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Microsoft: When The Growing Gets Tough...


Microsoft's announcement on July 20 that it will distribute a large chunk of its cash hoard to shareholders makes it look like the software giant has finally accepted that it's a mature company. After all, it will spend an astonishing $75 billion over the next four years on dividends and stock buybacks -- instead of investing that money in new growth opportunities. Investors will be able to count on Microsoft Corp. (MSFT) as a steady profit earner and source of dividend income -- much like a regulated monopoly.

But just because Microsoft is handing a load of cash to stockholders doesn't mean it won't have plenty of dough to invest in its future. After it makes a onetime special dividend payment of $32 billion in December, it will still have more than $20 billion in cash. And thanks to its profitable Windows and Office monopolies, it's racking up $1 billion in cash every month. That's enough to buy a lot of growth -- whether through acquisitions, product upgrades, or new business expansion. "When we look out over the next several years, I'm confident we have some of the greatest dollar-growth prospects in front of us of any company in the world," says Microsoft CEO Steven Ballmer.

Most stock analysts expect the $36 billion company to grow in the single digits for the next few years. But if the stars align, it could produce a surge toward the end of the decade. Here's how the scenario would work: The company is betting big on the next major update of Windows, called Longhorn, which is expected out in 2006. Since there hasn't been a major upgrade since 2001, you can expect to see pent-up demand from both corporations and consumers. Right after that, Microsoft plans a second wave of product upgrades, including new versions of its Office productivity suite and its applications for small and medium-size businesses. If things work right, it could also be reaping rewards from investments in the Xbox video game console and MSN Web site at the same time. Analyst Rick Sherlund of Goldman, Sachs & Co. (GS) says growth could reach as high as 15% in fiscal 2007 or 2008.

"IT'S TIME WE BOUGHT SAP"

What could go wrong? Microsoft is facing the most serious threat to its operating system monopoly that it has seen in years. Its chief adversary is not another software company but Linux, the open-source operating system. Governments around the world, leery of becoming too dependent on Microsoft, are encouraging their agencies and local companies to favor Linux over Windows. That's causing Microsoft trouble in one of the industry's biggest growth areas -- emerging markets such as China, India, and Russia.

That's why its biggest growth opportunity is in doing something completely different and out of character: Making a major acquisition. Though Microsoft has long been an active acquirer, it has concentrated on smallish purchases that add important new technologies. Chairman William H. Gates III signaled a willingness to break out of that mold with a June 2003 e-mail he sent to Ballmer in response to news that software rival Oracle Corp. (ORCL) had made a bid to buy corporate application maker PeopleSoft Inc. (PSFT) Gates's suggestion: "Another thought that came to mind is that it's time we bought SAP (SAP)," the runaway leader in the $30 billion corporate applications market.

While those talks foundered this spring, analysts believe Microsoft is still looking at possible deals that would improve its position in selling to corporate customers. One possible acquisition is Siebel Systems Inc., a specialist in customer-management software. Even SAP remains a possibility. Though the deal is officially off the table, some analysts believe talks could resume if Oracle eventually buys PeopleSoft, putting pressure on Microsoft's server business.

The most intriguing and dramatic deal would be for services giant Accenture. The company, which has a market cap of $24 billion, is a powerhouse in the lucrative consulting and business outsourcing arenas. Already there are affinities between the two companies: Ballmer sits on Accenture's board and the two companies co-own Avenade, a boutique consulting outfit that specializes in Microsoft technology.

If Microsoft doesn't make a major purchase, some of its best growth bets come from businesses launched in the 1990s. A decade ago, Microsoft moved into the server software business, the market that has produced its most meaningful sales gains in recent quarters. The server business is kicking off more than $8 billion a year, and analysts expect it to keep growing at a strong double-digit rate.

Now, Microsoft is hoping it can duplicate that success in the fast-growing market for software for small and medium-size businesses, which is close to Microsoft's core competencies. The company bought its way into the market two years ago by acquiring two existing players, Great Plains Software and Navision, for a combined $2.5 billion. But so far that hasn't worked out as planned -- with growth coming in at only 4% in the company's fourth fiscal quarter.

Are Ballmer's goals realistic? Maybe not. But it's fine to have them. If you need a company to grow at 10% per year, it's not a bad idea to aim higher -- especially if you're running a maturing company.

By Jay Greene in Seattle


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