Microstrategy Take-home case analysis Spring 1 2009qc2/accountg441/files/FSA Take-home... · Microstrategy for fiscal 2000, under the following set of assumptions. You can assume

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DUKE UNIVERESITY, FUQUA SCHOOL OF BUSINESS

ACCOUNTG 441: Financial Statement Analysis Take-home case analysis, Spring 1, 2009

Due: before class starts on Tuesday, Feb. 10, 2009

Instructions: This is a take-home assignment to be completely individually. You can consult only materials distributed for this course, including the course packet, class notes, the textbook, and materials distributed from the course website for this assignment. You cannot discuss any part of the assignment with any one before it’s due. Here “discuss” is defined in its broadest sense, including email or any other means of communication. Failing to do so is a violation of Fuqua’s Honor Code. Make sure you have the following documents:

1. Two CFRA reports, dated Nov. 9, 1999 and Jan. 24, 2000 2. Two FirstUnion analyst reports, dated Nov. 15, 1999 and Dec. 9, 1999 3. Two Forbes articles: “Microstrategy’s Curious Success” dated March 6, 2000 and

“Fallouts: Micropanic: Is the accounting scandal that hit MicroStrategy about to claim more casualties?” dated April 17, 2000.

4. One Business Week article, “Did the Auditors Cross the Line?” dated Sept. 25, 2000

There are three questions to this assignment. Your grade will depend on your answers to these questions. These questions are not related to each other. A spreadsheet file for this assignment, FSA Takehome Spring 1 2009.xls, is posted to the course webpage. You should type your answers to each question in their corresponding sheet, i.e., enter your answers to Questions 1, 2 and 3 in sheets named “Question 1”, “Question 2”, and “Question 3”, respectively. You are required to enter your answers in the spreadsheet and turn in a hardcopy print out (in class) and an electric version of the spreadsheet (online). Please submit the electronic version online. The submission link is on the calendar page of the course website. Before submission, please make sure to include your name as part of the file name for your spreadsheet. Both the electric and hardcopy submissions are due by the start of your registered session (10:30am or 1:30pm) Feb. 10, 2009.

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Question 1: Prepare the correct Statement of Cash Flows (10 points): refer to the analyst report on Royal Caribbean prepared by Salomon Smith Barney analysts Jill Krutick and Spencer Wang dated April 30. 1999. This report was included in your session 6 handout and is also available at the course website. The report contains the pro forma financial statements for year 1999 to 2003. For this question, let’s focus on the 1999 pro forma financial statements. Overall it’s a fairly carefully prepared report and all numbers in the pro forma income statement and pro forma balance sheets are correct. However, its 1999 pro forma Statement of Cash Flows (reproduced in Sheet 1 of the spreadsheet file) contains mistakes/inconsistencies with the pro forma income statement and balance sheet. Your task here is to identify and correct these mistake(s) and inconsistencies. Hint: I do not understand how they get $37.1 for “changes in working capital” in the Statement of Cash Flows. For Questions 2 and 3, you may refer to the materials on MicroStrategy. Question 2: Pro forma for 2000 with given assumptions (15 points). Assuming that we stand at the end of December 1999, prepare a set of pro forma financial statements (including balance sheet, income statement and statement of cash flows) for Microstrategy for fiscal 2000, under the following set of assumptions. You can assume the historical numbers given in the spreadsheet are accurate.

a. Revenue growth rate is 40% from 1999 to 2000. b. Gross profit margin is 80%. c. R&D expense is 15% of the revenue in year 2000. d. Sales and marketing expense is 50% of the revenue in year 2000. e. General and administrative expense is 10% of the revenue in year 2000. f. Other income (expense) net (including any income statement effect of the

transaction described in item k below) is 1% of the revenue in year 2000. g. Tax rate is 38%. h. Cash and cash equivalent is maintained at 25% of the revenue in year

2000. i. Accounts receivable collection day is 60 days (where the A/R turnover

ratio is calculated as revenue/average balance of accounts receivable). j. Other current assets is 3% of the revenue in year 2000. k. At the end of year 2000, a building with a net book value of $2 million

will be sold for cash of $3 million. Depreciation expense for year 2000 is 30% of the beginning book value of PPE. Capital expenditure for year 2000 is expected to be $20 million.

l. Accounts payable is 5% of revenue. m. Deferred revenue is 6% of revenue. n. Other current liabilities is such that current ratio (calculated as total

current assets/total current liabilities) is 3.5. o. Microstrategy will buy back a total of $5 million common stocks during

2000. p. Microstrategy will channel the excess cash by borrowing or paying back

its long term debt.

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Question 3: Pro forma for 2000-2004 under your own assumptions (15 points). In the Dec. 9 report, the price target for Microstrategy was raised to $300. And the stock price did indeed reach that level three months later.

For this question, you are free to choose your own assumptions to prepare pro forma financial statements for Microstrategy fiscal years 2000-2004. Perform a free cash flow valuation of Microstrategy that yields the price target of $300. The valuation date is Jan. 1, 2000. Assume that the weighted average cost of capital is 15%. The valuation should be based on your pro-forma forecasts, and your input assumptions must support a valuation of $300 per share. That is, you can make whatever assumptions needed, as long as they support a valuation of $300 per share, whether or not you find your assumptions or the $300 valuation reasonable. You can assume that the 2004 free cash flow grows at a constant rate (whatever rate you assume) thereafter. You can assume the historical numbers given in the spreadsheet are accurate.

Calculate the 2004 return on assets, net profit margin (i.e., return on sales) and total asset turnover. (No need to write up the following question, but do think about it: Do these figures – and the terminal value growth rate – seem reasonable to you?)

No Write-up is required for the following questions. They are for you to think about when reading the Microstrategy materials. We will briefly discuss these questions in class.

1. Did Microstrategy attempt to manipulate accounting numbers? If so, which number(s) and how?

2. Why do you think management did this? Do their actions tell you something about management’s beliefs about pricing mechanisms in the markets?

3. Give a brief overview of the events related to Microstrategy’s alleged earnings management, highlighting what you feel are the main points. In doing this, pay attention to when the first CFRA report came out, when the first Forbes article came out, and when the big drop in price happened. Given these timing differences, can we say something about what information and what level of analysis investors in Microstrategy were using at the time?

