. By the end of Q3, those bitcoin holdings were worth $380.8 million. 

Then the price of bitcoin took off in Q4, and so did the value of MicroStrategy’s holdings. By the end of Q4, those digital assets were worth $1.05 billion — roughly 72 percent of all MicroStrategy’s assets. See Figure 1, below; the bitcoin assets are in the line shaded grey.

 

 

MicroStrategy spent another $1.02 billion in February of this year to purchase 19,452 bitcoins. As of Feb. 24, the firm owned roughly 90,531 bitcoins, which it had acquired at a cost of $2.17 billion. Assuming MicroStrategy hasn’t sold any of those coins in the interim, its holdings today are worth more than $4.9 billion — at least six times as much as the company’s total assets just six months ago. (MicroStrategy announces its Q1 2021 earnings results on Thursday, so we should get a more current picture of things then.) 

At this point, if a person wants to invest in bitcoin but doesn’t want to pay the high transaction fees, you could just buy MicroStrategy shares. I know people who are doing this; people who have outright told me, “I’m buying MicroStrategy to buy bitcoin.” 

If that’s the case, then let’s not mince words: MicroStrategy has turned itself into a bitcoin mutual fund with a side business as a software firm. There’s nothing inherently wrong with that choice, but mutual funds need to obey the Investment Companies Act of 1940 and follow FINRA rules and do all sorts of other fun financial industry compliance stuff. At what point should that happen here, too? 

My point is this: bitcoin (and many other cryptocurrency assets) is a volatile asset, fueled by day-trader irrationality more than common sense. It acts as a black hole on the income statement and the balance sheet, exerting so much gravitational force that other line items are pulled out of their natural orbit. This is not a good thing for investors.

Yet again, we have a technological advance racing ahead of the legal, accounting, and regulatory framework to govern it wisely. I do believe SEC chairman Gary Gensler is superbly well-qualified to address these issues — but yikes, we gotta get on that, pronto.