MicroStrategy: Slow Decline with a Bitcoin Twist (NASDAQ:MSTR)

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Insight

While MicroStrategy (NASDAQ:MSTR) often gets the press for the $4.2 billion (aggregate purchase price, worth $3.77 billion at current prices) in Bitcoin it holds, it it is ultimately a business intelligence software company. The company recently completed work on a new cloud-native BI software called MicroStrategy One:

Next, I’d like you to introduce yourself to MicroStrategy One. Eight years and more than 2.5 million engineering hours have resulted in MicroStrategy One, a modern, open cloud-based BI platform that can meet all the analytics needs of large enterprises. MicroStrategy One is enhanced by a suite of modern products, including Folder, Library, Workstation and Hyperintelligence. It is fully open, built on Restful APIs and Python. And because we’re an independent analytics company, we work transparently with all data sources and clients.

Likewise, our cloud platform runs on AWS, Microsoft Azure, and soon Google Cloud Platform, supporting multi-cloud deployments through a container-based architecture. Finally, MicroStrategy One serves all major categories of analytics, self-service, business reporting, advanced applications, and embedded analytics.

The product looks modern in its architecture and also serves as the basis for further development of the MicroStrategy product:

With the completion of the MicroStrategy One platform and the focus on rebuilding much of our platform over the past eight years, we are now able to focus increasingly on the product innovation that characterizes MicroStrategy. Our innovation focuses on four areas: one, basic analytics; second, augmented analysis; third, artificial intelligence; and four, the Lightning Network.

As a data company, I think MicroStrategy is well positioned to potentially innovate in these areas, and it certainly has so far. As new product performance plays out over this year and next, I want to focus on MicroStrategy’s core fundamental metrics and valuation to see if it’s a good investment here and now.

finance

Since MicroStrategy has been in business for a while and public since the second quarter of 1998, we have a decade of financials to compare and review.

The income picture has unfortunately been one of decline; MicroStrategy’s revenue peaked in 2014 and has declined in every year but one since.

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Along with this, the business became unprofitable from 2020 and less and less for the following two years.

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MicroStrategy generated a profit in its most recent quarter, although this was due to a tax benefit related to bitcoin valuation adjustments which amounted to 98.3% of the company’s revenue for the quarter.

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On the cash flow side, MicroStrategy has had a generally healthy performance – until recently. Last year’s operating cash flow was the lowest in ten years. In its most recent quarter, the company generated a strong operating margin of 30.7%, but had negative operating cash for the previous 3 quarters.

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Cash operating margin will be an important metric to watch going forward because MicroStrategy has a lot of debt: $2.241 billion, to be exact. The company still retains assets beyond that, providing a margin of safety should things turn dire, but it has also paid increasing levels of cash interest. The business will need to return to historical levels of operating cash flow to prevent this from becoming a problem.

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Overall, there’s not much to like here. MicroStrategy has declining revenues, a persistent lack of earnings, and an uncertain ability to maintain historical levels of operating cash flow.

I believe money is the thing to focus on here. MicroStrategy has high debt levels and has continued to derive more of its cash from financing rather than operations. If it continues to take on more debt, it will have to pay more cash interest, acting to consume operating cash flow before it becomes free cash flow. Since the company is already on shaky ground when it comes to generating cash from operations, this feedback loop could very well work against it.

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Nevertheless, the company has a long track record of generating positive cash from its operations, and I think it is possible that it will start to do so again. This will also need to be followed by a return to profitability.

The problem here is that the company is at the end of an extended product development cycle – 8 years apparently spent building MicroStrategy One. It must now put its new product on the market and try to return to growth. However, this requires investment rather than cost reductions and acts as a counterforce to improving unit economics for profitability and cash flow generation – which is its other top priority.

As such, MicroStrategy has a fine line to walk, and regaining both growth and profitability will be very difficult. Since it’s a software company, however, the economy is more viable than most; there is very little cost/variable cost of goods sold for software companies. Yet MicroStrategy is unlikely to achieve both a return to growth and a return to profitability. Trying to do both at the same time can result in the company getting neither.

The strategic situation in which MicroStrategy currently finds itself is not good, and that is certainly also true for shareholders.

Assessment

MicroStrategy stock is cheap on a forward P/E basis compared to the rest of the IT sector. It’s not too surprising.

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What is more unexpected is that it is trading expensive on a price/sell basis, indicating that it could still be overvalued.

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In terms of capital structure, MicroStrategy, at its current market capitalization of $3.77 billion, has debt of $2.24 billion, or 59.52% of its market capitalization in debt. Factoring in Bitcoin, however, the company can trade it for $3.77 billion at current prices. Bitcoin is liquid enough to get this money quite easily, although likely with a significant transaction cost. Nonetheless, that $3.77 billion would pay off all of his debt while leaving him with $1.53 billion in cash. Its market capitalization would then be 40.6% cash.

The valuation scenario here is distinct because the company’s core business is in decline, while it has immense exposure to an asset that fluctuates beyond its control. This creates significant uncertainty in its basic parameters and erodes the usefulness of relative value calculations over time. Here, I believe the best thing to do is to look at the stock chart and try to make sense of it.

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MicroStrategy has seen periods of significant volatility since its IPO, but it has never returned what the NASDAQ Composite has had since 2000. This is a stock that has been beaten by the dotcom bust and has survived for tell a story. However, he certainly did not prosper afterwards.

Looking at the stock’s 1-month rolling correlation coefficient against the NASDAQ Composite, we see that it had a strong correlation with the index during its recent peak. This makes me skeptical that the stock experienced “differentiated buying” (demand for its stock in particular) during this time. As such, I don’t see it returning to those prior price levels without a significant change in its trading conditions, which are at a difficult time.

MicroStrategy appears to be cheap by historical levels, but it also faces an uncertain outlook.

Conclusion

This one is a real flip corner.

The bull case here is that MicroStrategy is succeeding with its new product offering while establishing positive profitability and cash flow generation. As a bonus, Bitcoin will rise.

The bear case is that MicroStrategy sees no return to growth and is only making marginal progress on improving profitability. Bitcoin will also go down.

In both of these cases, Bitcoin may end up acting for or against the company’s outlook. Given the company’s outsized exposure relative to its market capitalization, that’s the way it is. This creates another layer of uncertainty for MicroStrategy’s outlook.

All in all, I think the Bear case will prevail here. If the company was so good at developing new products, I think it would have already made progress in this regard and reversed revenue declines years ago. I’m skeptical that a flashy new system will turn everything upside down in one fell swoop, especially since B2B tech spending has been under pressure economy-wide.

Also, I think the conflicting needs of the business to increase revenue growth while increasing profitability are not particularly realistic. Given the company’s indebtedness and the unit’s recent poor economic situation, it will face some tough decisions no matter which direction it pivots. Finally, I don’t expect Bitcoin to save the day.

We can see others share this view and are actively selling the stock. Although not as high as at the start of 2023, short-term interest on these stocks is 23.19% as of the date of this article.

Koyfin

Overall, I’d say MicroStrategy is a sell.

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