4. Auditors, financial analysts, business press, sophisticated buyers, and specialized analysis services such as CFRA all perform monitoring roles in the capital markets. Discuss what part these groups played in the sequence of events. Did they, in your view, provide effective monitoring? Were the roles they played in line with your expectations?

5. Do you think there were long-term consequences for Microstrategy? For example, what implications did these events have on the firm’s financing option (e.g., possibilities to get additional debt and/or equity financing)?

EPS ESTIMATES (FY 12/31) 1998A 1999E 2000EQ1�March $0.01 $0.05A $0.05Q2�June 0.03 0.08A 0.12Q3�September 0.05 0.09A 0.13Q4�December 0.07 0.11 0.19Full-Year EPS $0.15 $0.33 $0.49

P/E RATIOS NMF NMF NMF

SHARES OUTSTANDING, FD: 42.7 millionMARKET CAPITALIZATION: $3.5 billion

AVERAGEVOLUME: 281,250

INSIDEROWNERSHIP: 68.4%

INSTITUTIONALOWNERSHIP: 13.4%

3�5 YEAR EPSGROWTH RATE: 50%

MICROSTRATEGY INC. (MSTR�OTC) STOCK RATING: 1PRICE TARGET: $100

Reiterate Strong Buy; Buying Opportunity On CFRA Report

PRICE: $82 5/8 November 15,199952-WEEK RANGE: $101�$15 Sarah BernsteinDIVIDEND/YIELD none/nil (212) 891-5031

KEY POINTS:

� We believe Microstrategy (MSTR) was under pressure Friday primarily due to the releaseof a CFRA report that was negative on MSTR and offers an excellent buying opportunity.

� We have not seen the CFRA report yet but believe it highlighted three concerns, none ofwhich, in our opinion, are conclusions supported by a sound analysis of the facts.

� Without the NCR deal, the company would have missed expectations for Q3�99. TheNCR deal has given MSTR excellent Q4�99 visibility.

� MSTR cash flow isn�t strong. We believe MSTR is, and should be investing for growth.

� Four management individuals selling. All MSTR management we speak to believes thecompany is at a major inflection point.

� From our conversation with the company Friday afternoon, November 12, we believeMSTR is on track for a strong Q4�99.

� We believe MSTR is poised to possibly generate significant upside to our FY�00 revenueestimate of $285 million (MM).

� In our opinion, there is also potential multiple expansion of MSTR�s market cap/revenue.

� We reiterate our Strong Buy rating.

Microstrategy is a rapidlygrowing, leading provider ofhigh-end Decision SupportSoftware (DSS) applications.

Rating Legend1�Strong Buy2�Buy3�Hold4�Underperform5�Sell

MSTR.111599B

2 Microstrategy Inc. November 15, 1999

INVESTMENT OPINION: STRONG BUY

In our opinion, all three issues that we understand were raised by CFRA incorrectlydraw negative conclusions about what we believe is a company exhibiting evidencethat it is beginning a potentially powerful upswing, off a base history of strong growth.

Below is our brief comment on each of the three points noted above. We will providefurther commentary once we have had an opportunity to review the CFRA report.

We Believe The NCR Deal Gave MSTR Excellent Visibility On Q4�99 since it was ableto hold deals for Q4�99 that it could have booked in Q3�99, not to mention the fact thatthe NCR agreement was very positive on its own, in our opinion.

Cash Flow: MSTR Is Investing For Growth, like every company targeting the enormousopportunities represented today in the growth in e-business enterprise software. Inaddition to ramping on sales, R&D, and investing in Strategy.com, MSTR is about tolaunch its first-ever marketing campaign (print ads expected in December 1999, followedby online and TV spots in the January/February time frame). In our opinion, theseinvestments are positive strategic moves. We would be concerned if MSTR was notinvesting for growth at this stage of the market.

Key Management Of MSTR Is Not Selling Any Significant Shares Of MSTR. CEOMike Saylor holds over 52% of the 42.7MM MSTR average shares outstanding, FDreported at the close of Q3�99, and expects to be with the company for the next �30 years.�Saylor stated in MSTR�s Q2�99 conference call that he would begin selling 1% of his shareson a quarterly basis for �estate planning purposes� on advice from his financial advisors.Despite this, we believe he sold no shares after Q3�99 reporting, despite the recent runup in MSTR. We believe all of MSTR management thinks the company is currently ata major inflection point in its business and is excited about the growth prospects.

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

20

40

60

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100

0.86

1.72

USD

Millions

11/12/98 to 11/15/99MSTRCL AMICROSTRATEGY INC

82.00Last: 15.50Low: 99.88High:

30 day moving avg300 day moving avg

Source: First Union Securities, Inc.

Microstrategy Inc. November 15, 1999 3

MSTR Delivered Outstanding Q3�99 Operating Results With Significantly Better-Than-Expected Revenue Performance and blue-chip new customers across all productareas. MSTR closed Q3�99 with 840 customers, booked revenue from 60 new customers,(as compared to 34 new customers in Q2�99), and closed four $1 million-or-largertransactions. The company is also successfully leveraging its installed base. Existingcustomers represent typically between 65% and 75% of revenue during a given quarter.In our opinion, MSTR is leveraging its dominant position in the high-end businessintelligence, or decision support market, to target its products for use in the burgeoning�intelligent e-business� market.

Valuation And Investment Conclusions. At $82 5/8, MSTR is trading at 12.4x our FY�00revenue estimate of $285 million forecast and at 169x our FY�00 earnings forecast of $0.49.Using a market capitalization of 14.7x our estimate of MSTR�s FY�00 revenue (a discountto comparables such as Broadvision [BVSN-OTC-$88 1/2, Buy rated], which is currentlytrading at a market cap/revenue of 47.7x our FY�00 revenue estimate of $161 million),our 12-month target price for MSTR is $100. In our opinion, there may be upside to bothour revenue estimates and MSTR�s multiple as the company further proves its capabilitiesin the e-business market. Our estimates include no potential revenue from Strategy.com.

Risks. (1) Potential fluctuation in operating results; (2) lengthy sales and implementationcycle; (3) ability to attract, train, assimilate, and retain highly qualified personnel; (4)rapid changes in technology; and (5) greater competition from larger, well-financed, well-established software vendors.

Additional information is available upon request.

