FEBRUARY 22, 2001
STREET WISE
By Amey Stone
Microsoft, Through Long-Term Lenses | While there's little upside this year, chances are patient investors will be rewarded later on as new products catch on
| Microsoft has always had critics and detractors. But until this past year, the company could do no wrong on Wall Street. With nearly 50% operating margins -- among the highest in the software industry -- it has been a money machine. At the end of 2000, Microsoft was sitting on a $27 billion mountain of cash. And even with the economy slowing, the company projects it will earn $1.81 cents a share on revenues of $25.2 billion for its 2001 fiscal year, which ends in June. That's more than $10 billion in profits.
Even so, it looks like Wall Street's love affair with Microsoft is over. The stock fell 62% in 2000 as analysts downgraded it, first due to concerns that PC sales were dimming in favor of handheld and wireless devices. Later in the year, their worries turned on the slowing economy, which further dampened Microsoft's sales growth. For its fiscal second quarter, which ended in December, Microsoft reported $6.6 billion in revenues -- an increase of just 8% vs. the same quarter of the prior year. In contrast, in their most recent quarters, Sun Microsystems (SUNW
) saw sales grow by 44% over the prior year, while Cisco's (CSCO
) increased by 55%.
DIM VIEW. Wall Street also was caught by surprise last spring when the Judge Thomas Penfield Jackson ordered Microsoft split in two -- a bullet most analysts still expect the company to dodge. That antitrust ruling, now under appeal, cost the stock about 10 points, estimates Michael Davey, technology analyst at Investec Ernst & Co. Now around $55, Microsoft is trading at about half its high of $115 a year ago.
The outlook for the stock through the rest of 2001 isn't much brighter. In perhaps one of the clearest signs of Microsoft's fall from grace in technology-investing circles, Merrill Lynch analyst Henry Blodget initiated coverage of the company on Feb. 8 with only an accumulate rating. Despite its financial strength, "over the long term, however, we don't find Microsoft's potential upside particularly compelling at this price," he wrote.
Long-term, most analysts believe Microsoft, which is in the midst of a new-product cycle, will increase sales at an annual average rate of 15% over the next three to five years, thanks in part to Windows XP and Office XP software upgrades that are expected later this year. But Blodget is doubtful these launches will drive much growth in the short term. He also thinks it will take a while before new businesses, like Microsoft's upcoming Xbox gaming system, have a real impact on its huge revenue base. He forecasts long-term earnings growth at only 8% to 10%, which makes Microsoft's price-earnings ratio of 32 look pricey. And if he's right, more analysts will be ratcheting down their estimates for, which will weigh on the stock this year.
GAME FOR GROWTH. That said, for long-term investors looking for a safer kind of technology play, Microsoft is increasingly attractive. Its financial strength should make it far more stable than other high-growth, but often profitless, tech plays. Plus, there's always the chance that Microsoft could surprise Wall Street and grow faster than expected.
Although 70% of its revenues are tied to the PC business, the remaining 30% are in fast-growth new businesses, funded by Microsoft's cash machine (see "When Microsoft Gets Past This Rough Patch"). The way Davey sees it, the company is in a temporary lull until its new businesses ramp enough to prove they can be an engine for future growth.
With Windows 2000, its corporate software sales are picking up. Its operating system for handheld devices is catching on. Its Xbox gaming console is eagerly anticipated, and its Windows XP and Office XP may inspire more businesses and consumers to upgrade their desktops. Davey thinks it may take as long as 18 months for Microsoft to show that its new businesses can fuel growth. "I don't think it is a three-month story," he says. "But it gets better from here."
Other fund managers say they're growing more optimistic about Microsoft. "Overall, I see better things for the company," says Jeffrey Van Harte, who has about 3% of the holdings in the portfolios he manages for Transamerica Premier Funds in Microsoft. "Is it going to be the kind of ride that we had with the PC in the early 90s? No. But at the margins, are things getting better for Microsoft? I think they are."
HAVING FUN YET? This is hardly a ringing endorsement. Erick Maronak, research director at investment firm Newbridge Partners, notes that Microsoft faces far stiffer competition as it enters non-PC markets. For his portfolio, he prefers investing in companies in faster-growing markets, like data storage and communications. "I prefer the higher-growth alternatives," he says, mentioning stocks like Cisco and EMC (EMC
).
"For a while there it wasn't fun to own," admits portfolio manager David Brady, who has maintained his position in Microsoft in the funds he manages for Stein Roe through the past year. But he thinks Windows XP will trigger an upgrade cycle that will spark earnings growth. He also expects Xbox and Microsoft's Internet strategy, called .Net, to created excitement among investors. "It's not the 40%- or 50%-type grower," he says, pegging earnings growth in the 12% to 15% range for the next five years. "It is more in the category of a solid blue-chip company with a leadership position in important markets."
That assessment may not be enough for Microsoft to win back Wall Street's heart. But for long-term investors looking for reliable stocks in today's turbulent markets, the promise of steady growth and financial strength should have plenty of appeal.
Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.
Questions or comments? Join in the discussion at our Ask Amey Stone interactive forum
Edited by Douglas Harbrecht
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Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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