Dum da dum duuumm:"Some Fans Cool to Microsoft,Citing Drop in Old Indicator By DAVID BANK Staff Reporter of THE WALL STREET JOURNAL
Some savvy investors, detecting fissures in Microsoft's armor, are pulling
back from the world's most highly valued company.
The concern: the first-ever drop in an arcane but closely watched indicator
of Microsoft's future results.
The balance in Microsoft's "unearned revenue" account, which declined to
$4.13 billion on Sept. 30 from $4.24 billion in June, has become a lightning
rod for more general concerns about the price of the company's shares.
These include the expectation on the Street of a negative ruling in the
government's antitrust case against Microsoft, possibly as early as Friday,
and a broader shift to Web-based computing, which may loosen
Microsoft's hold on the loyalty of outside software developers, its most
important constituency.
"There are enough hairline cracks in the facade to cause me to want to
reduce my exposure somewhat," said Stephen Dalton, senior vice
president of First Capital Group, the institutional-investing division of First
Union. Mr. Dalton said he has pared his Microsoft position in the past
month, "first tactically and then strategically." A recent sell-off in the stock
has knocked Microsoft from the list of his fund's 10 largest holdings.
Commerce Bancshares' Commerce Growth Fund has also lightened its
Microsoft holdings. "We're underweighting the stock," said fund manager
Eric Wynkoop. He sees the trend to free software and services on the
Web pinching Microsoft profit.
Says Mr. Wynkoop: "The question is: Do they represent the last generation
of computing and now it's changing?"
Managers of several other large funds also said they are shedding part of
their Microsoft holdings. The immediate trigger was the first
quarter-to-quarter decline in Microsoft's unearned revenue account, which
reflects sales from previous quarters that haven't yet been recorded on the
company's income statement.
In the software industry, Microsoft pioneered the practice of recording a
portion of the revenue from some products as "unearned," starting with the
release of Windows 95. The practice is common in some other fields:
Many magazine publishers, for instance, record subscription revenues only
when issues are shipped.
Similarly, Microsoft now holds back a portion of revenues from Windows
98, Windows NT and Office until it "earns" the revenue by delivering
interim upgrades, bug fixes and other customer support. The account also
includes the value of coupons that customers receive, which entitle them to
free upgrades when they buy a Microsoft product before the next version
is ready.
A delay in the shipment of Office 2000 earlier this year caused the
company to add $400 million to the unearned revenue account in the
March quarter to cover the coupons issued to buyers of Office 97. As
copies of Office 2000 were shipped, half of that amount flowed into the
June quarterly results; another $150 million was transferred in the fiscal first
quarter ended in September.
The effect was to bolster earned revenues in those quarters and lower
unearned revenues. In addition, an accounting change in June caused a
higher percentage of Windows and Office sales to be credited to current
revenues and lowered the set-aside for the unearned revenue account.
Microsoft executives believed that explanation would suffice. Chief
Financial Officer Greg Maffei has long steered analysts away from
consecutive-quarter comparisons, explaining that the seasonality of
Microsoft's revenues also affects the unearned revenues.
In addition, he has warned them the growth in the unearned account would
slow as the company stops adding new products to the unearned revenue
mix, and as the transition of many large corporate customers to annual
"enterprise agreements" nears completion. Indeed, on a year-over-year
basis, the unearned revenue account balance increased by about $1 billion
from $3.13 billion in September 1998.
But the concern didn't go away. First Capital Group's Mr. Dalton said
Microsoft's premium stock price assumes predictable future revenues, and
there is nothing more predictable than having the revenues already in hand
in the form of an ever-expanding unearned revenue account.
"People don't want to hear the mitigating factors," he said. In trying to
explain the decline, he said Microsoft has gotten "stuck in a defensive
mode, which makes the stock look uncertain."
And while the balance in the unearned revenue account by itself is not
critical, it is useful for analyzing the company's actual performance. Rick
Sherlund, an analyst for Goldman Sachs Group, recalculated Microsoft's
results on the basis of the company's total bookings, or gross revenues,
regardless of when the sales get "earned."
On that basis, Microsoft's sales in the most recent quarter increased just
19% from a year earlier, rather than the 28% top-line growth reported last
week, he said. "What that means is that the underlying strength of the
business is not as strong as the reported revenue growth figure implied,"
Mr. Sherlund said.
Mr. Maffei said, "We don't disagree with the math, but we don't think it's
meaningful." He said analysts had already factored the impact of the
redemption of the Office coupons into their estimates, which Microsoft
beat.
Mr. Sherlund also said sales of desktop applications, which consist
primarily of the company's mainstay Office suite, grew by only 18% to
20%, rather than 33% as it appeared at first glance at Microsoft's report.
Microsoft trumpeted the strength of Office as the reason behind its strong
quarter. But Mr. Sherlund says: "Office was a bit slower-growing than one
might have assumed." Because Microsoft doesn't break out results that
specifically, Mr. Sherlund's numbers are based on his own model of
Microsoft's operations.
In any event, there are many analysts who continue to believe in the
company's vast long-term potential. Most reiterated their "buy"
recommendations in the wake of the earnings report.
David Readerman, a partner at Thomas Weisel Partners in San Francisco,
said the decline in unearned revenues was of less concern than the impact
of the imminent ruling in the antitrust case. U.S. District Court Judge
Thomas Penfield Jackson is expected to issue his findings on the factual
issues in the case, setting the stage for renewed settlement talks or a final
ruling.
"That's why you're seeing the stock not going anywhere," Mr. Readerman
said.
Indeed, many fund managers took note of Mr. Maffei's uncharacteristic
bullishness on the recent quarterly conference call and wondered whether
he might be accentuating the positive in the face of potential trouble.
Not at all, Mr. Maffei said. "If there were 10 ways to measure the
numbers, eight or nine of them were very positive," he said. "That's why we
were optimistic on the call, not for spin." |