First Union Securities, Inc., maintains a net trading market in MSTR and BVSN.QR: 2 - MSTR, BVSN

4M

icrostrategy Inc.N

ovember 15, 1999

Microstrategy, Inc. (OTC: MSTR)

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BUSINESS SERVICESEducation / Marketing

Jerry R. Herman, CFA (216) 574-7351Robert L. Craig (216) 574-7350

Leigh D. Pollak (312) 574-5592Jerome Sheehan (216) 574-7339

Outsourcing SolutionsMark S. Marcon, CFA (804) 344-6268

Mark E. DeVaul, CPA (804) 782-6642

COMMUNICATIONS & TECHNOLOGYInternet / Business to Business

Charles J. Wittmann, CFA (804) 782-3316Matthew H. Cullen (804) 344-6205

Internet / Business to ConsumerCarolyn Luther Trabuco (212) 891-5026

Allison E. Brown (212) 891-5045David A. Trossman, CFA (410) 625-6371

Christopher M. Gay (410) 625-6381Internet / Digital Marketing Services / Technology

Bennett Notman, CFA (804) 344-6430Joseph D. Hiller (804) 782-6629

Internet / Enterprise SoftwareSarah T. Bernstein, PhD (212) 891-5031

Charles Goldblum (212) 891-5042Internet / IT Services

Edward S. Caso, Jr., CFA (410) 332-5239Richard A. Church (410) 332-5238Rebekah Whalen (410) 625-6373

Internet / Wireless TechnologyMark A. Roberts, CFA (650) 571-7285

Michael A. Whitfield (312) 574-5147Internet Access & Hosting

Andrea Grosz (312) 574-6235Kerren B. Berger (312) 574-5175

MediaKenneth T. Berents (804) 782-3417Asa W. Graves, CFA (804) 782-3765James B. Boyle (212) 891-5038

Matthew A. Karnes, CPA (212) 891-5039Telecommunication Services / Wireless

Jennifer A. Murtaugh (312) 574-5985Jill A. Desmarais (312) 574-5983

Telecommunication Services / WirelineFrank G. Murphy (804) 782-3694

Frank G. Louthan, IV (804) 782-3386James Wilhelm, Jr. (804) 344-6431

CONSUMERFood, Restaurants, and Tobacco

Jeffrey F. Omohundro, CFA (804) 782-3342L. James Borges, CFA (804) 782-3628Katie H. Willett (804) 782-3553Scott Schumann (312) 574-5991

R. Shane Glenn (804) 782-3049John P. Walsh (804) 782-3273

Consumer ProductsSteven M. Bernard, CFA (312) 574-6259

Tim Coats, CPA (312) 574-5197Specialty Retailing

H. B. Thomson III (804) 782-3441Brett P. Hawkins, CPA (804) 782-3760

Kelly B. Armstrong, CFA (415) 291-1230Ralph E. Jean (804) 344-6275

Shawn S. Tesoro (804) 344-3952

ENERGYExploration & Production

David A. Garcia, CFA (713) 346-2803Katherine Rice (713) 346-2801

Oilfield Services / MLPsYves C. Siegel, CFA (212) 891-5036

James S. Rhodes (212) 891-5047Arnold P. Kaufman, CPA (212) 891-5032

FINANCIAL SERVICESBanks

Edward R. Najarian (804) 782-3422Stephanie L. Green (804) 782-3320

Bradley S. Vander Ploeg (312) 574-5923David J. Long (312) 574-5938

InsuranceSteven C. Huffines, CFA (312) 574-5924

Specialty FinanceMeredith A. Whitney (212) 891-5040

Seth B. French (212) 891-5009Douglas C. Sipkin (212) 891-5062

FURNISHINGS, FLOORCOVERINGS &TEXTILES

Floorcoverings / FurnitureJohn A. Baugh, CFA (804) 782-3297

Scott H. Miller (804) 782-3027Mark S. Tyler, CFA (804) 344-6258

TextilesBryan C. Hunt, CFA (804) 782-3367

Mark O. Doehla (804) 344-6254

HEALTH CAREAssisted Living

Phillip J. Martin (312) 574-6280Disease Management / Hospital Management /

Managed CareJoel M. Ray, CFA (804) 782-3341

Julie B. Sydnor (804) 344-6409Healthcare Information Technology

Christopher S. Russ (212) 891-5037Marcus Cohen (212) 891-5041

Healthcare Services / Medical DistributionSeth Teich, CFA (804) 782-3074

Geeta Vemuri, PhD (804) 782-3617Healthcare Technology

Albert L. Rauch, PhD, CFA (312) 574-5935Darren Mac (312) 574-6993

Medical DevicesAndrew T. Jay, DMD (617) 342-1467

Jason S. Robins (617) 342-1443

INDUSTRIALElectric, Gas and Water Utilities

Thomas E. Hamlin, CFA (804) 782-3240Matthew T. Stith (804) 344-6449

Industrial Growth / ConstructionRobert R. Marshall (804) 782-3622

Greg Korondi (804) 782-3392Industrial Products and Services

Jennifer J. Cole, CFA (212) 891-5030Thomas J. D�Amore, CFA (312) 574-5385

REAL ESTATE / REITS / LODGINGHealth Care

Phillip J. Martin (312) 574-6280Land

Burland B. East, CFA (619) 702-4355Lodging & Leisure

Jeffrey J. Donnelly, CFA (619) 702-4356Multifamily

Stephen C. Swett (804) 344-6217Donald Fandetti, CFA (804) 782-3611

Office & Industrial, Diversified & SpecialtyChristopher P. Haley (804) 782-3708

Alice Hoey (804) 782-3442Sasha P. Hogan (804) 344-6164

D. Hollis Taylor (619) 702-4358Retail, Net Lease, and Storage

Eric Lohmeier (312) 574-5963

SUPERVISORY ANALYSTSWilliam K. Gooch, CFA / (804) 344-6427 Sarah A. Pair / (804) 782-3795 William B. Tiritilli / (312) 574-5913

