Is MicroStrategy Still a Buy?

Two months ago I concluded that after a 53% rise between early January -- when I first recommended it -- and May 12, 2011, MicroStrategy (NASDAQ: MSTR) -- a $1.8 billion market capitalization analytical software maker -- had further to rise. Since then, MicroStrategy stock has risen 24% more and is up a whopping 85% so far this year after hitting a new 52-week high Thursday. Are MicroStrategy's best days behind it?

Behind MicroStrategy's rise is an implicit put option -- that is the possibility that the company might be acquired by a company interested in expanding into MicroStrategy's analytical software industry.

A case in point it IBM (NYSE:IBM) which is flush with cash that it intends to use for acquisitions. IBM, in particular, is very interested in analytical software, a topic about which I posted in April, and the company expects to generate $16 billion in revenue from selling analytical software by 2015. One way for IBM to achieve that goal would be for it to acquire analytical software companies — such as MicroStrategy.

Of course, there is a good chance that MicroStrategy will remain independent. If so, does its stock still have further to run or is now a good time to take the 85% profit you would have earned if you had bought the stock in January?

There are two recent product announcements that could propel MicroStrategy into rapidly growing markets, according to Information Week:

• Gateway for Facebook would let companies trying to market to Facebook users target the most frequent communicators and influencers. Gateway for Facebook would do this more efficiently than competing products and thus enable marketers to get the highest return on their marketing investment.
• MicroStrategy Cloud would let companies analyze their data on MicroStrategy's computers -- taking advantage of the rapidly growing demand by companies to outsource their computing -- so-called cloud computing.  

However, there is one reason to pause -- first quarter earnings that missed expectations. MicroStrategy's first-quarter earnings might investors might reason to pause. Although its revenue was up 31%, its earnings per share of 10 cents a share badly missed the Thomson Reuters consensus estimate of 39 cents a share. However, investors appear to view this big miss as an aberration.

On the other hand, there are three offsetting factors that strengthen the case for investing:

• Long-term growth and solid financial position. MicroStrategy has grown steadily. Its $483 million in revenues have increased at an average rate of 11.2% over the last five years; however its net income of $38 million has been falling at a 7.7% annual rate over that period. However, its cash has been falling while its debt has risen. Specifically, MicroStrategy's cash rose at a 22% annual rate between 2006 ($79 million) and 2010 ($174 million) and it has no debt.
• Out-earning its capital cost but more slowly. MicroStrategy earned more after-tax operating profit than its cost of capital, however it's losing ground in that quest. MicroStrategy's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was -5%, based on 2009 revenue of $378 million, and EVA that declined from $40 million in 2009 to $23 million in 2010, using a 9% weighted average cost of capital.
• Inexpensive stock. MicroStrategy's price to earnings to growth (PEG) ratio of 0.93 makes it under-valued (a PEG of 1.0 is considered fairly priced). MicroStrategy's P/E is 52.6 and its earnings are expected to grow 56.5% to $4.50 in 2012.

It looks like MicroStrategy still has further to rise -- with one big caveat. If it does not exceed earnings expectations when it reports second quarter results, investors could suffer. Based on its ability to introduce new products that customers want, a drop in its stock price might be an opportunity to invest at an even lower price in this solid company.