MicroStrategy Incorporated (“MSTR”, “MicroStrategy” or the “Company”) is a provider of business analytics software.  Founded in 1989 by current CEO Michael Saylor, the Company develops software to help organizations analyze data and create reports in order to make business decisions. MicroStrategy organizes both internal and external data which allows users customize reports specific to their business.

MicroStrategy’s business intelligence platform has a strong reputation and is well regarded by industry users and commentators such as Gartner and Forrester. Its customer list includes Google, Hilton, Marriot, Facebook, Priceline, Netflix, Visa, and many more. The Company primarily competes against Tableau, Domo, QLIK, TIBCO, and Microsoft Power Business Intelligence. In July 2017, MicroStrategy traded down from $190 to $122 per share based on the following two factors disclosed with second quarter earnings:

1. Revenue growth from new large licenses turned negative, mainly attributable to deal slippage derived from retail customers.

2. Management committed to re-investing ~$40 million (40% of EBITDA) per year in sales & marketing and research & development. While MicroStrategy’s product is well-regarded, management highlighted the need to increase functionality in order to be ahead of the curve and grow in-line with business intelligence peers such as Tableau, Domo and Looker. Peers are experiencing revenue growth in excess of 10% yet show little in terms of profitability.

Street expectations exhibit skepticism for the current re-investment given mediocre results from 2010 through 2013 when the Company invested for growth. However, at that time MicroStrategy had 9 different products versus 1 today. In 2014, the Company restructured which increased EBITDA margins to over 28%.

The street’s “wait and see” approach and conservative sentiment particularly towards estimates past 2018E has created a compelling opportunity to purchase a market leading enterprise software franchise under 3.0x recurring revenues.

MicroStrategy common equity offers an asymmetric risk-reward profile with significant downside protection due to its sticky recurring revenue base (currently $318 million), history of consistent positive cash flow, and Fort Knox balance sheet (shout out to Andreas). The current valuation ascribes no value for a potential return of capital nor privatization in a highly active business intelligence M&A landscape (deals have been consummated at multiples more than double MSTR’s current valuation).

One of two outcomes will likely occur and both are positive for shareholders at current prices:

(1) Growth materializes and street estimates prove to be too low, MicroStrategy’s multiple will expand in-line with Tableau (whom faced a similar situation), as the shareholder base will transition from value to growth investors;

(2) Growth does not materialize and investments made in R&D and S&M are rolled back, leading to significant margin expansion as MicroStrategy is managed for cash generation and capital returns. In this outcome, the shareholder base would likely transition to income oriented investors.

Investment Merits

Our variant view for MSTR is merited by the following attributes:

Valuation Below Precedent Transactions

• MicroStrategy represents an attractive risk-reward trading under 3.0x recurring revenues, a 10% normalized FCF to EV yield and under 7x normalized EBITDA. While EBITDA will be depressed for FY18E due to investment spending, a sponsor or the management team can quickly scale back the incremental investments as they did in a previous restructuring starting in FY14 for which EBITDA margins went from 7% to 29%. We believe in a private no-growth or slow decline strategy, MSTR could generate 40% to 50% EBITDA margins.

• The M&A space for BI has been very active over the past decade. Many transactions in the space have occurred at multiples more than 4x-5x recurring revenues. Assuming similar transaction multiples, MSTR is worth $180 to $220 per share. In the past two years alone, competitors TIBCO and QLIK were purchased by Vista Equity & Thoma Bravo, respectively. The current price ascribes little to no probability of a take private nor value for a re-acceleration of growth.

•  Over the past five years, MicroStrategy has historically traded above 3x revenues and over 13x NTM EBITDA, materially higher than current and normalized EBITDA multiples.

• Sentiment particularly on the sell-side is neutral as they are taking a wait and see approach. Per conversations with sell-side, current forecasts past FY18E are conservative and assume no material growth is assumed nor margin expansion. Hence as the top-line grows and margins inflect, MSTR’s multiple should rerate above 5x recurring revenue.

Durable Cash Generative Business Model with a Strong Financial Position

• MicroStrategy is an enterprise software business that generates sticky recurring revenues (>90% retention rates) and strong margins (80% gross margins). Low capital intensity leads the Company to generate strong cash flow with cash flow from operations amounting to over 80% of EBITDA.

• MicroStrategy has a pristine balance sheet with over $600 million in net cash (40% of market cap). This provides optionality for return of capital via share repurchase or dividend.

• The Company has consistently generated positive free cash flow since FY03 (FY14 impacted by onetime restructuring costs).

• Despite a decline in new product licenses, recurring maintenance revenues (priced at ~22% of initial license fee) continue to grow slightly over 1% per annum while cloud subscription revenues have also continued to grow.

Diversified Customer Base & End Markets

• MicroStrategy boasts a diversified customer base with no customer concentration, serving a variety of industries and end markets ranging from tech companies (inc. Facebook), retailers, financial services companies, government organizations, and other industries.

Positioned for Growth

• Expert calls and industry sources discuss the Company as the lead front-end business intelligence software provider for enterprise reporting.

• Customer calls particularly on the enterprise side reflect positively on MSTR’s product and their mobile and cloud roll-outs. Calls also noted the product is mission critical and sticky / hard to replace due to infrastructure, reliability and training. Many customers rely on MicroStrategy’s 5,000+ reports which underpins business stability

• Given MicroStrategy’s leading market position and re-investment for growth, MSTR is well placed to take share from legacy providers such as IBM Cognos, Qlik, Information Builders and SAP. Expert note when MicroStrategy competes head to head against peers during a RFP, win rates have been more than 70%. This figure increases to 90%+ when a proof of concept has been completed.

