IN THE MONEY: A Cautionary Note On MicroStrategy
06/19/2000
Dow Jones News Service
(Copyright (c) 2000, Dow Jones & Company, Inc.)
By Michael Rapoport
A Dow Jones Newswires Column
NEW YORK (Dow Jones)--Hold on, MicroStrategy Inc. (MSTR) investors. This $125 million in financing the company just received may not be unalloyed good news.
True, the deal gives MicroStrategy some much-needed cash to continue its expansion. And it restores some stability to the company in the wake of its March disaster, when it said it would have to revise past results severely downward for accounting reasons. The company's stock is still more than 85% off its March high, but investors have driven it higher recently in anticipation of the financing, and it was up another 10% Monday.
But the financing, at least the details announced thus far, appears to be of a type that most companies are willing to accept only when they have little other choice. It raises the possibility that MicroStrategy is risking some future dilution that investors may not be taking into account - and placing a major bet on where its stock price is going to go over the next few years, with a chunk of the value belonging to current shareholders as the stakes.
Three investment firms have agreed to pump a total of $125 million into MicroStrategy, in exchange for shares of preferred stock that will be convertible to common stock in two to four years. Initially, the conversion price will be based on the stock's average price for the 17 trading days after the deal closes; if it were to convert at Monday afternoon's trading level of about $42.50 a share, the investors would receive about 2.9 million common shares, diluting current shareholders' stake by about 3.7%.
<b<That would be pretty modest dilution - but the potential problem arises because the conversion price can be revised on an annual basis, "subject to certain limits and conditions," MicroStrategy says.
The company doesn't say what those limits and conditions are(edit-of course NOT,the scoundrels--max90:), but one of the factors will certainly be MicroStrategy's stock price. If the price should be lower a year from now than it is today, MicroStrategy will have to issue more common shares when the preferred stock is converted.
"There are mechanisms, should the stock not perform, for resetting" the conversion price, said James O'Brien, a managing member of Promethean Asset Management LLC, one of the three outside investors.
Let's say, for example, that the preferred stock is ultimately converted to common stock at $30 a share - a level at which MicroStrategy stock traded less than two weeks ago. The investors would receive 4.2 million shares, representing dilution of 5.2%. If the stock were to be converted at $20 a share - where MicroStrategy stock was on June 1 - they would get 6.25 million shares, representing 7.9% dilution.
"Clearly, if the stock price goes down and the price gets reset in a year ... they'll have to issue more shares," said Eric von der Porten, a money manager at Leeward Investments in San Carlos, Calif.
Of course, it could also go the other way. If MicroStrategy's stock price is higher when the time comes to reset the conversion rate, it could be able to issue fewer shares, with less dilution; the company also has the option to require the investors to convert after two years if conditions then are advantageous to MicroStrategy.
That's the bet MicroStrategy is placing - that its stock price will head higher rather than lower over the next two years. If it doesn't win that bet, the company's current shareholders could have the value of their stock diluted to a greater extent.
This deal bears some resemblance to what's generally known as a "floorless convertible" - a convertible-preferred issue without any effective lower limit at which the conversion can occur, with the resulting danger that an ever-growing number of common shares will have to be issued as the stock price drops.
That can result in a double whammy for the unfortunate company saddled with such a deal: A falling stock price means more common shares have to be issued in the conversion, leading to dilution that drives the price down even further. For this reason, floorless convertibles have another, more biting name: "death-spiral convertibles."
O'Brien says the MicroStrategy financing isn't this kind of deal. "What people generally consider to be a floorless convertible, I definitely don't consider this to be one,"(edit- !sure! like he going to say yes-max90) he said. Officials from MicroStrategy and from the other two outside investors, Angelo Gordon & Co. and Citadel Investment Group, couldn't be reached for comment.
To be sure, the MicroStrategy financing doesn't appear to be a pure floorless convertible. It's not even as close to one as is EToys Inc. (ETYS), which got $100 million in financing last week in a floorless-like deal in which Promethean, Angelo Gordon and Citadel were also the investors.
But both deals are indicative of the new reality that once-hot, now-fallen high-tech companies are finding it a lot harder to get financing. Once they could easily tap the public markets, with stock or bond offerings at just about any price they wanted to name - MicroStrategy itself had planned a secondary stock offering for March, but had to cancel it after its stock plunged more than 60% because of its accounting revisions.
Now these companies have to do private placements and swallow terms significantly more favorable to the outside investors in order to get the money they need. No company would accept a floorless convertible and possibly unlimited dilution if it had any choice - but some companies aren't going to have a choice.
"I would think whatever terms (the investors) get from these companies would be fairly advantageous," said Tom Sugiura, a convertible-bond analyst at Bear Stearns & Co.
As I reported last week, there a few other cautionary notes investors might want to consider before they assume MicroStrategy stock will inevitably move higher in the future. The company faces a Securities and Exchange Commission probe and a bundle of shareholder lawsuits over its accounting practices, it's posted $63 million in losses over the past year and analysts expect it to continue losing money at least through the end of 2001.
Finally, consider that if MicroStrategy's stock price declines over the next year or two and the company runs short of cash, dilution could get worse. The terms of MicroStrategy's preferred-stock placement call for a 7% annual dividend. That's $8.75 million a year, payable to the investors in cash or common stock at MicroStrategy's option.
But if the company burns through its cash, it may have no choice but to pay that dividend in stock. And that may happen quicker than investors would like to think: MicroStrategy had $54.8 million in cash as of March 31, so the latest cash infusion would boost that to about $180 million. But the company had a negative operating cash flow of $23.7 million last quarter - and MicroStrategy's plans for rapid expansion may mean that burn rate isn't going down anytime soon.
.Stay tuned. I've got a hunch this story isn't just going to quietly fade away.
-Michael Rapoport; Dow Jones Newswires; 201-938-5976; michael.rapoport@dowjones.com
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