This is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments mentioned. The informationhas been obtained or derived from sources believed by us to be reliable, but we do not represent that it is accurate or complete. Any opinions orestimates contained in this information constitute our judgement as of this date and are subject to change without notice. First Union Securities,Inc. (�FUSI�), or its affiliates may provide advice or may from time to time acquire, hold or sell a position in the securities mentioned herein. FUSIis a subsidiary of First Union Corporation and is a member of the NYSE, NASD and SIPC. FUSI is a separate and distinct entity from its affiliatedbanks and thr i f ts . SECURITIES: NOT FDIC-INSURED � NOT BANK-GUARANTEED � MAY LOSE VALUE

Kenneth T. Berents Director of Research (804) 782-3417Joel M. Ray, CFA Assistant Director of Research (804) 782-3341Steven C. Huffines, CFA Assistant Director of Research (312) 574-5924Linda L. Ridley Administrative Manager (804) 782-3362

EPS ESTIMATES (FY 12/31) 1998A 1999E 2000EQ1�March $0.01 $0.05A $0.05Q2�June 0.03 0.08A 0.12Q3�September 0.05 0.09A 0.13Q4�December 0.07 0.11 0.19Full-Year EPS $0.15 $0.33 $0.49

P/E RATIOS NMF NMF NMF

SHARES OUTSTANDING: 42.7 millionMARKET CAPITALIZATION: $8.3 billion

AVERAGEVOLUME: 303,890

INSIDEROWNERSHIP: 68.4%

INSTITUTIONALOWNERSHIP: 15.8%

3�5 YEAR EPSGROWTH RATE: 50%

MICROSTRATEGY INC. (MSTR�OTC) STOCK RATING: 1PRICE TARGET: $300PRIOR TARGET: $100

Reiterate Strong Buy; Raising Price Target To $300 From $100

PRICE: $194 December 9, 199952-WEEK RANGE: $205�$15 Sarah BernsteinDIVIDEND/YIELD none/nil (212) 891-5031

KEY POINTS

� From our meetings with Microstrategy (MSTR) management on December 7, we believeMSTR is well positioned to become a leading E-CRM software platform.

� We anticipate announcements of new MSTR customers and strategy.com affiliatesduring Q4�99.

� The MSTR television campaign is scheduled to begin January 30, 2000, during the SuperBowl (four commercials).

� MSTR print ad campaign is underway in December�99 in various business and technol-ogy magazines including Forbes, Fortune, and Business Week.

� In our opinion, MSTR is successfully accelerating its technology partnership strategy,including recently announced alliances with Net Perceptions and Sybase.

� We believe MSTR�s strategy.com program is gaining momentum, attracting affiliatesand customers.

� We believe MSTR is likely to exceed our Q4�99 revenue estimate of $60.0 millionand is poised to possibly generate significant upside to our FY�00 revenue estimate of$285 million.

� We are raising our 12- to 18-month price target on MSTR to $300 (Market Cap toRevenue FY�00 Ratio of 45.0x) from our prior target of $100.

� We reiterate our Strong Buy rating and maintain our AAL listing of MSTR.

Microstrategy Inc. providessoftware applications en-abling enterprise-scale data-base analysis and automatedinformation dissemination toemployees, partners, andcustomers via Internet, e-mail, telephones and pagers.

Rating Legend1�Strong Buy2�Buy3�Hold4�Underperform5�Sell

MSTR.120999B

2 Microstrategy, Inc. December 9, 1999

Source: First Union Securities, Inc.

INVESTMENT OPINION: STRONG BUY

MicroStrategy Is Poised To Become A Major Platform Vendor Across The E-CRMMarketplace. Earlier this week, our meetings with Microstrategy (MSTR) managementCEO Michael Saylor, COO Sanju Bansal, CFO Mark Lynch, and vice president ofmarketing Joe Payne, further underscored our confidence in MSTR�s ability to becomea leading vendor in the E-CRM marketplace. In our opinion, MSTR is an early leaderin the exploding market for delivering a one-to-one relationship with customers viawireless communication channels. We believe that MSTR�s 800+ installed customer basegives MSTR a competitive advantage in offering its e-Business intelligence products tothe marketplace. MSTR continues to display compelling strategic direction and executewell in all metrics including financial performance, product development, and strategicpartnership building.

Advertising Campaign �Kicking Off�. Pushing the strategy.com branding inititative,MSTR is advertising in various leading magazines including Forbes, Fortune, and BusinessWeek. A television campaign will be highlighted by four ads during the Super Bowl onJanuary 30, 2000 (at a total cost of approximately $2.5 million).

More Customers Wins For MSTR �Intelligent� e-Business Solutions. In recent weeks,MSTR announced new business intelligence customers including US Office Products,Netradio.com, and SatoTravel. On December 7, Ameritrade went live with its OnlineInvestor Index powered by MSTR�s business-intelligence platform. MSTR managementadds that their E-CRM solutions are being leveraged in B2B as well as B2C applications.One customer, Kmart, is developing a supplier information network based on MSTR�sbusiness intelligence and information dissemination tools.

MicroStrategy Joint Marketing/Sales Agreement With NCR Moving Forward. NCR isdedicating 20 sales representatives to exclusively to re-selling the MSTR product suite.MSTR is dedicating six sales representatives to this joint agreement. MSTR anticipatesa joint team meeting to take place during December 1999.

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12/10/98 to 12/9/99MSTRCL AMICROSTRATEGY INC

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30 day moving avg300 day moving avg

Microstrategy, Inc. December 9, 1999 3

MSTR Strategy.com Initiative Rolling Out Successfully. MSTR�s strategy.com isnow live with a finance channel and is testing a beta-version of a weather channel tobroadcast requested information to individuals by phone/email/pager. 38 affiliates (upfrom 23 at the close of Q3�99) have enlisted to brand-sell strategy.com information,including washingtonpost.com and phone.com. Live strategy.com sites include EarthLinkand Usatoday.com. Management anticipates royalty fees from strategy.com affiliates tobegin in Q1�00.

Key Partnerships Continue To Grow. In our opinion, MSTR is expanding salesopportunities via its growing partnership base that number over 200 systems integrators,e-Business software vendors, and platform partners. MSTR�s OEM partners now includeNCR, Accrue Software, Prime Response, and Exchange Applications; in addition torecently announced partnerships with Net Perceptions, a leader in real-time personal-ization software, and Sybase, a leading database software provider. MSTR COOSanju Bansal anticipates adding three-to-five new OEM relationships per quartergoing forward.

