MICROSTRATEGY INC MSTR
May 21, 2013 - 10:13am EST by
nathanj
2013 2014
Price: 93.50 EPS $0.00 $0.00
Shares Out. (in M): 11 P/E 0.0x 0.0x
Market Cap (in $M): 1,056 P/FCF 0.0x 0.0x
Net Debt (in $M): 330 EBIT 0 0
TEV ($): 726 TEV/EBIT 0.0x 0.0x

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  • Buybacks
  • S/O cannibalization
  • Software
  • Recurring Revenues
  • Discount to Peers

Description

As a great source of investment returns, Charlie Munger is to have said to pay close attention to cannibal companies – that is, businesses that are buying back a huge amount of their stock.  Microstrategy (MSTR) is one of these cannibals.

 

Thesis

MSTR is a deep-value software stock and a free call option on its improving sales trend.  Given all the hype around Big Data, one would think that MSTR would get more love as a business intelligence vendor.  Yet, this is one of the most hated stocks because investors are concerned about (1) new competitive threats; (2) management changes and (3) a controlling CEO.  I believe these fears are overblown. 

At just 2.7x recurring maintenance revenue, MSTR has very little downside. While MSTR deserves to trade at a discount to its faster growing peers, the valuation gap is so wide (over 10x EV/maintenance revenue for peers) that it just doesn’t make sense.  In fact, few software companies trade for less than 3x maintenance, and those that do are either illiquid and/or have weak competitive positions.  In my upside case, MSTR should be valued closer to $140-150/share (5x maintenance) as it starts growing its license revenue over easier quarterly comps.  This represents 50-60% upside.

Importantly, I believe MSTR will aggressively buy back its shares as it did during 2005-2010 when it bought back $470m of stock and reduced shares outstanding by 36%.  The company recently divested its non-core business for $110m to boost its already over-capitalized balance sheet. 

Company background

Microstrategy is one of the pioneers of business intelligence (BI) software.  Founded in 1989 by current CEO Michael Saylor, the company develops software that helps organizations analyze internal and external data in order to make business decisions and to develop mobile apps.  MSTR’s BI platform has a strong reputation for being the most complex in terms of functionality, having a large numbers of users, high data volume and wide deployment across an enterprise.  Its impressive customer list includes Google, eBay, Priceline, Netflix and Visa.  MSTR’s meteoric rise from its IPO debut in 1998 was met by an accounting scandal in 2000 that saw its stock lost over 90% of its value within a few weeks.  The company subsequently cleaned up its book, but the CEO decided to stop talking to Wall Street.  Since then, MSTR has focused on growing its business organically with revenue increasing from $175m in 2003 to $595m in 2012 (15% CAGR). 

Why this opportunity exists

Fear #1: New competitive threats. Qlik Tech and Tableau are Wall Street’s latest Big Data darlings and competitors to MSTR.  Comparing MSTR’s declining license revenue over the past four quarters to Qlik Tech and Tableau’s rapid growth, one may conclude that MSTR is finished.

Why this concern is overblown: My checks with BI consultants and customers indicate that Qlik and Tableau have great data visualization tools and are easier to use, but they are not scalable.  Thus, Qlik and Tableau cannot displace MSTR for large volume of data and users.  What the newer BI tools have done is to expand the use of BI to even wider audience. They are often used in conjunction with MSTR as the customers’ BI platform.  MSTR has not stood idle and has been improving its data visualization tools to better compete against Qlik and Tableau.  Gartner has continued to rate MSTR highly in its most recent Magic Quadrant for BI and Analytics Platforms (http://www.gartner.com/technology/reprints.do?id=1-1DZLPEP&ct=130207&st=sb).  Net-net: MSTR is not a dinosaur even though it’s trading like one.

Fear #2: Management changes. MSTR’s prior COO and head of sales were replaced in October 2012 after two straight quarters of license decline.

Why this concern is overblown: The change obviously has not produced an immediate impact as license revenue continued to decline for two more quarters.  This is not unexpected as it typically takes some time for the new heads of sales to effect results.  At MSTR, the COO and head of sales were replaced with internal candidates so I’d expect the transition pain not to persist.  Q2 2013 will be the first “easy” comp for license revenue (versus -5% license growth in Q2 2012) and should get easier for the following three quarters (versus negative double-digit license decline in prior year quarters).

