From: Linda (joelinda1@home.com)
Date: Wed Jul 19 2000 - 17:15:53 PDT
Don't Be Confused About Microsoft: The News Is Bad
By Brett D. Fromson
Chief Markets Writer
7/19/00 6:14 PM ET
So now the world knows Microsoft's (MSFT:Nasdaq - news) quarterly
results. And they were unimpressive for the greatest growth stock in
history run by the richest man in the world. Revenues were flat.
Operating earnings were down. Earnings per share met analysts' already
lowered expectations.
Microsoft's sluggish numbers left investors decidedly downcast. After a
brief pop in after market trading Tuesday evening, the stock slumped
badly Wednesday and closed down 5 3/8, or 6.9%, at 73 1/8. Analysts at
Prudential Securities and SG Cowen downgraded the stock from a buy to a
hold. Other analysts held their buy recommendations but reduced their
published estimates for growth in revenues, operating income and
earnings per share (excluding investment gains).
Let's sift through the dross.
Revenues for the quarter were $5.8 billion, 1% higher than a year ago
and 3% higher than last quarter. That is the kind of growth rate one
would expect from a cigarette company. (In fact, Philip Morris (MO:NYSE
- news) yesterday reported better revenue growth numbers than
Microsoft!)
In its conference call with analysts last night, Microsoft executives
had various explanations for the anemic performance. Year-over-year
revenue comparisons, they argued, were so weak because last year's
quarter had been unusually good. There was, however, no explaining away
the weak quarter-to-quarter results. Companies are not buying PCs
loaded with Microsoft software as quickly as before. Intel chips for
high-end computers have been in short supply. Windows 2000 has not been
quickly embraced by corporate users.
Operating earnings excluding investment gains were $3 billion, 22% lower
on a year-over-year basis and 6% worse than the prior quarter. The
company's operating margin -- operating income as a percentage of
revenues -- declined to 45.3%. That is thinner than at any time since
late 1997 because marketing and research and development expenses
surged. The cause? The shift in demand towards consumer machines vs.
corporate PCs, which are much more profitable to Microsoft because they
tend to be loaded with Office 2000 and the higher priced Windows 2000.
Reported earnings per share were 36 cents, down 7% from the year before
and off 5% from the previous quarter. The company was only able to meet
analysts' expectations by including about $650 million of investment
gains.
Perhaps most worrisome is the drip, drip, drip erosion in the past 18
months of the company's return on equity and return on assets. ROE fell
to about 27% from 36%. ROA dropped to 22% from 27%.
Don't Worry, Bill's Still Rich
What are we to make of these slightly pathetic results? Two things, at
least:
One, the core PC-based business is vulnerable. (Windows products account
for 40% of revenues, which is just about what they were in 1998.) Its
new Windows 2000 product line has yet to catch on. There is no way to
get around the fact that Microsoft's profits key off PC growth, which
is unlikely to recover to rates reached last century -- i.e., in the
1990s. Whatever the future holds for Microsoft, we will have to wait
until late in the year to find out whether Microsoft's core corporate
PC business has picked up. (Companies tend not to buy PCs so much in the
summer.)
Two, the company is still struggling to segue from the old PC-based
computing world to an Internet-based one. The company finally presented
the general outline of an Internet strategy in June, but that is about
it right now. Whether it can dominate the markets for Internet-based
software is truly unclear. Those neighborhoods are already claimed by
formidable competitors like Oracle (ORCL:Nasdaq - news) and Sun
Microsystems (SUNW:Nasdaq - news).
Even Morgan Stanley Dean Witter Internet analyst Mary Meeker has her
doubts. In a report issued today, she said, "We continue to believe that
Microsoft just might not achieve the kind of market share on the
Internet it achieved on the desktop [i.e., a monopoly], and with the
move to the Internet will come stiffer competition and the potential
for margin erosion."
And Meeker is a supposed fan of Mister Softee! (Not only does Morgan
Stanley do investment banking for the company, it also has been retained
by Microsoft to provide expert testimony in the courtroom fight with the
Justice Department.)
Even with no current growth and worrisome challenges in the future,
Microsoft still trades at nearly 50 times this year's earnings and 40
times next year's. What gives?
Meeker speaks for many when she says in her latest epistle, "It is
important to remember who we're dealing with here. This is Microsoft
(i.e., Bill Gates, Steve Ballmer, etc. [sic]), and their track record
speaks for itself. We've already seen signs that the company is very
focused on making its model transition work, as exemplified in the
recent performance of MSN.com and Gates' recent presentation of the
future of the .NET platform and the benefits of XML to over 7,000
developers in Orlando."
So there you have it. An investment in Microsoft is a pure bet that
past performance by Gates & Co. guarantees future results.
You might not want to bet against them -- i.e., short the stock. But is
Microsoft a must buy at these levels? Goldman Sachs' ace Microsoft
analyst Rick Sherlund, who took the company off his firm's recommended
list back in April, did not put Microsoft back on after yesterday's
news. Should you?
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