Can DCG Escape a Potential Creditor Siege?

Only last week we looked at the situation around DCG and raised the possibility that a single overlevered subsidiary might be able to topple the whole group. With more information emerging in the last few days we can begin to sharpen the questions. This analysis is a little bit speculative. But we’ve learned enough that the terms of any eventual deal, if one occurs, are pretty well boxed in.

What We Know Now

From a leaked DCG shareholder letter we know five important things:

DCG owes Genesis US$1.1 billion in about 10 years
DCG owes Genesis US$585 million in about 1 year
DCG has drawn US$350 million on a US$600 million secured credit facility
DCG was borrowing from Genesis to fund stock buybacks and other investments
DCG is “pacing” to do about US$800 million in revenue in 2022

To be extra clear on that last point: we do not know anything about free cash flow or profitability — we just know revenue. Grayscale collects a 2%+ annual fee on the contents of all their trusts. At an average YTD bitcoin price of US$30,000 just GBTC alone throws off US$390 million per year. The Ethereum trust is good for about another US$50 million per year. As those businesses cost very little to run and comprise over half of DCG’s revenues let’s just assume they make all the money. If some other DCG subsidiary was tremendously profitable it is a safe bet we would have heard about it in the last week.

DCG also owns, per public disclosures, about 70 million shares of GBTC corresponding to about 70,000 bitcoin. Their other trust holdings do not amount to much relative to their known debts.

And the final key fact, which we mentioned last time, but bears repeating here: DCG did not even fully cover Genesis’ trading losses from FTX, only injecting US$140 million out of 175 million lost.

Some Safe Inferences

From just this information we can make a few inferences about DCG’s situation. First, the partial-bailout of Genesis’ latest losses suggests they are nearly out of cash. In fact, when paired with the knowledge that DCG was borrowing from Genesis to buy back stock, it sounds like they always ran with a small cash position. That is fine as far as it goes — but it’s looking dangerous now.

Second, it seems likely that Grayscale or some part of the Grayscale fee stream is securing the credit facility. There is not much else to pledge as meaningful security here. And even at an extremely low bitcoin price it seems likely the Grayscale fees can cover the debt service on a US$600 million loan. Even at a high rate of 10% that would only require US$ 60 million per year — and GBTC can cover that at pretty much any bitcoin price over US$5,000. Recall that Genesis collects their GBTC fee in bitcoin — so the premium or discount does not matter to them.

If Grayscale’s fee stream, in some guise, really is the security it means DCG cannot sell or otherwise touch Grayscale without the lender’s consent. How DCG manages to repay, refinance or somehow roll the credit facility is completely up in the air — but those are problems for later.

Third, DCG’s GBTC holdings are not worth enough to resolve this problem. The math is simple. They hold about 70,000 bitcoin worth of GBTC. Even in the absolute best case where they can withdraw the coins and sell spot that is just over US$1.1 billion at a 16,000 price. There is no way they can sell such a position without severely impacting the price — and there is surely no way they can get US$2 billion for it to cover all the debts.

Fourth, DCG is not going to be able to restructure or otherwise roll their US$ 585 million, 1 year debt to Genesis. Genesis froze withdrawals. If they try to restructure a parent-company loan with that freeze in place every creditor will sue. Related parties, especially parent company debtors, cannot get favourable treatment without ending up in court. DCG needs to find a way to pay back that loan through either an asset sale or capital raise.

DCG’s Choices

So what can they do? The simplest route is simply to try to sell Grayscale and their GBTC position to cover the debts. This is not an insane idea. It is possible someone wants to spend US$1.5 billion or more to acquire Grayscale. By way of comparison Blackrock’s market cap is about 1% of their AUM. But Blackrock charges 10s of basis points for their funds while Grayscale charges 2% or more. Might somebody pay 10% of Grayscale’s over US$20 billion AUM for the company? Maybe. Maybe not. Certainly no such rumours have emerged yet but this is at least a theoretically-reasonable possibility.

Unfortunately for DCG it looks pretty unlikely they have any other way out. Keeping Grayscale will allow them to service the secured debt facility. But it will not, absent a massive increase in bitcoin prices, cover the loan due in year. As they cannot restructure that they’ll need to sell something. However their GBTC holdings are only worth about US$650 million at current prices inclusive of the discount. There is almost certainly no way they can realize the US$585 million needed from there.

Maybe, just maybe, they can find a way to cover that loan from Grayscale fees and selling the GBTC (and maybe ETHE) on their balance sheet. But what would that get them? DCG would owe Genesis US$1.1 billion in 10 years with nothing but the Grayscale fee stream to sustain them. Might Grayscale generate that many fees over the next decade? Sure. But that would both consume most of their cash and require Genesis to maintain their withdrawal pause for at least a few years.

This is the “Genesis under a medieval siege” scenario. All the gates are barred and the creditors are constantly attacking from the outside. Yes they might accrue hundreds of millions in fees from Grayscale this year. But absent bitcoin hitting new all time highs it will take at least a few years for those fees to cover the US$1.1 billion debt. The price at which one quarter of fees can pay back that debt is approximately 1.1b / (635k * 2% * 1/4) = US$350,000. Waiting for that is not much of a plan.

If they are going to try to keep Gemini Earn, and other programs, frozen for years while the parent company accrues fees we are likely looking at an epic multi-year legal battle that is only getting started.