Microstrategy Take-home case analysis Spring 1 2009

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)?

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