A point of view I respect and I think if we can subscribe the better it is.. Microsoft MusingsBy Joe ArenaEditorThe High Tech Arena 12/20/98-
Since our initial position in Microsoft was purchased in 1994, we have
maintained that one of the most salient reasons to own the stock is the
company's marketing prowess and ability to execute. Our investmentthesis has
long been that Microsoft should be viewed as a marketing company first,a
technology company second. This week's developments regarding thestrategic
alliance with Qwest as well as the announcement made by SunMicrosystems and
Oracle further exemplifies this phenomenon.
Moreover, we believe that focusing on the marketing aspects of suchdeals, and
the concomitant revenue streams, (versus analyzing the more arcaneaspects of
Qwest's technology) is the key to understanding the success ofMicrosoft in
general as well as what specific strategic benefits this deal will havein the
future. First and foremost, the alliance formed with Qwest has to do with
Microsoftlicensing its NT operating system (Windows 2000). In addition,
Microsoft will
now be able to sell Qwest products through their direct sales force aswell an
immense network of 88,000 value added resellers. It should also benoted that
about 7000 of these resellers sell direct to high end corporateaccounts.
These products can be classified into three different types; virtualprivate
networks, complex web hosting, and managed software services. What is
important to identify here is the dollar opportunity for theseproducts. The
market for virtual private networks is projected to grow to $20 billionby
2003. Qwest's goal is to have about 5% of this market, or $1 billion. The
key question to ask, however, is how much of Microsoft's $17 billionwar chest
will be spent pursuing other alliances to capture a greater share ofthis
business. The same can be said of the complex web-hosting business,which is
expected to grow to $15 billion by 2003, and is one in which Qwestaspires to
gain about a 7% share. Managed software services is the part of thisdeal
which is relatively inconsequential, as this market is expected to beonly
about $2 billion by 2003.
In understanding the strategic significance of this deal, it must be
asserted that it is all about e-commerce and bandwidth. The growth of e-
commerce has been well documented, with many industry market researchfirms
projecting revenue in the range of $1.2 trillion by 2002. In terms of
bandwidth, this represents another opportunity for Microsoft to sellbullets
instead of fighting a war. For the uninitiated, think of bandwidth asthe
plumbing in your house; the bigger the pipes, the greater the amount ofwater
that can flow through them at a faster rate. More importantly, however,we can
use the analogy of Intel's success to explain how important bandwidthwill be
in the future. As Intel developed faster and more powerfulmicroprocessors,
"killer applications" were developed to take advantage of theseincreases. It
will be no different with bandwidth; the greater the increase inbandwidth,
the more new services will be created to exploit this.
We have discussed at length in some of our recent analyses on CiscoSystems
about the convergence of voice, video, and data. It is likely that by2000,
data and IP (Internet protocol) will overtake voice in terms ofaccounting for
more bits traveling through a network. By 2003, there are someestimates
projecting that data will account for as much as 90% of the bits goingthrough
networks. The bottom line here is that data creates an exponentialdemand for
bandwidth. Moreover, when you consider the convergence of voice,video, and
date in the context of Cisco Systems estimate that there are 7 newInternet
users every second, the growth potential is staggering. Thus, byvirtue of
this alliance with Qwest, Microsoft has confirmed what Andy Grove woulddefine
as a strategic inflection point. This deal not only indicatesMicrosoft's
belief that we are rapidly evolving toward a network-centric paradigm,but it
provides them with guaranteed access to bandwidth. Finally, from amarketing
standpoint, the Qwest alliance not only enables Microsoft to leverageWindows
2000 in a broadband, IP environment. It also provides an opportunity to
generate recurring revenues from sales fees and other residuals, aswell as to
participate in the e-commerce business with corporations using Windows2000.
Is it any wonder, then, why Oracle and Sun Microsystems are soconcerned
with the impending launch of Windows 2000 in about 6-9 months? (not tomention
the introduction of SQL Server 7.0 which we recently discussed) Although we
continue to be impressed with Sun Microsystems, Oracle's "Raw Iron"initiative
appears to be another ill-conceived marketing strategy focused more on
combating the threat from Microsoft then in satisfying the needs ofcustomers.
