What's this Wall Street infatuation with revenues? Investors have carried it to ridiculous extremes for some young software companies.

MicroStrategy's Curious Success

By David Raymond

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 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.