Fear #3: Controlling CEO. Saylor owns 18% economic interests and 64% voting power through super-voting Class B shares.  Other than the required SEC filings, MSTR does not talk to Wall Street.  Thus, analyst estimates are all over the place since they receive zero guidance.  CEO has been investing internally since 2010 to drive growth at the expense of near-term profit. 

Why this concern is overblown: No doubt the stock would see a significant pop if Saylor was somehow removed.  His presence is an obstacle to activists and takeover interests.  He has made some questionable decisions.  Nevertheless, I do not believe Saylor is driving this company into the ground.  First, he has over $200m stake in the company.  Second, he deserves some credit for building this company from scratch to $500m in annual revenue without acquisitions.  Third, Saylor was early in recognizing the importance of mobile and invested in the platform.  MSTR is now the leader in mobile BI. 

I think it’s fair to question MSTR’s recent lack of profitability.  But one should note that MSTR has a high operating leverage model given that its license and maintenance revenues have 95% gross margins.  In the past MSTR delivered operating margins as high as 35%.  Since 2010, Saylor has decided to sacrifice profit for higher growth (as many highly-valued software companies are doing today).  As a result, MSTR generated 20%+ revenue growth in 2010 and 2011, but stumbled in 2012.  I believe Saylor is likely to keep investing in new products and marketing to reaccelerate growth.  I also believe Saylor can dial back on spending and produce at least 20-25%+ operating margins if he wanted to (albeit with slower revenue growth).  In any case, at 2.7x maintenance and with a roster of Fortune 500 customers, MSTR is a free call option on its improving sales trend.

Valuation

Granted, MSTR should trade nowhere close to Qlik and Tableau.  But the valuation gap between MSTR and its peers are just too wide to make any sense (see Table 1).  MSTR’s valuation implies that it is forever irrelevant.  That’s just not the case if you speak to customers.  Even a smaller peer Actuate trades at a premium to MSTR even though its maintenance revenue is in decline.

Table 1: BI Peers EV to total revenue and EV to maintenance revenue

Actuate (BIRT): 1.9x, 3.8x

Informatica (INFA): 4x, 9.1x

Qlik Tech (QLIK): 6x, 18.8x

Tableau (DATA): 22x, 80x

Microstrategy (MSTR): 1.3x, 2.7x

JPMorgan software analyst John Difucci has an excellent primer on why software vendors with stable and high-margin maintenance streams should have a baseline M&A valuation of 5x maintenance revenue.  Please see his weekly software piece for more details.  Most of MSTR’s direct BI competitors were taken out in 2007 by Oracle, IBM and SAP at multiples much higher than where MSTR is at today (see Table 2).

Table 2: Comparable transactions EV to total revenue and EV to maintenance

Applix acquired by Cognos: 5x, 10x

Cognos acquire by IBM: 4.3x, 9x

Business Objects acquired by SAP: 3.6x, 9x

Hyperion acquired by Oracle: 3.4x, 7.7x

I believe MSTR should be valued closer to $140-150/share (5x maintenance) as it starts growing its license revenue over easier quarterly comps.  Even without strong license revenue growth, I do not believe MSTR will stay at less than 3x maintenance forever.  With nearly 1/3 of its current market cap in cash, MSTR is likely to buy back shares in meaningful amounts, as it did during 2005-2010 when it bought back $470m of stock and reduced shares outstanding by 36%. 

 

Risks

New entrants Tableau and Qlik continue to drive wider adoption and improve scalability, leaving MSTR to a smaller market niche.

Potential customers accept inferior but “free” BI tools from IBM, SAP and Oracle.

Saylor manages the company for his own benefit.

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Easier license revenue comp: MSTR’s past 4 quarters of license revenue decline coincided with high double-digit growth comparisons in prior quarters.  Beginning Q2 2013, the comparison gets easier.   While MSTR may still not climb out of its Q1 hole completely in Q2, I’d expect license growth to return in Q3 with a -19% comparable growth quarter the year before.

Share buyback: MSTR was aggressively buying back its stock prior to 2011 but took a pause the past two years, most likely as it sacrificed profit for growth.  With the stock now trading at low multiples again, I expect Saylor to step up his buyback.  The company recently divested the last of its two non-core businesses for $110m to boost its already over-capitalized balance sheet.  Saylor has shown no inclination to make acquisitions.  His past capital allocation track record strongly indicates that an aggressive share buyback is in the cards.   Recently the Board extended its buyback program, which was scheduled to expire at the end of April 2013, to April 2018.  The program had $455m of stock remaining available for repurchase.

