Back in January, I suggested that investors consider taking a bite out of MicroStrategy (NASDAQ:MSTR), an analytical software company. Since then, the stock has risen about 53%. But MicroStrategy’s first-quarter earnings, announced last week, were disappointing. Is it time to get out of the stock or get in?
Last September, I wrote that big technology companies, such as IBM (NYSE:IBM) were flush with cash that they intended 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 is to acquire analytical software companies — such as MicroStrategy.
Of course, MicroStrategy might not be acquired, so it’s important to consider how the company is performing on its own. And on the basis of its first-quarter earnings, investors might have 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.
The numbers suggest that MicroStrategy’s expenses might be getting out of control. After all, its net income of $1.1 million was 84% below last year’s level on a 37% increase in operating expenses to $87.8 million. Moreover, its cost of revenue is up as well — most notably a 58% spike in support costs to $28.5 million.
When MicroStrategy announced earnings, its stock sold off, but it’s up 4.6% since then. Does this mean it has further to run? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.
Based on a PEG of 1.06 — it trades at a P/E of 41.8 and its earnings are expected to rise 39.5% to $4.44 in 2012 — I’d say the stock is reasonably valued. The bad news is that its first-quarter earnings miss was huge and its expenses appear to be growing too fast. The good news is that its cash balance grew 17% to $203 million in the first quarter despite the profit plunge.
If IBM bought MicroStrategy, it would get an analytical software company with $483 million in sales and a long list of blue chip clients. For that, IBM would need to pay a premium over MicroStrategy’s $1.46 billion market capitalization — a price IBM could afford to pay.
Investing in MicroStrategy is not without risks, but I think its upside outweighs them.
Peter Cohan has no financial interest in the securities mentioned.