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You would think that analysts who cover Microsoft would have been up late all last week crunching numbers and making projections in anticipation of the Apr. 28 announcement that to end the company's monopolistic behavior, the feds will push for the tech giant to be split in two. Not the case at all. It appears instead that the herd of 30 or so analysts who cover the beleaguered company yawned in apathy and tightened their blinders.
One woman among them, however, had the courage to make projections based on the Justice Dept.'s suggested remedy. Melissa Eisenstat of CIBC World Markets, who rates Microsoft a hold, issued a research report on Apr. 28 that ventured where no other analyst dared to go. According to her calculations, a split-up Microsoft is worth a total of $59 a share, 15% below the $69.25 a share it traded at when the market closed on Apr. 28.
Justice recommends dividing Microsoft in two: an operating systems company and an applications company. They wouldn't be allowed to join back together for 10 years. The idea is that Microsoft couldn't use its stranglehold on the operating-systems market to stifle competition in the applications market and vice versa (see BW Online, 4/28/00, "Microsoft: The Trustbusters Show Their Hand").
THREE INTO TWO.
Eisenstat used traditional valuation metrics to look at Microsoft's pieces as independent companies. According to her model, which deals with Microsoft as three companies, the operating systems arm would be worth $29 per share, the applications company would be worth $19, and the consumer business would be worth $11. Throw the applications and consumer sections together, and you have two new companies worth $29 and $30.
Her model splits the company into three rather than two because Microsoft is currently divided into three divisions: applications, operating systems, and consumer. The consumer division consists of the company's Web properties, its small but profitable hardware segment, and everything else that's not software. If the company is split into two, the consumer division will, for the most part, be added to the applications division.
Such straightforward pricing makes sense since both segments share Microsoft's current revenue pie evenly. The operating systems division has lots of potential for future growth, thanks to the recent launch of Windows 2000. But at the same time, the consumer division would add a lot of growth pop to the applications side, thanks to its quickly expanding Web businesses.
"NETWORK EFFECT."
Eisenstat used discounted cash-flow analysis, the most traditional method of valuing stocks, to come up with the $59 figure. The assumptions she made (otherwise known as educated guesses) were that the new companies would be valued roughly equivalent to their peers in the operating system and applications businesses.
Her conclusion raises the question of why Microsoft is worth less broken up than as a single entity. The answer, Eisenstat says, is due to what she calls "the network effect." Simply put, the whole point of the antitrust lawsuit is valid: Microsoft's monopoly position in one area of software allows it to squelch competition in other areas of the industry and dominate those also, according to her analysis.
These results underscore why her colleagues are probably so fearful of doing the same thing. But the analysts do a disservice to their clients by avoiding this issue. Are they fearful of angering the powerful executives at Microsoft headquarters in Redmond, Wash.?
ART, NOT SCIENCE.
To be sure, analysts hate to guess. Their profession is based on the concept that one can look at cold hard facts, sift them through a logical system of analysis, and come up with a credible answer to that eternal question: How much is this stock worth? But the process, which Wall Street expends so much energy trying to defend, is worth about an acre-and-a-half worth of horse manure. Financial analysis is an art, not a science. Specifically, it's the art of the educated guess -- and successful analysts have mastered it, no matter how much they try to deny it.
The Microsoft news that hit Apr. 28 is a case in point. When Justice and the states suing the company announced their suggestions to the judge on how best to rearrange the company, it was clearly news of paramount importance to Microsoft shareholders. Now that we know the government's desired scenario, how might that affect the valuation of the company? What would a bifurcation of the company do to the stock price? The need for such analysis seemed obvious.
But one analyst I telephoned became rather irritated about the direction my questioning was taking when I asked him to value a breakup. "We know absolutely nothing new now that we haven't known the past few months," he said. "You people in the press must be so smart to know exactly how this will all play out." Then he hung up on me. Well, he's right about us people in the press being smart. But he's wrong that Justice's remedy proposal isn't news.
HUGE NEWS.
Of course, the trustbusters don't have the final say. Judge Thomas Penfield Jackson is free to ignore its prescription and come up with his own remedy. But what's most important about Justice's proposal is that it's most likely a worst-case scenario. It's difficult to imagine that the judge will go even further than Justice's request. So, the downside has been quantified and is no longer infinite. That's huge news for anyone trying to figure out how much Microsoft is worth to investors.
To be fair, it's just as important to avoid the mistake of assuming that Justice's prescription will be the case's actual outcome. It'll probably be years before the appeal process is over and an actual split-up occurs. Even so, the Wall Street lemmings who cover Microsoft might want to consider the idea that the company may not win this war. Rather than idolizing Bill Gates and his minions in Redmond, they should start worshipping the only deities who really matter: the clients for whom they write their research in the first place. Now there's a concept.
Jaffe writes about the markets for Business Week Online What's your take on Justice's proposal to break up Microsoft? Talk about it on our Ask Sam Jaffe Forum EDITED BY BETH BELTON
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