Commentary: The rise, fall and recovery of MicroStrategy

The architect of MicroStrategy’s miraculous recovery departs

You can contact Nigel Pendse, the author of this section, by e-mail on NigelP@olapreport.com if you have any comments, observations or user experiences to add. Last updated on December 15, 2004 .

This is the extraordinary tale of MicroStrategy, which shot to amazing heights, almost collapsed and now, in an extraordinary comeback, has become an ordinary software company for the first time in its history.

In spring 2000, MicroStrategy became one of the most famous OLAP vendors outside the Business Intelligence industry, but not for reasons that any vendor would choose. Its rise and fall brought an unprecedented whiff of scandal and controversy to the otherwise placid world of OLAP, and it was, among other things, called “the poster child for aggressive accounting”. However, MicroStrategy’s disgrace was dwarfed by the Enron, Tyco, WorldCom and Xerox accounting disasters that followed. Curiously, however, the late John Sidgmore, WorldCom’s short-term CEO, had been on MicroStrategy’s board of directors since February 2000 (just before the restatement) and had also headed its now closed Strategy.com subsidiary — so he should have been no stranger to restatements of accounts that occurred before his involvement. However, having made significant capital structure changes and given a string of improved financial results in 2002 and 2003, MicroStrategy can now be called a remarkable software turnaround story and is both profitable and growing again.

Unlike most OLAP vendors, MicroStrategy was led by a flamboyant and exceedingly ambitious founder, Michael Saylor. He managed to achieve genuine high growth rates for the company before it went public without any need for external funding — the only OLAP vendor to have achieved this. But it seems that MicroStrategy’s continued unbelievably high post-IPO growth rates coupled with good profitability were just that: unbelievable. In March 2000, the company announced that it would have to restate its earnings for the two previous years (in the event, three years of earnings had to be restated), and it became clear that the company had been inflating its revenues ever since the IPO.

The shock restatement was triggered because the company was forced to defer the recognition of most of the revenues from two large contracts following a compulsory change to a more conservative accounting policy which requires revenues from complex contracts to be recognized over the implementation period, and not up front. It seems that MicroStrategy had not been complying with SEC accounting policies. It had been booking large contracts at the last moment of each recent quarter (as it later admitted, sometimes before they were actually signed), and immediately booking most of the revenues, despite much of the software being prepaid and the fact that the contracts included a significant service element. The company had to cancel its planned second secondary public offering, which had been expected to raise about $1bn ( a BI record) for the company and management shareholders (the latter taking almost 40 percent). Of the new funds, over $100m had been earmarked for investment in Strategy.com, and the company had already announced that it expected to move into the red because of the higher investment levels.

Both before and after the announcement, the company had been attracting adverse publicity over its accounting policies, for example in Forbes, National Post, Time, Slate, and the hitherto almost eulogistic (but now very critical) Washington Post. The PwC relationship — which involved reselling and advising on MicroStrategy's products, as well as auditing the company — also came under critical scrutiny. In less than 48 hours after the announcement, the Yahoo MSTR message board alone accumulated well over 4000 new posts, the vast majority of which were critical of the company and its management. The previous 4000 messages had taken over 15 months to be posted.

The 1999 revenue growth rate turned out to be 58.4 percent, rather than the spectacular 92.9 percent originally reported. License fee growth was a relatively modest 39.3 percent instead of the 96.9 percent originally reported. License fees in 1999 were 57 percent of the total revenues, rather than the impressive 70 percent originally reported.

Entry into the 99 Percent Club

The company's stock price dropped over 61 percent on March 20, 2000 (followed by further smaller falls over the following weeks) after the restatement announcement. Perhaps significantly, the fall actually started a few days before the announcement. Within hours of the release, the first of some 27 shareholder class action law suits had been filed, and the SEC soon issued a formal order of private investigation. The SEC’s findings on MicroStrategy’s auditor, finally released in August 2003, make interesting reading as they describe specific accounting misdeeds by both the company and its PwC audit partner.

MicroStrategy made a reluctant entry to the 99 Club on March 30, 2001, when its stock price first closed more than 99 percent down from its peak from just over a year earlier. It closed at $2.88, having closed at a peak of $313 on March 10, 2000 (with an intra-day peak of $333). The collapse in the stock price had followed the accounting scandals from March 2000, and the financial problems that followed. Fears of the looming dilution due in mid 2001 continued to drive the price down until MicroStrategy CEO declared a “war on short sellers”. With some fluctuations, the stock price has stayed in the region of about one percent of its peak, as can be seen in this link which compares MicroStrategy (MSTR) with the industry average over the last year. The stock dropped below $1 for the first time on June 21, 2002, but, after the 1:10 reverse split has grown almost ten-fold.

