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MICROSTRATEGY, INC.  (MSTR)

Last Updated: Jul 4, 2008


Business Summary

Microstrategy is a provider of business intelligence (BI) software. This software uses various corporate databases (such as sales transactions, customers, employees, inventory, etc) to produce reports, analyze trends, and forecast future results. Using this information, management can improve efficiencies, reduce costs, and improve profitability. Microstrategy's platform is fully web-based, allowing fast and wide accessibility, and includes features such as dashboards, custom reports, predictive analysis, and more. Microstrategy earns it's revenues both from selling new software licenses (30%) and from recurring maintenance fees, as well as for consulting services and education. The company's impressive list of clients includes such firms as Netflix, Starbucks, Comcast, Wells Fargo, GEICO, Lowe's, and the U.S. Postal Service.

Growth Strategy

The company's stated goal is to be the leading provider of business intelligence software. This is a fast growing market, as more and more data is being stored in corporate databases, and companies are looking for any way to increase efficiency to better compete. Gartner estimates the growth for the BI market at nearly 9% a year through 2011, so organic market growth is clearly a tailwind. Additionally, Microstrategy has been beefing up it's foreign sales force, particularly in Asia, where the market is in it's infancy. Over 35% of revenues come from outside the United States.

Competitive Position

BI being a new and fast growing software field, it's no surprise that the big boys have come to play. The market is seeing fast consolidation. In the past year, several of Microstrategy's competitors have been swallowed by the software giants... Oracle bought Hyperion for 3.3 billion last March, SAP acquired Business Objects for 6.8 billion in October, and IBM shelled out 5 billion for Cognos in November. With these companies bundling BI software with other enterprise offerings, Microstrategy could see pricing pressure which would hurt profitability. On the bright side, BI software is very complex to install, and once it's in place, switching costs are high for customers. Microstrategy has the highest satisfaction rates in the business, and technically is considered the best in the field. The company has a small but real competitive moat.

Risks

The primary risks are competitive. With full enterprise level offerings, Oracle, SAP, and IBM can provide BI capabilities as part of their standard offerings. In theory at least, this affords the customer a more easily integrated experience and pricing is more flexible for the vendor (although in practice many bolt on software acquisitions are poorly integrated). Microstrategy has had difficult growing new license revenue - it's been flat over the past 4 years. This is also a one trick pony. If their BI software faces pricing pressures or loses it's competitive edge in a fast changing field, this stock will get hammered.

Management

Management is a mixed bag. On the one hand, the company is controlled by it's founder, CEO Michael Saylor, who controls 66% of the voting power in the company (and owns over 20% of outstanding shares). Over the past 5 years, the company has been managed admirably, averaging over 100% return on capital and executing huge share buybacks that have reduced share count by 26%. However, governance is a concern. Majority control by the CEO/Founder allows him to block an acquisition attempt (like, perhaps, Microsoft). Also, Saylor has earned huge bonuses - over 2 million dollars in 2006, despite lukewarm growth. The company also wastes shareholder money on unnecessary perks like private parties and country club memberships, and management just purchased a 43 million dollar private jet. Is this really necessary? 43 million dollars nearly equals net income for all of 2007!

Financial Health

Typical of a successful software company, Microstrategy has an outstanding balance sheet and enviable returns on capital and free cash flow. There is 88 million on the balance sheet in cash, and no debt at all. Free cash flow margins have typically been over 30%, an impressive number, and management has returned them to shareholders with generous buybacks. Since 2004, return on tangible capital has averaged well over 100% annually. Microstrategy is on solid financial footing. However, it should be mentioned that nearly 30% of cash flow over the past 3 years has been due to recognition of deferred income tax credits earned while the company was a money loser in the early 2000s. While there are still about 2 years of tax credits on the books at this level, they are not operating cash flow. Subtracting these numbers out, free cash flow margins have averaged in the low 20% range.

MagicDiligence Opinion

Business intelligence software is an attractive market. New age companies like Netflix and Ebay are internet based and so conduct nearly all business electronically, and old school enterprises are increasingly moving towards the internet for both customer transactions and business process management. This fundamental shift in record keeping has opened up the door to trend analysis, making it much easier for management to identify what areas need attention and how to address them. An increasingly global and competitive market requires any advantage a company can get, and business intelligence is something that will be universal, before long. However, as investors we need to tread carefully in these new and fast evolving markets. Quick technology turns can wipe out a technical advantage instantly, and pricing muscle by large software vendors can bury independent firms like Microstrategy. I don't necessarily feel this is inevitable. This software is time consuming to set up, and management becomes comfortable with it, making switching costs fairly high. This allows for pricing power in recurring maintenance fees. However, there are a lot of question marks about the future here, and management's excesses further sour the case. Microstrategy is not a terrible stock, but not one I'd recommend as a Top Buy.

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