Will Microsoft's Malaise Sicken the
Nasdaq Again?
By Adam Lashinsky
Silicon Valley Columnist
4/23/00 6:26 PM ET
Once again, nervous tech investors approach Monday's
session with a single question in mind: Will Microsoft
(MSFT:Nasdaq - news - boards) bring down the rest of
tech with it? Late Thursday, when most people were
heading out for the long holiday weekend, Microsoft kept
investors and analysts after class, issuing a third-quarter
earnings report that, as usual, exceeded the consensus
estimates. Mr. Softee recorded a very healthy $2.3
billion of cash flow in a quarter with $5.7 billion in
revenues.
But, as they always say in the fine print, past results
are no guarantee of future performance. And this time,
it's more than boilerplate. Microsoft execs issued a glum
assessment for the current quarter and fiscal 2001.
Beating Wall Street's March-quarter expectations (with a
healthy dollop of investment gains) is irrelevant
compared to the company's instructions to analysts to
lower their estimates for the next fiscal year.
Remember, the forward guidance is far more important
than the reported results.
How bad could the market reaction be? In after-hours
trading Thursday, Microsoft shares tumbled four points.
And, just two weeks ago, the shares took the Nasdaq
into a 7.1% nosedive on April 12 after Goldman Sachs
analyst Rick Sherlund presciently predicted that
Microsoft might have trouble meeting the revenue
numbers expected by the street. And, voila, Microsoft's
revenue did come in light because of
lower-than-expected sales to PC makers.
"There are lots of cross-currents here," says David
Readerman, an analyst with Thomas Weisel Partners
in San Francisco. "There will be either a continued
rotation into other tech leaders like Oracle
(ORCL:Nasdaq - news - boards) and Intel (INTC:Nasdaq
- news - boards), or there will be a rotation out of tech
because of Microsoft."
Readerman wasn't willing to disclose his bet last week,
although he did speculate that "Sun and some of the
Linux players will be dancing on the grave a little bit." By
that he means that Sun Microsystems (SUNW:Nasdaq
- news - boards) will benefit at Microsoft's expense from
hardware sales based on its Unix operating system, as
will various Linux companies that may steal market
share from Microsoft with the open-source operating
system. On the other hand, Charles Phillips, enterprise
software analyst at Morgan Stanley Dean Witter, is
betting that the market will see this more as a Microsoft
event than as a sector-slammer. "This is more evidence
that Microsoft has peaked in influence, which is good for
people who compete against it," he said over the
weekend. "They've gone from being the company that
could do no wrong to just another important player."
There is already evidence for Phillips' case. Even as
Microsoft has slipped 32% on negative news since Jan.
1, Sun's shares are up 13% in the year to date. (On
April 14, Sun reported a stunning 35% jump in quarterly
revenue and beat analyst earnings estimates.) It's
tougher to handicap the action in the Linux area,
however. If, as Microsoft's comments to analysts on
Thursday night indicate, there is a slowdown in sales
growth in desktop PCs and PC-based servers, the Linux
companies would also be victims. Shares of Red Hat
(RHAT:Nasdaq - news - boards), perhaps the
best-known of the Linux brigade, are down 75% so far
this year, having closed Thursday at 25.
What is clear is that when traders return on Monday, the
psychology for tech stocks will likely be in the dumps.
As James Cramer wrote here Thursday, the tone of the
Microsoft conference call couldn't have been worse.
Microsoft has often used the quarterly calls to tamp
down overheated analyst expectations, encouraging
analysts not to raise their estimates for future periods
just because the company had beaten their previous
expectations.
Last week, Microsoft Chief Financial Officer John
Connors went beyond suggesting that rosier outlooks
would be a mistake. He instructed Wall Street to scale
back existing earnings-per-share estimates for the year
ending June 30, 2001, indicating they were too high by 5
cents. That's a precedent that could rattle a market
accustomed to seeing Microsoft shrug off just about any
setback and go on to set new highs.
Conner placed the blame on disappointing demand for
corporate PCs and pointed out once again that a
company as large as Microsoft -- it's fiscal year
revenues are expected to approach $23 billion this June
-- will find it increasingly difficult to rack up 20%-plus
annual growth. Prodded by analysts Sherlund and
others, Connors couldn't even speak optimistically about
the current April, even though the month is nearly
two-thirds gone by now. The implication: The world's
most important tech company is off to a lousy start in
its fourth fiscal quarter.
Or, could it be that Microsoft is suffering from unique
problems that other tech companies may not feel? Intel
told analysts last week that it remains upbeat about PC
demand. Cisco (CSCO:Nasdaq - news - boards) and
other suppliers say they still see strong demand, too.
Even if Microsoft is suffering from unique problems, it
could still drag down all tech shares simply because it's
so huge. CFO Connors made that point during the
conference call when he bragged that Microsoft's
revenue increase in the quarter alone accounted for four
and a half Yahoo!s (YHOO:Nasdaq - news - boards), 20
RealNetworks (RNWK:Nasdaq - news - boards) and
75% of Oracle's (ORCL:Nasdaq - news - boards) entire
software sales (not including its consulting revenues).
Then again, Morgan Stanley's Phillips says the tech
markets may not be so dependent on the mood swings
of the software giant. He acknowledges that the
Microsoft news could make the coming week in tech
stocks another turbulent one. "But I don't think it's as
cataclysmic as it would have been a year ago," he adds.
There's another aspect of the Microsoft earnings
announcement that bodes ill for the software giant and
other tech companies that have been generating great
numbers, in part, through gains on investments.
Connors said Microsoft locked in enough gains in early
April to ensure that its stock-sale gains in its fiscal
fourth quarter equal the $442 million that it amassed in
the third. This isn't great news for the rest of the stock
market because it means that Microsoft has already
begun bailing out. It also suggests that investors will
begin scrutinizing every other company that has relied
on portfolio windfalls, a strategy tech companies have
adopted only recently as a way to manage earnings.
Microsoft's fall from glory also should give pause to the
entire high-multiple crowd. Even taking into account
Microsoft's revised earnings outlook for fiscal 2001, it
still trades for about 42 times 2001 earnings. But the
company expects earnings growth only in the midteens.
Nonleaders with growth rates in the midteens get
multiples in the midteens. But Microsoft remains very
much a leader. What's the proper multiple for other
leaders in this climate? That's to be determined this
week.
How the market reacts to Mr. Softee's news will have
huge repercussions. A hit to the already-dented stock
could take down both the Dow and the Nasdaq.
Influential analysts such as Thomas Weisel's
Readerman will play a role. On Friday, I asked him if
he's thinking of changing his current buy
recommendation, his firm's second-highest. "I've got 48
hours or so to make up my mind on that," was all he
would say.
Come Monday morning, tech investors will quickly learn
if this is a Microsoft-only event or if the contagion will
spread. |
