The case for Microsoft
The company has obvious problems, but its prospects aren't nearly as glum as the share price suggests.
By Michael Sivy
As the closing arguments in the Microsoft antitrust case wound down this week, the company was facing daunting problems on almost every front. At such times, it's essential to remember that stock prices always discount bad news that's widely known. In fact, shares of the world's largest independent software maker are moderately undervalued. Not only should existing shareholders hang on to Microsoft, there's even a case for making cautious new investments.
Among leading growth stocks, Microsoft is remarkable for the consistency of its earnings growth--and its share price gains. But in the past year, as the company's legal problems have worsened and threats to its key businesses have grown more serious, the stock has run out of gas. At $94.25 shares are still up 27% in the past 12 months, but that's mediocre performance for this stock. And shares are well off their December high of $119.
If Microsoft shares carried the sort of premium they have in the past, the stock could easily trade for more than $140. Admittedly, the company's current problems warrant a lower price than that--but they don't come close to justifying less than $100 a share. Let's go through the biggest issues one by one.
Losing the antitrust case would help Microsoft. Growth companies frequently are held back by overreliance on their past successful products--that's certainly true for Microsoft, which gets 43% of its revenues from Windows. Any settlement that forces Microsoft to unleash its more exciting businesses would help the stock. Just look at what happened to AT&T after its most recent breakup: Long-distance did no worse than it would have done under the old company while Lucent took off.
Windows 2000's problems aren't all that bad. Microsoft's newly introduced operating system has received a lot of negative publicity, including reports that the system may not run some existing applications. But previous Microsoft products have had bugs, too. And despite complaints, sales haven't suffered.
The Internet won't make Windows obsolete anytime soon. As more software becomes available through the Internet, you won't always need a full operating system on your desktop. It will take more than a couple of years, however, for open systems like Linux to threaten proprietary software. And Microsoft has plenty of time to prepare. The company also has $18 billion in cash to revamp its existing product line or go off in new directions.
The PC isn't obsolete--yet. The most innovative sector of the computer business may be smart products--like telephones, for instance--that incorporate their own chips and software. But such devices won't replace the enormous installed base of desktops for quite a while.
It's true that Microsoft's earnings growth likely will slow from a historical 40% a year to something more like 25%. But consider that Cisco carries a 105 P/E, 3-1/2 times its projected 30% growth rate. By contrast, with a 49 P/E Microsoft is trading at just under twice its projected growth rate. That leaves a bit of room on the upside.
You can expect Microsoft to be volatile and possibly suffer setbacks this year. But the current share price incorporates a huge discount because of the company's well-publicized troubles. You can never know that all the bad news is out, of course. But I expect that Microsoft will have more positive surprises than negative ones over the next six months. MS |