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    Description

    As a great source of investment returns, Charlie Munger is to have said to pay close attention to cannibal companies – that is, businesses that are buying back a huge amount of their stock.  Microstrategy (MSTR) is one of these cannibals.

     

    Thesis

    MSTR is a deep-value software stock and a free call option on its improving sales trend.  Given all the hype around Big Data, one would think that MSTR would get more love as a business intelligence vendor.  Yet, this is one of the most hated stocks because investors are concerned about (1) new competitive threats; (2) management changes and (3) a controlling CEO.  I believe these fears are overblown. 

    At just 2.7x recurring maintenance revenue, MSTR has very little downside. While MSTR deserves to trade at a discount to its faster growing peers, the valuation gap is so wide (over 10x EV/maintenance revenue for peers) that it just doesn’t make sense.  In fact, few software companies trade for less than 3x maintenance, and those that do are either illiquid and/or have weak competitive positions.  In my upside case, MSTR should be valued closer to $140-150/share (5x maintenance) as it starts growing its license revenue over easier quarterly comps.  This represents 50-60% upside.

    Importantly, I believe MSTR will aggressively buy back its shares as it did during 2005-2010 when it bought back $470m of stock and reduced shares outstanding by 36%.  The company recently divested its non-core business for $110m to boost its already over-capitalized balance sheet. 

    Company background

    Microstrategy is one of the pioneers of business intelligence (BI) software.  Founded in 1989 by current CEO Michael Saylor, the company develops software that helps organizations analyze internal and external data in order to make business decisions and to develop mobile apps.  MSTR’s BI platform has a strong reputation for being the most complex in terms of functionality, having a large numbers of users, high data volume and wide deployment across an enterprise.  Its impressive customer list includes Google, eBay, Priceline, Netflix and Visa.  MSTR’s meteoric rise from its IPO debut in 1998 was met by an accounting scandal in 2000 that saw its stock lost over 90% of its value within a few weeks.  The company subsequently cleaned up its book, but the CEO decided to stop talking to Wall Street.  Since then, MSTR has focused on growing its business organically with revenue increasing from $175m in 2003 to $595m in 2012 (15% CAGR). 

    Why this opportunity exists

    Fear #1: New competitive threats. Qlik Tech and Tableau are Wall Street’s latest Big Data darlings and competitors to MSTR.  Comparing MSTR’s declining license revenue over the past four quarters to Qlik Tech and Tableau’s rapid growth, one may conclude that MSTR is finished.

    Why this concern is overblown: My checks with BI consultants and customers indicate that Qlik and Tableau have great data visualization tools and are easier to use, but they are not scalable.  Thus, Qlik and Tableau cannot displace MSTR for large volume of data and users.  What the newer BI tools have done is to expand the use of BI to even wider audience. They are often used in conjunction with MSTR as the customers’ BI platform.  MSTR has not stood idle and has been improving its data visualization tools to better compete against Qlik and Tableau.  Gartner has continued to rate MSTR highly in its most recent Magic Quadrant for BI and Analytics Platforms (http://www.gartner.com/technology/reprints.do?id=1-1DZLPEP&ct=130207&st=sb).  Net-net: MSTR is not a dinosaur even though it’s trading like one.

    Fear #2: Management changes. MSTR’s prior COO and head of sales were replaced in October 2012 after two straight quarters of license decline.

    Why this concern is overblown: The change obviously has not produced an immediate impact as license revenue continued to decline for two more quarters.  This is not unexpected as it typically takes some time for the new heads of sales to effect results.  At MSTR, the COO and head of sales were replaced with internal candidates so I’d expect the transition pain not to persist.  Q2 2013 will be the first “easy” comp for license revenue (versus -5% license growth in Q2 2012) and should get easier for the following three quarters (versus negative double-digit license decline in prior year quarters).

    Fear #3: Controlling CEO. Saylor owns 18% economic interests and 64% voting power through super-voting Class B shares.  Other than the required SEC filings, MSTR does not talk to Wall Street.  Thus, analyst estimates are all over the place since they receive zero guidance.  CEO has been investing internally since 2010 to drive growth at the expense of near-term profit. 