Wireless Transaction Engine Expected Q1�00. MSTR expects to add wireless transactionsoftware to its high-end business-intelligence analytic engine, DSS Server, and informa-tion distribution technologies, BroadCaster, TeleCaster, and InfoCenter. WithinStrategy.com, MSTR is developing advanced Web-content management software thatmay be released as a product during FY�00.

Financial Outlook: Upside To Our Estimates. For the upcoming Q4�99, we expect MSTRto come in with $60.0 million in total revenue, a 68% increase over $35.7 million in Q4�98.Revenue for FY�99 is estimated to be $196 million, growing 84% year over year from $106million in FY�98. In FY�00, we expect MSTR to grow revenue 45% to $285 million. EPSestimates for the upcoming Q4�99 is $0.11 per share, with FY�99 EPS estimate of $0.33.Our FY�00 EPS estimate is $0.49. In our opinion, there is potential upside to our estimates.

Valuation And Investment Conclusions. At $194, MSTR is trading at 29.1x our FY�00revenue estimate of $285 million forecast. In our opinion, MSTR�s strong businessintelligence/decision support product suite is proving a strategic advantage, as MSTRhas expanded its product into e-Business applications. The e-Business market is currentlyin a rapid growth phase in which early market share gains are critical. A MC/R valuationis necessary to compare MSTR to other companies in the e-Business community. Our12- to 18-month target price for MSTR of $300 is based on a market capitalization of 45.0xour estimate of FY�00 revenue, which is a 20% discount to e-Business software leaderBVSN trading at 56.5x FY�00R and a 15% discount to ARBA trading at 52.7X FY�00R.In our opinion, there may be significant upside to our revenue estimates as the companyfurther proves its capabilities in the e-Business market. Our estimates include no potentialrevenues from Strategy.com

Risks include potential fluctuation in operating results; lengthy sales and implementa-tion cycle; ability to attract, train, assimilate, and retain highly qualified personnel; rapidchanges in technology; and greater competition from larger, well-financed, well-estab-lished software vendors.

Additional information is available upon request.

First Union Securities maintains a net trading market in MSTR.MSTR is on the Analyst Action List.

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BUSINESS SERVICESEducation / Marketing

Jerry R. Herman, CFA (216) 574-7351Robert L. Craig (216) 574-7350

Leigh D. Pollak (312) 574-5592Jerome Sheehan (216) 574-7339

Outsourcing SolutionsMark S. Marcon, CFA (804) 344-6268

Mark E. DeVaul, CPA (804) 782-6642

COMMUNICATIONS & TECHNOLOGYInternet / Business to Business

Charles J. Wittmann, CFA (804) 782-3316Matthew H. Cullen (804) 344-6205

Internet / Business to ConsumerCarolyn Luther Trabuco (212) 891-5026

Allison E. Brown (212) 891-5045David A. Trossman, CFA (410) 625-6371

Christopher M. Gay (410) 625-6381Internet / Digital Marketing Services / Technology

Bennett Notman, CFA (804) 344-6430Joseph D. Hiller (804) 782-6629

Internet / Enterprise SoftwareSarah T. Bernstein, PhD (212) 891-5031

Charles Goldblum (212) 891-5042Internet / IT Services

Edward S. Caso, Jr., CFA (410) 332-5239Richard A. Church (410) 332-5238Rebekah Whalen (410) 625-6373

Internet / Wireless TechnologyMark A. Roberts, CFA (650) 571-7285

Michael A. Whitfield (312) 574-5147Internet Access & Hosting

Andrea Grosz (312) 574-6235Kerren B. Berger (312) 574-5175

MediaKenneth T. Berents (804) 782-3417Asa W. Graves, CFA (804) 782-3765James B. Boyle (212) 891-5038

Matthew A. Karnes, CPA (212) 891-5039Telecommunication Services / Wireless

Jennifer A. Murtaugh (312) 574-5985Jill A. Desmarais (312) 574-5983

Telecommunication Services / WirelineFrank G. Murphy (804) 782-3694

Frank G. Louthan, IV (804) 782-3386James Wilhelm, Jr. (804) 344-6431

CONSUMERFood, Restaurants, and Tobacco

Jeffrey F. Omohundro, CFA (804) 782-3342L. James Borges, CFA (804) 782-3628Katie H. Willett (804) 782-3553

R. Shane Glenn (804) 782-3049John P. Walsh (804) 782-3273

Consumer ProductsSteven M. Bernard, CFA (312) 574-6259

Tim Coats, CPA (312) 574-5197Specialty Retailing

H. B. Thomson III (804) 782-3441Brett P. Hawkins, CPA (804) 782-3760

Kelly B. Armstrong, CFA (415) 836-5936Ralph E. Jean (804) 344-6275

Shawn S. Tesoro (804) 344-3952

ENERGYExploration & Production

David A. Garcia, CFA (713) 346-2803Katherine Rice (713) 346-2801

Oilfield Services / MLPsYves C. Siegel, CFA (212) 891-5036

James S. Rhodes (212) 891-5047Arnold P. Kaufman, CPA (212) 891-5032

FINANCIAL SERVICESBanks

Edward R. Najarian (804) 782-3422Stephanie L. Green (804) 782-3320Chris W. Murphy (804) 344-6245

Bradley S. Vander Ploeg (312) 574-5923David J. Long (312) 574-5938

InsuranceSteven C. Huffines, CFA (312) 574-5924

Scott A. Schumann (312) 574-5991Specialty Finance

Meredith A. Whitney (212) 891-5040Seth B. French (212) 891-5009Douglas C. Sipkin (212) 891-5062

