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Peering Inside A "Black Box"


C'mon Michael, you can tell me all your little secrets


The trepidation over Microstrategy's (MSTR) 10-Q was apparently all for naught. I am no forensic accountant, or non-forensic accountant for that matter, but just about anyone who can balance a checkbook and considers him/herself qualified to buy a house on 110% financing, could read and understand MSTR's latest financials. Without nitpicking about "modeling type" metrics, what you are left with is this:

  • 2004 - 2006 Avg. Operating Income Growth: 21% (Based on reported numbers and Street estimates)
  • Tr. 12 Months Avg. Sales Growth: 29.1%
  • Tr. 9 Quarters Avg. Sales Growth: 24.7%
  • Tr. 12 Months Free-Cash-Flow-To-Enterprise-Value Yield: 13.9
  • Net Cash Per Share: $9.30
  • All "margin" figures trending in the right direction
  • Best in class technology

As our friend Jeffrey Saut often reminds us, perhaps the most important element of a successful investment is what valuation one pays for it. Jeff uses the Benjamin Graham rule of thumb of looking for an Earnings Yield 2x the current 10 year treasury, as a guideline for a "reasonably safe" purchase price. Right now the EY threshold is about 8.5%. Tweaking the EY rule to fit a software company model - software companies typically throw off cash well in excess of earnings, and carry a lot of cash on the balance sheet - a reasonable substitute could be the Tr. 12 Months Free-Cash-Flow To Enterprise Value Yield. At a current 13.9%, I think even Boo would have a tough time arguing against this one.

Too good to be true? Who knows. And there's the rub. It is this doubt and the lingering questions that follow MSTR's management and history, which probably account for the fire-sale valuation of the stock.

Here are the flies in the story.

  • During the tech bubble, CEO Michael Saylor's egomaniac behavior resulted in one of the most spectacular financial wipe-outs of the time. Here and here you can read the gory details. Has he learned? If he did, it was no small lesson staring at him. The fact that Saylor has complete control of MSTR through his voting-class stock does not exactly instill peace and serenity in one's mind.

  • Beginning in Q4 of 2004, MSTR management has slashed the amount of information it releases with quarterly earnings (God I hope Herb Greenberg does not read this) and for all intents and purposes has gone on "radio silence" during the conference calls. The only info investors are going to get out of management will be in the SEC filings. On the last conference call, the reaction of analysts and shareholders to this "black-box" attitude was bordering on the furious.

  • If that were not smelly enough, 3 months ago MSTR's auditor PwC, effectively fired the client. Grant Thornton, of Parmalat's fame, is the new auditor.

  • The company is generally viewed as having the best available technology, especially for large enterprises. But, I suppose to remain consistent with its other quirks, it also has a reputation of being rather abrasive with its own clients. Not shocking given the character of its leadership.

So why mess with these many intangible headaches? Well, back to square one: the numbers that MSTR is putting up are pretty darn impressive (if they are not cooked again) and the valuation allows for unexpected "execution" glitches in the future, something that investors cannot otherwise glean given the lack of disclosure.

Ultimately though, I am on the long side of this one on a gut feel that Saylor's behavior amounts to a gigantic "middle digit" to the financial community which - rightly or wrongly - he feels has persecuted him for the last 4 years. With business humming, he has decided to let the cash do the talking as he watches the sell-siders trash in the wind.

Hopefully that finger does not end up poking shareholders in the eye a second time.

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Position in MSTR
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