• Peers such as IBM, Oracle and SAP are placing on-prem products at end of life cycles, opening up opportunity for MSTR.

• MicroStrategy historic sales strategy was predicated upon a “build it and they will come” approach. The Company historically operated under an “engineering” mentality predicated upon product quality being the key determinant that leads to sales growth. While product quality is critical, it is not the only factor. MSTR has taken cues from the success of Tableau and other smaller BI upstarts whom market extensively and invested heavily in building a recognizable brand name, participating at multiple conferences and attending key IT events to build awareness and a sales funnel. MicroStrategy is taking a page from their book and implementing this strategy.

• MicroStrategy has high-graded its sales force offerings with the addition of the Infomatica’s former CMO, Marge Breya as CMO and Kevin Norlin as EVP of Sales (formerly HP Enterprises, Dell Software and NCR).

Why Does This Opportunity Exist?

• MSTR traded down substantially from ~$190 per share post 2Q17 results as new product license revenue growth was -19% year over year as well as skepticism around the Company’s reinvestment plan given the lack of growth since announcement (these plans take time to implement).

• MicroStrategy is controlled by Michael Saylor, who currently holds a 17% stake and effective voting control through a dual-class share structure. Michael Saylor has been a controversial character due to his role in the FY2000 dot-com boom and bust, whereby MSTR experienced a ~90% decline in its share price. This was due to accounting irregularities as MicroStrategy was improperly recognizing revenues.

• Management was fined ~$11 million and drastic accounting changes were enacted. Fast forward 17 years, our expert calls have noted Mr. Saylor was traumatized from this experience (rightfully so) and has made crucial changes. Nonetheless, he is a polarizing figure whom our experts noted is heavily involved in all aspects of the business

• Additional noteworthy items: MSTR has a company aircraft which has been utilized for personal use by Mr. Saylor (likely to charter him back and forth from Miami), up to $1 million per annum in security expenses and $100,000 in catering, a cubicle and entertainment.

• Mr. Saylor’s voting control limits the ability to implement a change in control (i.e. activism or a forced sale).

• While negatives do exist, all experts agree Mr. Saylor is a competent CEO who has a very strong pulse on the industry. Furthermore, he has made smart capital allocation and business decisions such as timely share repurchases as well as increasing operating margins from FY14 to present.

• The CFO, Phong Le also has a solid background and is a positive for the accounting story. One former employee who spent 15 plus years at MSTR noted that accounting rules swung from loose to conservative post 2000 restatement.

• Street expectations are low, mainly due to skepticism around the $40MM investment in R&D and S&M. The sell-side has modeled revenue growth materially below Management’s 10% or greater top-line growth targets in FY19E. This effectively implies the $40MM investment in R&D and marketing bears little in terms of revenue growth. However, they have also assumed in this scenario EBITDA margins stay compressed. Our variant view is predicated upon one of two outcomes likely occurring (1) revenue growth materializes above 10% and MSTR trades in-line with BI peers; or (2) revenue growth fails to materialize and MicroStrategy is managed for 25% or greater EBITDA margins.

Valuation

It’s pretty clear that MSTR is one of the cheapest enterprise software assets on the market. Assuming ~40% “privately ran” EBITDA margins, MSTR currently trades for under 4x EBITDA. Moreover, enterprise software assets with low to no growth and lower gross margins currently trade for ~6x revenues (not recurring). Given that MSTR is so hated and expectations are ultra-low, any sign of a pulse should lead to a re-rating to a multiple closer in-line with peers.

Private Market Transactions

The BI software M&A market has been highly active over the past 10 years, with deal activity from both strategic firms and financial sponsors such as Vista Equity and Thoma Bravo. Sponsors are attracted to the space given the strong gross margins and sticky recurring revenues. Deals often are consummated at multiples greater than 5x recurring revenues and 15x to 20x EBITDA.

Technicals

• 2.6% short interest and $14 million daily liquidity

• Coverage includes Citi, CS, DB, First Analysis, Benchmark and JMP. Most are hold to neutral on the name and on the sidelines. Expectations are low. Extremely low.

• Largest shareholders include mostly mutual funds and indices. CEO/Founder Michael Saylor is the largest shareholder with a 17.6% stake valued at ~$265 million.

Catalysts

Capital Allocation

• Near-term catalyst (1 to 2 quarters) is a function of capital allocation, mainly through a share repurchase program announcement. Note at the JMP conference last year, management noted they would repurchase stock as new license growth resumes, hopefully in 2H18E.

• MSTR has aggressively repurchased their stock in the past.

• The investment in growth does not require MSTR to operate at negative operating margins nor cash flow.

Revenue Growth Re-Acceleration

• MSTR will invest ~$40 million per year in additional S&M as well as R&D capabilities to drive top-line growth in excess of 10%. If growth were to materialize over 5% per annum, MicroStrategy’s multiple would re-rate in-line with Tableau.

• Sentiment is negative/neutral on MSTR with the street taking a “wait and see” approach. Hence any revenue growth will lead to a re-rating and corresponding shareholder base shift from value investors to growth/GARP holders.

Take-Private

• M&A landscape for business analytics companies is very active with both participation from strategic and financial sponsors.

• Transactions have occurred in excess of 3.5x revenues and closer to 5x recurring revenues. Given MSTR’s market position, consistent profitability and ultra-low trading multiple, this is a likely outcome albeit timing unknown

• This is dependent upon Michael Saylor whom controls the business

Risks

• Insider control/take-under;

• Lack of execution on growth opportunities/stealing share;

• Competition (no as likely from Tableau).

• Capital squandered if growth does not materialize, or pursues an acquisition that destroys the Fort Knox balance sheet.