FURNISHINGS, FLOORCOVERINGS &TEXTILES

Floorcoverings / FurnitureJohn A. Baugh, CFA (804) 782-3297

Scott H. Miller (804) 782-3027Mark S. Tyler, CFA (804) 344-6258

TextilesBryan C. Hunt, CFA (804) 782-3367

Mark O. Doehla (804) 344-6254

HEALTH CAREAssisted Living

Phillip J. Martin (312) 574-6280Disease Management / Hospital Management /

Managed CareJoel M. Ray, CFA (804) 782-3341

Julie B. Sydnor (804) 344-6409Healthcare Information Technology

Christopher S. Russ (212) 891-5037Marcus Cohen (212) 891-5041

Healthcare Services / Medical DistributionSeth Teich, CFA (415) 284-6959

Geeta Vemuri, PhD (804) 782-3617Healthcare Technology

Albert L. Rauch, PhD, CFA (312) 574-5935Darren Mac (312) 574-6993

Medical DevicesAndrew T. Jay, DMD (617) 342-1467

Jason S. Robins (617) 342-1443

INDUSTRIALElectric, Gas and Water Utilities

Thomas E. Hamlin, CFA (804) 782-3240Matthew T. Stith (804) 344-6449

Industrial Growth / ConstructionRobert R. Marshall (804) 782-3622

Greg Korondi (804) 782-3392Industrial Products and Services

Jennifer J. Cole, CFA (212) 891-5030Ananda P. Baruah (212) 891-5035

Thomas J. D�Amore, CFA (312) 574-5385

REAL ESTATE / REITS / LODGINGHealth Care

Phillip J. Martin (312) 574-6280Land

Burland B. East, CFA (619) 702-4355Lodging & Leisure

Jeffrey J. Donnelly, CFA (619) 702-4356Multifamily

Stephen C. Swett (804) 344-6217Donald Fandetti, CFA (804) 782-3611

Office & Industrial, Diversified & SpecialtyChristopher P. Haley (804) 782-3708

Alice Hoey (804) 782-3442Sasha P. Hogan (804) 344-6164

D. Hollis Taylor (619) 702-4358Retail, Net Lease, and Storage

Eric Lohmeier (312) 574-5963

SUPERVISORY ANALYSTSWilliam K. Gooch, CFA / (804) 344-6427 Sarah A. Pair / (804) 782-3795 William B. Tiritilli / (312) 574-5913 Anthony Colonna / (804) 782-3305

This is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments mentioned. The informationhas been obtained or derived from sources believed by us to be reliable, but we do not represent that it is accurate or complete. Any opinions orestimates contained in this information constitute our judgement as of this date and are subject to change without notice. First Union Securities,Inc. (�FUSI�), or its affiliates may provide advice or may from time to time acquire, hold or sell a position in the securities mentioned herein. FUSIis a subsidiary of First Union Corporation and is a member of the NYSE, NASD and SIPC. FUSI is a separate and distinct entity from its affiliatedbanks and thr i f ts . SECURITIES: NOT FDIC-INSURED � NOT BANK-GUARANTEED � MAY LOSE VALUE

Kenneth T. Berents Director of Research (804) 782-3417Joel M. Ray, CFA Assistant Director of Research (804) 782-3341Steven C. Huffines, CFA Assistant Director of Research (312) 574-5924Linda L. Ridley Administrative Manager (804) 782-3362

OutFront Companies MicroStrategy's Curious Success What's this Wall Street infatuation with revenues? Investors have carried it to ridiculous extremes for some young software companies. BY David Raymond 961 words 6 March 2000 Forbes 058 English Copyright 2000 Forbes Inc.

SHORTLY AFTER MICHAEL SAYLOR'S fledgling software company, MicroStrategy, went public in June 1998, he had harsh words for those looking to make a quick buck. "We're industrialists," he told FORBES. "Industrialists make money in 30 years. Speculators make money in a month. Investors make money in a quarter."

Thirty years? In the past three months MicroStrategy shares have gone haywire. At the close of business Feb. 15 they were $172, making this company worth $13 billion and the 35-year-old Saylor's stake worth $7.5 billion. The Vienna, Va. company is in some hot markets: helping corporations sift through large customer databases looking for patterns useful in marketing efforts. Its Strategy.com division is even sexier, letting corporations deliver personalized information via wireless networks and the Internet.

But how hot is hot? You can't justify this valuation based on earnings. MicroStrategy is trading at a meaningless 590 times 1999 net, fully diluted. Searching for some kind of rationality in the Internet era, you are led to revenues as the driving force for market values. MicroStrategy is trading at a mere 65 times revenues, undiluted. Then you ask yourself: How much do this stock's fans know about the revenues?

In the past two quarters MicroStrategy unveiled three hefty deals that had a resounding effect on the company's top line, just in the nick of time. Although all three were announced days after the quarter closed, they were at least partially recognized in the closed quarter, and so helped MicroStrategy maintain its momentum. In last year's third quarter, revenue increased 20% from the one just before. The fourth quarter had the company boosting sales another 27% over the third quarter, to $69 million.

In many ways MicroStrategy is merely a case in point for practices that have become widespread. Look at where some of its growth is coming from. On Oct. 4 MicroStrategy and NCR announced what they described as a $52.5 million licensing and technology agreement. NCR agreed to pay MicroStrategy $27.5 million to license its software. MicroStrategy bought an NCR unit which had been a competitor for what was then $14 million in stock, and agreed to pay $11 million cash for a data warehousing system. Saylor's firm reported $17.5 million of the licensing money as revenue in the third quarter, which had closed four days earlier. Pretty nice chunk of change for a back-scratching deal.

Mark Lynch, the MicroStrategy chief financial officer, defends the accounting, pointing out that NCR paid cash. Even so, the NCR deal represented nearly a third of MicroStrategy's revenue and almost half of its licensing revenue for the quarter. The $17.5 million also represented all of MicroStrategy's quarter-to-quarter revenue growth and then some.

On Jan. 6, almost a week after the close of its fourth quarter, MicroStrategy announced an even bigger deal: a $65 million agreement with the software firm Exchange Applications in Boston. The deal called for Exchange Applications to make an initial payment of $30 million to MicroStrategy ($10 million cash and $20 million stock) and up to $35 million more over two to three years. MicroStrategy recognized $14 million in its fourth quarter.

Now it happens that MicroStrategy and Exchange Applications, besides both being newly public software companies, are in similar businesses: They both help corporate marketers comb through customer databases in search of patterns. For its outlay Exchange gets to use MicroStrategy's software in future products.

While MicroStrategy was selling software to Exchange, Exchange was selling its own customer management software to MicroStrategy. The deal enabled Exchange to recognize $4.5 million in revenue in its fourth quarter, a third of its total revenue.

Here's something else that makes MicroStrategy and Exchange kin: Exchange is another newly public company

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4/7/2006http://global.factiva.com/aa/default.aspx?pp=Print

with a magical stock. It's worth $1.2 billion, or 28 times 1999 revenue. As is the case with its partner, Exchange has a stock for which the price/earnings ratio, the classic measure of valuation, is meaningless--in this case, 450.

