Microsoft always seeking a fiscal fountain of youth
As growth slows, the company invests billions in new realms
By HELEN JUNG
THE ASSOCIATED PRESS
Monday, February 24, 2003
They're stats to die for: Market share of 90-plus percent. Profit margins of 80 percent. Stocks that have created thousands of millionaires in the Seattle area alone.
But behind those figures is Microsoft Corp.'s biggest challenge for the future: Just what is a monopolist to do next?
As growth slows for Microsoft's main products, the company has been aggressively expanding into new realms, investing billions in everything from selling video-game consoles to loaning small businesses money to buy its software.
Those new ventures, however, are losing millions of dollars -- and creating tensions with such big-name companies as IBM and Sony.
Meanwhile, slower profit growth and a now-listless stock price has intensified pressure on Microsoft to find a fiscal fountain of youth.
"It's become extremely critical for them to grow these other segments," said Rob Enderle, an analyst with Giga Information Group. "Otherwise the (stock) market will not be kind to them."
Microsoft maintains its growth prospects are strong. At an analysts' conference last month, Chief Financial Officer John Connors pledged "incredible products that change the world." Still, Connors acknowledged the question that has been hounding Microsoft lately: whether "those products translate into the kind of profitability we've had from some of the very incredible products we've done historically."
To be sure, the company remains the envy of businesses around the world.
At 28 years old, the company owns the market for desktop operating systems with Windows. Its co-founder, Bill Gates, is a star and the company's phenomenal rise in stock price is legendary: One share of Microsoft bought for $21 in its 1986 stock-market debut, with nine stock splits over the years, is now worth about $7,000.
Microsoft also continues to outpace the rest of the industry, pulling out profits while others desperately try to stem losses. For the second half of 2002, Microsoft earned a $5.3 billion profit on record revenue of $16.3 billion.
"They truly have been defying gravity by showing growth and strong financial performance at a time when (information technology) spending was down," said Eric Upin, software analyst with Wells Fargo Securities.
But that strong showing may be a sign of leaner times to come, analysts said.
The record revenue stemmed mostly from a change last year in how Microsoft charges bulk buyers of software.
The windfall from the shift to a subscription model won't continue forever, Upin said, and some companies are considering alternatives to Microsoft software. Upin thinks Microsoft has "a couple quarters left in the gas tank."
In addition, with the market for personal computers drastically slowing, there are fewer customers for Windows.
Analysts also say Microsoft will have a tougher time showing customers why they need costly upgrades to their Windows or Office software.
Perhaps the biggest sign of Microsoft's maturing came in January when the company announced its first-ever dividend, which analysts see as a response to increased frustrations among investors over the stagnating stock price while Microsoft hoards $43.4 billion in cash reserves.
But some say issuing a dividend is like admitting you can't throw a fastball. And Microsoft's decision to split its stock in February -- at prices lower than previous splits -- was seen by some as an effort to jump-start trading and regain the pattern of acrobatic leaps of the stock's younger days.
The moves are focusing attention on where the money is coming from -- and where it's not.
Microsoft's Windows, Office and Server businesses collectively provided 81 percent of company revenues for the second half of 2002.
The three sectors also boast huge operating profit margins of 83 percent, 78 percent and 32 percent, respectively.
From there, it's all about pouring money into areas Microsoft believes will someday deliver profits.
The four money-losing businesses -- its MSN Internet Service, Home and Entertainment segment including Xbox, Business Solutions for smaller companies and CE/Mobility software for wireless devices -- brought in a $3.2 billion combined in revenues but lost a little over $1 billion for the six months.
Those figures don't include another $905 million in losses that can't be attributed to any one business unit.
In many of its businesses, Microsoft is doing battle with some established competitors, including AOL Time Warner in the Internet access market, Sony in the video-game business, Nokia and Palm in wireless and IBM in selling software and services for companies.
Many have been bruised in previous brushes with Microsoft, and none intends to let a company synonymous with monopoly gain a dominant foothold in their industries.
Marty Shagrin, a research analyst with Victory Capital Management, wonders: How far are those money-losing Microsoft businesses from profitability -- and are they worth the effort?
"I don't think they're out in left field in what they're doing," Shagrin said.
"It's just the economics of it aren't clear yet."
MICROSOFT AT A GLANCE
Microsoft Corp. is split into seven business units. Here's a look at the divisions and some of their main products.
Client: Microsoft's Windows software is by far the dominant desktop operating system with more than 90 percent market share. The company is working on a new version, codenamed Longhorn.
Information Worker: Microsoft's Office suite of software and other business applications. Microsoft is slated to release a new version of Office this year. Profits from the Client and Information Worker segments fuel much of the company's investments. But analysts said Microsoft must prove to customers that the new versions will be worth the cost of upgrading.
Server Platforms: Microsoft's server software unit is profitable but the company faces a looming showdown with an elusive competitor - open-source Linux-based software. Many vendors, including IBM, are building software products on top of the free Linux source code, making the initial costs much lower than Microsoft's software. Both are gaining market share at the expense of older Unix-based systems, but analysts say they will eventually compete.
Home and Entertainment: This division includes Microsoft's Xbox video-game consoles and its new Xbox Live online video game service. Although the division has sold more than 8 million consoles since its launch in November 2001, sales were lower than expected. Sony's Playstation 2 remains the top dog worldwide.
MSN: The company came out with its most improved Internet browsing software yet, with the release of MSN 8. But with about 9 million subscribers at last count, it's still far behind Internet leader America Online, despite Microsoft's ongoing $300 million advertising campaign.
Business Solutions: With the purchase of business software companies Great Plains and Navision in the past two years, Microsoft has assembled a business unit that some analysts believe will have some of Microsoft's best growth opportunities -- the market of serving small and medium-sized businesses.
CE/Mobility: With the number of wireless devices exploding around the world, Microsoft is pushing hard to be the software provider of choice. But it's finding some of its toughest competition yet as rivals are striking deals to try to limit Microsoft's power in the emerging industry.
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