04/20/19 ONLINE ORIGINAL: THE VIEW FROM WALL STREET

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THE VIEW FROM WALL STREET

If Microsoft (MSFT) is subjected to government regulation or forced to split up, it would clearly be a disaster for its stock. But that's not what Wall Street thinks will happen. Although analysts concede that the Justice Dept.'s investigation into Microsoft's business practices will continue to cause plenty of volatility in its shares, they remain focused on the most profitable scenario: that the software giant will be allowed to function much as it does today.
Analysts currently forecast Microsoft's earnings growth rate at about 30% a year, based largely on the company's lock on the market for computer operating systems. Most analysts rate the company a weak buy. But that has more to do with Microsoft's current sky-high stock price than with antitrust issues. Its has risen 38% this year alone and nearly tripled in price in the past two years. It closed on Apr. 9 at 89.
COMFORT ZONE? With analysts estimating 1998 earnings at about $1.72 a share, Microsoft has a forward p-e of about 52. That multiple, when compared to the company's earnings growth rate, makes the stock look pretty darn expensive. John Puricelli, an analyst at A.G. Edwards, on Mar. 5 lowered his rating to "reduce" mostly on the basis of what he saw as an overvalued stock price, when it was trading at about 82. "I would be a lot more comfortable if it were trading in the high 60s to low 70s," says Puricelli, who thinks investors should keep Microsoft as a core holding, but take some of their chips off the table.
Puricelli, however, may be just about the most negative analyst covering the company. And although he changed his rating for several reasons -- including slowing PC demand -- "antitrust was not it," he says. A Merrill-Lynch analyst reiterated a buy rating on Microsoft on Mar. 26 without once mentioning the antitrust case -- not even in a discussion of current negatives.
At most, Wall Street is betting that Microsoft may have to rein in some allegedly anticompetitive business practices. There are signs that it may agree to package a version of Windows 98 (the next-generation operating system, which should go into manufacturing in a month), without Internet Explorer, the company's browser, says analyst Mary McCaffrey at BT Alex. Brown. But with some moderate self-policing, analysts think Microsoft can ward off an expanded Justice Dept. suit. The original case against Microsoft, filed last October, focused solely on the browser issue, but has since broadened out.
"My sense is that Microsoft is getting more political," says McCaffrey. The company is trying to get the public on its side by arguing that integrating applications into the operating system makes computers easier to use -- which is clearly true. On Apr. 9, Microsoft ran advertisements in newspapers in New York, Seattle, and Washington, D.C., arguing for its "freedom to innovate." But McCaffrey thinks it will also be willing to compromise a bit. "They will get flexible," she says, "but not more flexible than they have to."
DELAYING TACTICS.Even if the antitrust investigation led to major regulation or a split up of the company, most analysts think that would probably be years away. "I think we are a long way off from that kind of resolution," says McCaffrey.
The first real danger, says Puricelli, is that the government will delay shipment of Windows 98 to gain more time to sort these issues out with Microsoft. That would have a huge negative impact on the stock price, not because it would delay sales -- Windows 98 is not expected to be a big seller anyway -- but because it would raise questions about Microsoft's ability to roll out other new products. On Apr. 6, word leaked that Justice might take action before the launch, and Microsoft's stock fell 2 11/16 points.
"As these issues come up, it does give investors pause," says McCaffrey. "But the main thing that drives the stock is how well the company does from a financial point of view." For now, analysts say the effects of potential government action are impossible to quantify, so they don't enter them into their earnings models. "The customers aren't concerned -- they are still buying the products," says McCaffrey. "We're not at the point where this is a drag on earnings."
DEAF EARS. And, although earnings growth is expected to slow a bit from the 50% annual rate of the past three years, future profits look rosy. On Mar. 24, Microsoft preannounced that first-quarter earnings would come in much better than analysts were expecting. At the same time, Microsoft Chief Financial Officer Greg Maffei, warned that growth in subsequent quarters would slow. But since he is gaining a reputation for being unnecessarily cautious, investors ignored the warning, pushing up the stock price up an additional 5% the next day.
Microsoft will officially announce results for the quarter on Apr. 22. For its fiscal second quarter ending December 31, 1997, Microsoft earned $1.13 billion, or 57 cents a share, on revenues of $3.59 billion. For its 1997 fiscal year, it earned $3.45 billion, or $1.32 earnings per share, on $11.4 billion in revenues.
Investors who already own Microsoft may well want to hold onto their shares for the long run. But those who haven't bought in yet may want to wait until some of the antitrust issues are sorted out. At its current share price, even if Microsoft does avoid Justice's clutches, the stock is looking a litttle rich.
By Amey Stone
Associate Editor
Business Week Online

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