Isn't this a crazy world we live in? Take any two fast-growing technology companies, both trading at 20 times revenues. If they swap $5 million of revenue, there is every reason to expect that each will get a $100 million boost in its market value. In days of old (say, a decade ago) you couldn't do this. Back then it was normal to value companies as a multiple of earnings, and it's not easy to trade revenues in a way that boosts the net income of both parties.

And what happens when such companies run out of last-minute big deals? Saylor says this is the way business works. "My job is to manage the business in such a way that nobody's disappointed. I have lots of levers at my disposal."

The MicroStrategy momentum carries on. Four days after the Exchange deal was announced MicroStrategy said it had an $11 million deal to distribute financial news from a financial information service provider, Primark. Conveniently, $6 million of this sum qualified to go into MicroStrategy's fourth quarter. Together with the Exchange exchange this deal accounted for a fourth of MicroStrategy's revenue for the quarter.

More momentum: On Jan. 19 MicroStrategy announced that it was kicking off its Super Bowl advertising. Excitement over the $5 million campaign ran the stock up 12 points that day, adding $450 million to the market cap. Nifty, isn't it? On Wall Street these days, you can spend yourself rich.

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OutFront Fallouts: Micropanic: Is the accounting scandal that hit MicroStrategy about to claim more casualties? Let the Web investor beware. BY Bernard Condon 762 words 17 April 2000 Forbes 060 English Copyright 2000 Forbes Inc.

THE STUNNING FALL FROM GRACE of Michael Saylor's MicroStrategy, which plunged 60% in value over a thorny accounting issue, has rattled denizens of Silicon Valley. The question on everyone's lips: Who's next?

FORBES was the first to tell you about Saylor's questionable bookkeeping (see story). The Vienna, Va. data-mining software outfit had booked revenue from three deals faster than accounting rules allow. Saylor has since been forced to restate financials for two years. The change cut 1999 sales by 25% and turned a profit of 15 cents a share into a loss as big as 51 cents a share. The stock tumbled from $227 to $86 in a day, erasing $12 billion in value. It has recovered only to $113.

Now other firms, such as makers of semiconductor equipment, software companies and Web shops, could come under scrutiny. Among those that might be at risk: Amazon.com, DoubleClick, 24/7 Media, Drugstore.com, Novellus, SciQuest.com and Ventro. All say not to worry or can't comment.

"MicroStrategy is a sobriety checkpoint," says Jack Ciesielski, publisher of the Analyst's Accounting Observer. "For the first time in a while, people are focusing on what's realistic."

MicroStrategy's nosedive came three months after the Securities & Exchange Commission warned against overambitious sales recognition.

In a worst-case scenario, companies would have to restate revenues and thereby turn profits into losses--at a time when a few pennies a share of disappointment can spell disaster on Wall Street. Many firms, however, will simply have to push revenue and costs further out so that overall profit won't get cut; some, in fact, could see higher profits as a result. Even then, however, they will lose the flexibility to manage their financials to deliver the smooth, upward curve in growth that Wall Street expects of high-tech outfits. "There's a whole lot of smoothing that goes on in this business," says Merrill Lynch analyst Mark FitzGerald. "It's going to be a little more up and down from here."

Few companies admit they are worried--but MicroStrategy was similarly unconcerned at first. Then it reversed course and restated earnings, citing the new "SAB101" guidelines the SEC issued in December. Then, a day later, MicroStrategy changed its story, saying it had violated sales-recognition rules on the books for 2 1/2 years.

Other companies got hurt in MicroStrategy's downdraft. Vignette, an Internet software maker, fell 15% in one day in March, despite its reputation for conservative accounting. Short-sellers are now searching for the next hit.

Makers of chip gear may be the most vulnerable. Two big players--Applied Materials and Teradyne--are so concerned that they flew down top brass for last-minute meetings at the SEC in Washington, D.C. For years these firms booked the sale of a machine as soon as they shipped it to a chipmaker. Now they may have to wait until the gear is plugged in and running to the satisfaction of the customer. That can take a month or two. The delay could shave second-quarter net at Teradyne, Novellus and others.

With nerves on edge, companies with other accounting issues could also take a hit. One of the Valley's most troubling issues: booking "gross revenue" in a way that gooses the top line. Airline middleman Priceline.com, in a much-celebrated example, books the total price of a ticket as revenue instead of just its own fee.

The gap between the numbers can be huge. Ventro, a lab-supplies site formerly known as Chemdex, expects $131 million in revenue this year--but that could fall to a mere $13 million if it reports only its cut of the resale. At rival SciQuest, revenue could similarly drop by 90% if such a revision were made.

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SciQuest may have other tricks up its sleeve. In a secondary offering filed in March it revealed plans to add the value of warrants issued to customers DuPont and Dow Chemical to operating costs. It had previously said it would take the sum out of revenues, which makes more sense. The warrants, after all, are essentially rebates to some of its biggest clients. One accounting official calls that shift "nonsense."

The climate of fear sparked by Saylor's fall may fade, but not the issues it raises. Companies--and investors, too--had better take a hard look at all this.

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ACCOUNTING DID THE AUDITORS CROSS THE LINE? The SEC has tough questions for MicroStrategy and PWC By Christopher H. Schmitt and Paula Dwyer in Washington 1381 words 25 September 2000 Business Week 168 Number 3700 English (c) 2000 McGraw-Hill, Inc.

On a recent August morning, Michael J. Saylor, CEO of MicroStrategy Inc., stood before an overflow crowd at a high-tech trade show in the bowels of the convention center in Washington. He spun his vision of the future, in which personalized news and alerts are delivered through wireless devices and clip-on computers equipped with voice recognition. The crowd was riveted.

The electrifying moment allowed Saylor to look past the software maker's calamitous earnings restatement of last spring. The company had booked $66 million more in revenue than it should have from 1997 through 1999--more than one-fifth its sales total. The restatement wiped out $55.8 million in earnings, turning profits into losses for each of those years.