Both the rapid rise until ten days before the shock news, and the immediate fall before and after it are very clear. The huge peaks in volume are also very evident. MicroStrategy (MSTR) had peaked at $333 on March 10, 2000, and was down almost 95 percent to $19 exactly two months later on May 10. However, unconfirmed rumors of a $100m refinancing led to the price shooting up in the first week of June; the eventual announcement on June 19 of $125m ($120m net) of convertible preferred stock with investors led by Cayman Islands based Promethean Asset Management led to a slow slide, perhaps because of disappointment with the terms of the “toxic” deal (which has now been fixed). These figures are even worse than those anticipated in the shock March 20 announcement, and included a restatement of three years figures, not two. The Q1 2000 net loss of $32.9m was actually more than the restated net loss for the whole of 1999, but it was beaten the following quarter.

These figures have been adjusted to allow for a stock split in January 2000 and a reverse split in July 2002. The stock closed at $105.63 on its first day on June 11, 1998 and had its highest close of $3130 on March 10, 2000 (the peak was $3330). MicroStrategy joined the 99 Percent Club on March 30, 2001, when its stock price closed at $28.75, a fall of over 99 percent from the highest close. Subsequently, the price fluctuated and fell further to a lowest close of $4.50 on July 26, 2002. It had recovered to over $50 by April 2004, but it still remained almost 99 percent below its peak and about 50 percent down on the first day close.

Although MicroStrategy was able to spin off Strategy.com and raise $53m in a private placement financing in late 2000, in 2001 it became apparent that the Strategy.com business model, which was capital intensive and dependent upon advertising impression revenue, was not sustainable. MicroStrategy finally abandoned its failed Strategy.com project in September 2001 closing it down and laying off all the remaining employees. At one time, Strategy.com attracted a significant portion of MicroStrategy’s management attention and marketing budget and the company apparently had great ambitions for it. But the unit never generated significant revenue and it accounted for a significant portion of the company’s huge losses (and accounting errors).

On December 14 2000, MicroStrategy had announced that its executives had settled its SEC case. The deal was approved in April 2001. The company itself was not penalized, but three executives each paid $350,000 fines as part of a consent decree with the SEC, the largest penalties ever in a civil accounting fraud case not involving insider trading. The executives neither admitted nor denied the allegations contained in the SEC's complaint. Under the accord, Mike Saylor also agreed to repay $8.3m, Sanju Bansal $1.6m and Mark Lynch $0.14m to shareholders, as disgorgement in connection with the class action lawsuits. Furthermore, Saylor, Bansal and Lynch and the company agreed to refrain from future violations of federal securities laws. The company has made significant changes in how it is run to ensure compliance with securities laws. Lynch, the former CFO, also consented to the entry of an administrative order barring him from practicing before the Commission as an accountant, with a right to reapply after three years. Lynch was moved to a part-time consulting role with the company and quietly left in 2002.

Previously, MicroStrategy had announced on October 24, 2000 that it had reached agreement to settle its class action lawsuits, for about $100m, paid as a mixture of $80.5m five-year unsecured 7.5 percent interest promissory notes, stock with a minimum value of $16.5m, and five-year warrants to purchase 1.9 million MicroStrategy A shares at $40, which now have a post reverse split strike price of $400. The same three executives who were fined by the SEC (Saylor, Bansal and Lynch) personally provided $10m of the stock compensation, as noted above. Insurance will cover just over $13m of the compensation, in cash. MicroStrategy took a $113.7m non-cash provision for the litigation settlement in its September 2000 results. These class action securities were distributed in June 2002 which concludes the legal and financial issues relating to the restatement, though not the refinancing.

MicroStrategy cut staff rapidly and others departed voluntarily, so the current headcount is less than 40 percent of the peak of spring 2000. Total headcount has now stabilized at a little over 800 people (838 in August 2003). The revenue fall was much less than this, so headcount-related metrics (such as revenue/head) are actually now much healthier than when MicroStrategy was growing rapidly.

While MicroStrategy suffered some tumultuous times after March 2000, the company has been taking actions to turn the company towards profitability. In August of 2000, the company appointed Eric Brown, an experienced CFO from outside the company, as CFO; he became both President and CFO in November 2000, with the job of turning the company round. Through his leadership, in October of 2000 Brown announced a restructuring plan to get the company to profitability by the end of 2001. This plan included a reduction in workforce and in brand marketing with a refocus on lower cost product marketing.

Later, the plan expanded to include the elimination of non-core businesses (ie, Strategy.com, the CRM applications division, hosting & ASP services, and systems integration) and alignment of incentive compensation of executives and departmental managers with company profitability. All of MicroStrategy’s worldwide field and departmental managers are measured on contribution margin rather than revenue, which has increased efficiencies across the company. From a famously free-spending culture before the restatement, a chastened MicroStrategy has now belatedly instituted the financial controls that a conventional business would be expected to have.

