Time To Short MicroStrategy?

Summary

MicroStrategy is going through both a management and product transition with some serious unknowns about restoring growth and margin.

The shares have not corrected and discount everything going well over the next 12 months.

An informed eye would say they will have trouble, particularly in expanding into the identity and access market.

The company will survive, but the shares are vulnerable to a sell-off as investors wait for more positive results.

Nutshell

MicroStrategy (NASDAQ:MSTR) has had some challenges lately and is now working on both an organizational and product line transition that will take a year or more to play out. Meanwhile, the shares haven't had any meaningful pullback, which seems at odds with our expectations.

MSTR has long been a bit of a cult stock in the business intelligence (BI) segment due in no small part to a small stock float and its eccentric CEO. As the stock price chart included later in this article shows, the stock often swings up and down by 20 to 40 points (or about 20-40% based on an average share price of $100).

Recently, management acknowledged that revenue growth is low (+3% for June 2014) while expense growth is too high (+15% for the same period.) They announced a $40M restructuring, simpler product packaging, and have embarked on a brand new initiative called Usher, which is in the crowded identity management space. Management describes the transition as at least a 12-month period after which they believe they can generate 10% operating margins.

If we give them growth back to $625M in 2015, the 10% margin, apply a generous 20x multiple, and adjust for the $367M in cash, we end up with a total market capitalization of $1.6B, which is right where the shares are right now.

There are quite a few moving parts here and plenty of potential bumps in the road as the company works through the transition. We follow the identity management space closely and have a hard time envisioning high margin sales growth for MSTR in that market.

Challenges and Opportunities

Before firing off bullet points about the company, the end markets are healthy. Business intelligence is quite mature, but still growing 8% or so per year according to Gartner Group. Firms with differentiated solutions like Splunk (NASDAQ:SPLK), Tableau (NYSE:DATA), Varonis (NASDAQ:VRNS) and Qlik (NASDAQ:QLIK) are growing revenue much faster. Identity management is a little harder to pin down, but it is certainly growing in terms of activity and priority. However, here existing platform technology and online service providers are extending their solutions into this space. At the same time, numerous start-ups and smaller companies (like LifeLock (NYSE:LOCK), for example) target this specific market.

An excellent article by woodworker-analyst David Hernandez prompted our look at MicroStrategy, and it makes an excellent backdrop to our own views: MicroStrategy's Leadership Causing Company to Struggle.

Challenges:

· After a weak Q2 during a stated "transition year," the shares remain near highs, making the share price vulnerable to a major decline before "easy compares" begin to materialize in 2015.

· An increase in investor-related communication is probably a good thing, but the CEO might be prone to gaffs as a technical founder type. Sometimes it works out fine (as in Zuckerberg), or not (as in Andrew Mason.)

· Competition in BI is as stiff as ever, and MicroStrategy will find it difficult and/or expensive to get back into a mode of gaining (or at least not losing) market share. Despite fairly heavy spending on sales and marketing ($215M in 2015), revenue growth is slight. Gartner Group has MSTR in its "leadership quadrant," but behind eight other vendors including Microsoft (NASDAQ:MSFT), IBM (NYSE:IBM) and Oracle (NYSE:ORCL).

· Pushing into identity management is risky. Industry analysts have pointed out that this has "created an ambiguous product portfolio and blurred the company's marketing message" and "have diverted sales, development efforts, and focus away from addressing critical market requirements for ease of use and data discovery."

· To make matters worse, in identity management the strong players, notably IBM, are investing huge sums of money in being a leader in this market, including buying best-of-breed technology vendors and service providers. This is not a great market to attack without a 10-year plan.

· Management restructuring and "vacuum" in Head of Sales role is often a situation that causes some operational shortfalls, particularly in booking sales and hitting quarterly numbers. Even if the new sales executive is announced today, it takes three to six months to review and revamp existing processes and staff (where required).

Opportunities:

· With over $360M in cash on the balance sheet, MicroStrategy is in a good position to acquire companies that might accelerate their execution. Purchase accounting can help with growth and technology, and service-provider acquisitions might create a strong brand message in either BI or identity.

· In the BI space, firms like Datawatch (NASDAQ:DWCH), or even Veronis, would provide some new facets of functionality, growth and long-term positioning in the core market.

· Activist investor Apex Capital is targeting MSTR. If it gets its way and forces an ouster of the current CEO and a big stock buyback (with such a small float) the shares would get a major lift. And Apex would enjoy a nice return on the 467K shares it owns. For example, a $300M buyback at the

current price would take out about 20% of the already-thin float.

Conclusion

It seems unlikely that activist investors will be enough to unseat the current CEO, and the transition will proceed apace over the next year. If Apex Capital doesn't get satisfaction, then it will be tempted to sell off its shares. (Investors should be reminded that it's often the case that options are used in concert with outright share ownership, which can make ownership a murky issue.)

The corporate strategy to go after a meaningful position in the identity management space, even while its core BI business is not growing, is at least risky even if it's not just a plain bad idea.

At current prices, the stock appears to reflect a successful restructuring even though the company hasn't demonstrated much yet and has two to four more quarters to go. With management in the midst of an organizational restructuring and no announced Head of Sales, it may lose a step or two along with some of its better people.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.