Specifically, "Raw Iron" refers to Oracle's strategy of developingdatabase
appliances which do not require an operating system. However, since the
Oracle/Sun Microsystems agreement consists of selling database serversrunning
on Sun's operating system (called Solaris), it is difficult todetermine what
exactly makes this strategy revolutionary and "value added." Althoughwe do
expect Oracle to generate some interest at least initially, longer termit is
hard to envision that "Raw Iron" will prove to be any more successfulthan the
NC (network computer) touted by Larry Ellison two years ago. It shouldalso
be noted that there are a number of analysts on Wall St. who believethat
Oracle's strategic direction is viable. Notwithstanding, there are anumber
of IT managers who are viewing "Raw Iron" with more than a modicum ofdoubt;
we tend to put more credibility in the perceptions of the trade thanthe
sometimes questionable motives of Wall St. analysts. In conclusion,when it
comes to marketing, no one does it better than Microsoft; this is justanother
case in point. TRADING UPDATE:
Regarding Microsoft short term, we believe the wind has started toblow in a
different direction concerning the DOJ. Judge Jackson's comments thisweek
concerning the AOL/Netscape merger represent a sea change in attitude.
Despite our aforementioned comments regarding the Oracle/SunMicrosystems
alliance, this will provide Microsoft lawyers with more fuel for thefire. In
addition, recent surveys indicate that Microsoft is winning in thecourt of
public opinion, which should come into play when remedies are imposedshould
the DOJ prevail. In addition, Microsoft witnesses will begin to takethe stand
sometime in January, which should at least eliminate the negativerhetoric
emanating from the media. (let's face it, negative news about apredatory
monopolist sells much more than a story about an exceptionally wellmanaged
company that plays hardball versus the competition) Finally, Wall St.will
begin to anticipate another earnings surprise on the upside on January21, (we
are looking for 63 cents/share) and investors will begin to anticipateanother
2 for 1 split announcement. We believe the stock should trade around150 in
January, and continue augmenting our long position in the stock bygoing long
Jan 2001 calls, with strikes ranging from 100-140. Our twelve monthtarget
price on the stock is 190, and two year target is 250. We are lookingfor
earnings per share of $2.60 in fiscal 1999, and $3.35 per share infiscal
2000. Built into our stock price targets is the expectation thatMicrosoft's
p/e ratio will expand as Wall St. places a greater premium on thosecompanies
which consistently demonstrate superior earnings growth of 25% in a
deflationary/slow growth environment.TRADING UPDATE: CISCO SYSTEMS
In response to the many questions we have received regarding ourtrading
strategy of shorting puts, we offer some further clarification.
We have recently continued our strategy of shorting January 2001 putson
Cisco, (using strikes of 60, 70 and 73.3) with the objectives being as
follows: a.) generate long term capital gains in accounts that are 100%
invested without paying margin interest. b.) Refrain from chasing astock
which has run up 120% since October 8, yet still participate in further
upside. c.) Purchase more of the stock on any significant correction.At a
time when it is emotionally very difficult to do so, getting assigned astock
at the strike price eliminates the emotion from a decision to purchasea stock
that is down 30-40%.
The important point to note is that shorting puts is never asubstitute for
buying the stock, and we have been long Cisco stock since May 1996. Ifthis
strategy is used as a substitute for buying the stock, the risk is thatyou
will never own the stock. We remain long the stock and the Jan 200156.6calls.
In addition, we have received questions about the Jan 2001 Ciscocalls that
we are long. We remain committed to the philosophy that you buildwealth by
buying only outstanding companies and holding them long term until the
fundamentals change, and by not paying capital gains taxes every year.
Consequently, we plan to exercise these options rather than takeprofits in
January 2001. This strategy serves two purposes. First and foremost, it
defers taxes until you decide to sell the stock. Second, since Leapsare not
marginable securities, their appreciation does not increase the buyingpower
in your account. Thus, for aggressive investors who trade on margin,
exercising these Leaps will give an immediate and substantial increaseto your
buying power. We believe that given the strong fundamentals that aredriving
the price of Cisco stock, it is within the realm of possibility thatthe stock
could split 3 for 2 three times in the next two years. This wouldprovide us
with an opportunity to add to our position in the stock at a splitadjusted
price of 16.7. If the stock splits twice in the next two years at 3 for2,
this would be 25.1, or 37.7 in the case of one 3 for 2 split.
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THE HIGH TECH ARENAJoe ArenaEditorJRArena@aol.com |