But as diverting as the interlude may have been, recovery will not come that easily for Saylor and MicroStrategy. As he attempts to rebuild the company he founded 11 years ago, one of his chief hurdles is a Securities & Exchange Commission investigation into the company's accounting practices. BUSINESS WEEK has learned that the SEC is investigating whether MicroStrategy and its auditor, PricewaterhouseCoopers LLP, covered up a prohibited financial relationship by using a third party as a go-between. The agency also is probing whether PWC sacrificed its independence by entering into deals to buy MicroStrategy products for resale to consulting clients--a financial link the SEC thinks may have made PWC unwilling to make tough audit decisions. And the SEC is investigating whether MicroStrategy backdated documents to move revenues from one quarter to another. FAST-TRACK PROBE. The swift fall of MicroStrategy exemplifies the questions that arise when auditors do more for a client than just examine the books. Shareholders lost $10.4 billion in stock value, and 10% of the company's employees have been laid off. The scope of investor losses, and the web of relationships between auditor and client, have persuaded the SEC to put its investigation on a fast track.

While MicroStrategy admits that it overstated revenues, it denies doing so deliberately. MicroStrategy and PWC representatives deny they used a third party to disguise their relationship or that any documents were backdated. And both companies deny that PWC's reseller role or any other factor compromised the auditor's independence. MicroStrategy insists the SEC eventually will agree with its view that the accounting debacle stems from the failure of the company's accounting system to keep up as MicroStrategy's product mix became more complex.

In the first detailed discussion of the sequence of events, MicroStrategy lawyer Ralph C. Ferrara of New York-based law firm Debevoise & Plimpton says the company largely sold off-the-shelf software in its early days. Accounting rules allow companies to recognize the revenue from such sales at the time of the sale. But soon the company began adding services and customization to the mix--`èlements,'' as they're known in accounting lexicon. There, accounting rules dictate that revenue must be spread over the life of a job--as products and services are delivered or as project milestones are met--rather than all at once.

In simple terms, that's what the company failed to do and what its auditors failed to flag, MicroStrategy says. ``There was a realization the accounting model hadn't kept up with the business model,'' says Ferrara. But the SEC's case goes beyond technical questions of when to ring up software revenue. To investigators, MicroStrategy and its auditors had relationships that suggest the auditors had a financial stake in MicroStrategy's success. And that's a line an auditor isn't supposed to cross.

The company's problems date back to March, 1997, when MicroStrategy signed a three-year contract with Price Waterhouse, one of two PWC predecessors. The firm at the time did not audit MicroStrategy but was a ``value-added reseller,'' meaning the accounting firm acquired MicroStrategy software, then resold it to consulting clients. Price Waterhouse bought at least $500,000 worth of MicroStrategy products and services. POSTMERGER DEALINGS. In 1998, Price Waterhouse merged with Coopers & Lybrand, MicroStrategy's auditor, to form PricewaterhouseCoopers. Seven months after the merger, the newly formed PWC ended the reseller agreement with MicroStrategy. A PWC spokesman says the firm did so `ìn order to better assess independence issues.''

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But the relationship continued on what both companies call a ``project-by-project'' basis.

Now the SEC is probing not only the basic relationship but also whether the postmerger dealings continued through an unnamed third party in an effort to mask them. Indeed, some purchases of MicroStrategy software by PWC were made through a vendor and not directly from MicroStrategy. `Ìt raises questions whether it was done to cover the tracks of what they knew was inappropriate,'' says one person familiar with the investigation.

In all, PWC consulting clients selected MicroStrategy products in eight projects over about 18 months, netting the firm $187,892, says PWC. A typical arrangement: PWC would purchase a license for its client, and in return the client paid PWC for the MicroStrategy software. ``These transactions were few in number, small in dollar amount, and within the firm's independence guidelines,'' a company spokesman says.

But the connections between MicroStrategy and its auditor ``show that the firm has become too allied in interest to the company they are supposed to be auditing with a neutral eye,'' says the person familiar with the SEC investigation. And the agency is likely to discount the idea that only small sums of money were involved, says one knowledgeable source, noting there are no degrees of independence. BODY BLOW. Another key issue in the case: Did PWC's on-the-ground auditors consult with their own in-house experts? PWC declined comment. MicroStrategy's Ferrara says that the local audit partner did indeed consult with others in the firm `às he thought appropriate. Both the company and the engagement partner felt they had gotten it right.''

But clearly they didn't get it right. The case may also expose a fault in the accounting profession's contention that consulting work improves the audit by helping the auditor better understand a client's business. In this case, PWC consultants certainly had access to MicroStrategy's software products. After all, they were selling them to PWC's own clients. But that inside knowledge didn't prevent the audit oversights.

What's indisputable is that MicroStrategy's restatement dealt the company a body blow--extending far beyond the simple matter of recalculating numbers. ``What's happened over the past six months is we had to basically strip the business down to zero and build it back up again, and check all of our premises,'' Saylor says.

On the way up, Saylor won recognition as the archetype of the New Economy executive, exuding a brilliance that dazzled with brashness and an aloofness that often repelled. Today he pronounces himself chastened and humbled. He has even given up some authority. On Sept. 4, Saylor appointed John Sidgmore, vice-chairman of WorldCom Inc., to head MicroStrategy's wireless services unit, Strategy.com.

Nevertheless, Saylor insists that he has dug in for the long haul and that he'll stay hands-on. `Ì have a lot of work to do during the next decade,'' Saylor says, ``to make sure that all the constituencies that depend on us find their trust returned.'' The SEC hopes that at the top of the list are the shareholders who rely on the impartiality of MicroStrategy's audits.

THE RISE AND FALL OF MICROSTRATEGY 11/10/99 First warning about accounting practices, by Center for Financial Research & Analysis Inc. 2/24/00 Unveils stock offering with potential to raise $2 billion 3/20/00 Restates revenues and earnings 4/13/00 Says it overstated revenues for past three years 6/19/00 Announces $125 million in new financing 8/01/00 New CFO and internal audit director named

Photograph: CHASTENED Once known for his brashness, Saylor now concedes he has `à lot of work to do during the next decade'' PHOTOGRAPH BY KATHERINE LAMBERT Illustration: Chart: THE RISE AND FALL OF MICROSTRATEGY

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Microstrategy Take-home case analysis Spring 1 2009qc2/accountg441/files/FSA Take-home... · Microstrategy for fiscal 2000, under the following set of assumptions. You can assume