Windows 2000: Microsoft's Money Machine
by Pat Dorsey
With all of the media squawking over the Windows 2000 launch, you'd think Microsoft MSFT was already dead and buried.
Check out a few of the headlines I ran across on some financial sites: "Windows Delays Give Linux a Chance," "Microsoft Foes Say They Already Beat Windows 2000," and my favorite, "Windows 2000 Launch Has Some Looking at Linux Stocks" (as if nobody was looking at Linux stocks before the launch).
Enough already. Now repeat after me: Microsoft is going to make a ton of money from Windows 2000. A ton. Of money.
Yes, Sun Microsystems SUNW is a truly fearsome competitor. Its Solaris operating system is rock-solid, and the company has a huge amount of momentum in the marketplace. And yes, Linux has a huge cost advantage over Windows 2000--it's tough to beat a free product on price--and is growing by leaps and bounds.
But before we do too much hand-wringing, let's separate fact from reality. Luckily for us, this task is made much easier by last week's release of market share data for server operating systems from industry watchers International Data Corp. The numbers that got blasted across the headlines were that Linux's market share had exploded from 16% of the operating system units shipped in 1998 to 25% of units shipped in 1999, which is tremendous growth by any measure. Bad news for Microsoft, right?
Well, not really. Between 1998 and 1999, Windows NT's market share was stable at 38% of units shipped. So, although Microsoft would have probably gained market share in a world where Linux didn't exist, the fact remains that Linux's growth came at the expense of other operating systems--not at the expense of Windows.
Moreover, Linux's share of server operating system revenue was a measly 0.6%, while Windows NT got a fat 30% share of server operating system revenue. Conclusion? Nobody makes much money from a free operating system.
As an investor, you must ask two questions when you're evaluating a market segment: Where the dollars are going, and what's the valuation of the entity getting those dollars? The answer to the first question, in the case of server operating systems, is that 30% of the dollars are flowing to Microsoft and 0.6% are flowing to the Linux crew. As for the second question, Microsoft currently trades at a trailing price/earnings ratio of 60. Red Hat RHAT, one of the leading Linux distributors, trades at a trailing price/sales ratio of 223. Which is the better buy? I'll let you answer that question for yourself.
(As a side note, what this data really tells us is that the way to make money from Linux is in the embedded device market and in service and support--not in license sales. But that's the subject for a future column.)
Finally, let's remember that the server market is the tough battle for Microsoft. The desktop battle has already been won, and that's where a lot of the earlier Windows 2000 revenue is going to come from. For one thing, Windows 2000 upgrades will likely also drive upgrades to the Office 2000 application suite, because it's easier for information-technology departments to upgrade everything all at once.
Second, there are going to be a lot of Windows 2000 upgrades this year. The Gartner Group estimates that by the end of this year corporate America will upgrade 15% to 20% of its PCs to Windows 2000 and 50% of all new PCs will be shipped with the new operating system. Even if these estimates wind up being optimistic, the bottom line is that Mister Softee is going to make a ton of money from Windows 2000 over the next 18 months--especially because the number of server upgrades will really take off in 2001.
Although Microsoft's stock isn't necessarily cheap on an absolute basis right now, its valuation relative to the market is pretty much in line with where it's been for the past few years. With the company on the cusp of a major earnings cycle, you'd think it would be trading higher, and the reason it's not is almost certainly the antitrust trial. (Thought I was going to forget about that, didn't you?)
But with Microsoft making more conciliatory noises, and any decision years away--absent a settlement, the company will almost certainly appeal if the government wins--a negative litigation outcome seems already priced into the stock. If you were ever thinking about getting a piece of Microsoft for yourself, now looks like the best time in quite a while. |