    Why this concern is overblown: No doubt the stock would see a significant pop if Saylor was somehow removed.  His presence is an obstacle to activists and takeover interests.  He has made some questionable decisions.  Nevertheless, I do not believe Saylor is driving this company into the ground.  First, he has over $200m stake in the company.  Second, he deserves some credit for building this company from scratch to $500m in annual revenue without acquisitions.  Third, Saylor was early in recognizing the importance of mobile and invested in the platform.  MSTR is now the leader in mobile BI. 

    I think it’s fair to question MSTR’s recent lack of profitability.  But one should note that MSTR has a high operating leverage model given that its license and maintenance revenues have 95% gross margins.  In the past MSTR delivered operating margins as high as 35%.  Since 2010, Saylor has decided to sacrifice profit for higher growth (as many highly-valued software companies are doing today).  As a result, MSTR generated 20%+ revenue growth in 2010 and 2011, but stumbled in 2012.  I believe Saylor is likely to keep investing in new products and marketing to reaccelerate growth.  I also believe Saylor can dial back on spending and produce at least 20-25%+ operating margins if he wanted to (albeit with slower revenue growth).  In any case, at 2.7x maintenance and with a roster of Fortune 500 customers, MSTR is a free call option on its improving sales trend.

    Valuation

    Granted, MSTR should trade nowhere close to Qlik and Tableau.  But the valuation gap between MSTR and its peers are just too wide to make any sense (see Table 1).  MSTR’s valuation implies that it is forever irrelevant.  That’s just not the case if you speak to customers.  Even a smaller peer Actuate trades at a premium to MSTR even though its maintenance revenue is in decline.

    Table 1: BI Peers EV to total revenue and EV to maintenance revenue

    Actuate (BIRT): 1.9x, 3.8x

    Informatica (INFA): 4x, 9.1x

    Qlik Tech (QLIK): 6x, 18.8x

    Tableau (DATA): 22x, 80x

    Microstrategy (MSTR): 1.3x, 2.7x

    JPMorgan software analyst John Difucci has an excellent primer on why software vendors with stable and high-margin maintenance streams should have a baseline M&A valuation of 5x maintenance revenue.  Please see his weekly software piece for more details.  Most of MSTR’s direct BI competitors were taken out in 2007 by Oracle, IBM and SAP at multiples much higher than where MSTR is at today (see Table 2).

    Table 2: Comparable transactions EV to total revenue and EV to maintenance

    Applix acquired by Cognos: 5x, 10x

    Cognos acquire by IBM: 4.3x, 9x

    Business Objects acquired by SAP: 3.6x, 9x

    Hyperion acquired by Oracle: 3.4x, 7.7x

    I believe MSTR should be valued closer to $140-150/share (5x maintenance) as it starts growing its license revenue over easier quarterly comps.  Even without strong license revenue growth, I do not believe MSTR will stay at less than 3x maintenance forever.  With nearly 1/3 of its current market cap in cash, MSTR is likely to buy back shares in meaningful amounts, as it did during 2005-2010 when it bought back $470m of stock and reduced shares outstanding by 36%. 

     

    Risks

    New entrants Tableau and Qlik continue to drive wider adoption and improve scalability, leaving MSTR to a smaller market niche.

    Potential customers accept inferior but “free” BI tools from IBM, SAP and Oracle.

    Saylor manages the company for his own benefit.

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Easier license revenue comp: MSTR’s past 4 quarters of license revenue decline coincided with high double-digit growth comparisons in prior quarters.  Beginning Q2 2013, the comparison gets easier.   While MSTR may still not climb out of its Q1 hole completely in Q2, I’d expect license growth to return in Q3 with a -19% comparable growth quarter the year before.

    Share buyback: MSTR was aggressively buying back its stock prior to 2011 but took a pause the past two years, most likely as it sacrificed profit for growth.  With the stock now trading at low multiples again, I expect Saylor to step up his buyback.  The company recently divested the last of its two non-core businesses for $110m to boost its already over-capitalized balance sheet.  Saylor has shown no inclination to make acquisitions.  His past capital allocation track record strongly indicates that an aggressive share buyback is in the cards.   Recently the Board extended its buyback program, which was scheduled to expire at the end of April 2013, to April 2018.  The program had $455m of stock remaining available for repurchase.

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