Sorting out the balance sheet

Perhaps because of the dilution resulting from the potential conversion of its convertible preferred securities (otherwise known as toxic convertible preferred), or MicroStrategy’s announcement of a proposed reverse split in its stock, there was a sharp drop in the stock price on June 21, 2002, and it closed at $0.72, falling further to $0.55 in the following week, and then below $0.50, putting it in real danger of delisting. This is bad news for any company, but was much more serious for MicroStrategy, as it would have triggered a potentially enormous issuance of common shares upon conversion of the toxic preferred securities. As of the middle of 2002, the company had $76 million worth of preferred securities that, assuming conversion at $0.50 per share, would have resulted in more than 60 percent dilution to the common stockholders.

At the same time, it became critical for the company to sort out the complex and unstable balance sheet. After the restatement, a desperate MicroStrategy had been forced to refinance in June 2000 using whatever sources of finance were available to it, and these included ‘toxic convertibles’, where loans converted to stock at the prevailing rather than a fixed stock price. The lower the stock price, the more stock that would have to be issued to redeem the loans. With stock prices falling below $0.50 in July 2002, there was the risk of huge and growing dilution, and MicroStrategy became a shorting target for hedge funds.

This would have been a disaster for MicroStrategy, but the holders of the ‘toxic convertibles’ would also have lost out, as their investment would probably have become worthless. MicroStrategy astutely turned this imminent crisis into an opportunity in mid 2002 when it sat down with the three main lenders and negotiated a conversion of the stock on more advantageous, fixed terms that removed the downward pressure on the stock price. It also carried out the one for ten reverse stock split, moving the stock price to about $5, and thus avoiding the apparently inevitable, but potentially fatal, delisting. As a result, the balance sheet instability was cured. MicroStrategy also began redeeming some of its other notes (issued as part of the SEC settlement) at a deep discount. These notes could be redeemed for stock at MicroStrategy’s discretion, and so their remaining presence on the balance sheet was less of an issue than it seemed at first. As there was no liquid market in these notes, the holders of them would either have to wait for the scheduled repayment date or accept MicroStrategy’s occasional offers of discounted terms for early repayment, in the form of stock.

The recovery

For the quarter ended June 30, 2003, MicroStrategy posted GAAP profits for the sixth consecutive quarter and pro forma profits for the seventh consecutive quarter. It was also growing its license fees at a time when both Business Objects and Hyperion were shrinking theirs.

MicroStrategy picked a good time to convert its debt, when its stock had climbed to its highest level in over 18 months.

Another financial measure showing the evidence of a turnaround is the growth of EBITDA (Earnings before interest, taxes, depreciation and amortization), which is sometimes used as a proxy for cash flow. MicroStrategy’s EBITDA has been positive since Q2 2001 and on a trailing 12 month basis is $28.9m.

At the end of July 2003, MicroStrategy completed the process of cleaning up its balance sheet. It issued 1.7m new Class A shares to settle the $53m outstanding on its unsecured loan notes, thus eliminating its remaining long-term debt at a stroke. This transaction incurred a non-cash charge of $30.2m, leading to a GAAP loss in Q3 and for the whole of 2003. By executing this transaction when the stock price was almost at a two-year high, MicroStrategy minimized the dilutive effect. Eliminating this debt saved $4m a year in interest charges.

MicroStrategy also paid off its remaining short-term debt at the same time, leaving it entirely debt-free for the first time since late 2000. This also means that MicroStrategy no longer shows a shareholder’s deficit on it balance sheet. Not having a negative book value will significantly improve the company’s credibility with prospective customers and investors.

Finally, in the summer of 2003, for the first time ever, MicroStrategy became an ‘ordinary’ software company. It no longer proclaims grand visions to change the world or seeks comparisons with Mother Teresa and elite figures from history. It finally has comprehensible financials and a stock price that is neither absurdly inflated nor ridiculously low. It has a more normal employment policy, compared to the era when its sales revenue per employee were far lower than those of other BI software companies. It has instituted much-needed financial controls and the company is run conventionally for profit, not vision. It concentrates on selling BI software (which it is now doing rather successfully) and has put its dotcom misadventures behind it. And now that Mike Saylor has sold much of his stock, the ownership profile is closer to that of a normal public company (though the Class B high voting founders’ stock that he holds still gives him outright control).

In 2004, the company now has a positive cash flow, is debt-free and profitable, and is growing faster than the market as a whole, so it is again gaining market share from its larger competitors. This would not seem remarkable to people who knew the company only before 2000, but for anyone who witnessed the disasters in 2000 and 2001, it is a near-miraculous comeback from apparently imminent death.

In December 2004 it was announced that Eric Brown, the main architect of the astonishing financial recovery, would be leaving the company to become CFO at McAfee Inc. This news was not greeted favorable by the markets, and led to an immediate drop in MicroStrategy’s stock price, even though he was succeeded by Arthur Locke III, previously MicroStrategy vp of finance, overseeing the company’s worldwide accounting, tax, and financial reporting operations.

This page is part of the free content of The OLAP Report, but which represents less than a tenth of the information available to subscribers. You can register to access a free preview of a small sample of the large volume of subscriber-only information.

All information copyright ©2004, Business Application Research Center, all rights reserved.