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Technology Stocks : How high will Microsoft fly? -- Ignore unavailable to you. Want to Upgrade?

To: Jill who wrote (23556)	6/2/1999 7:08:00 PM
From: taxman	Respond to of 74651

THE TRIAL RESUMES June 1, 1999 John McChesney of National Public Radio discusses the Microsoft anti-trust trial as it resumes today after a 13-week recess. PHIL PONCE: The United States versus Microsoft resumed today after a three-month break. The blockbuster antitrust case began last October, with the government accusing the software giant of illegal practices that stifled innovation and competition. Both sides have presented their main cases. Today the rebuttals began. Here to update us, as he has periodically throughout the trial, is John McChesney, who's covering the case for National Public Radio, NPR. John, the trial started last October, the government went first with its case in chief and Microsoft with its case in chief. In this three-month recess, why the recess for that long? JOHN McCHESNEY: Judge Thomas Pennfield Jackson had a criminal case that he had to preside over. So they took a break. And I think the Judge also hoped that perhaps these two parties might get together. I was noticing in the earlier piece there that there's a trend towards shorter and flashier stories, Phil. This is not a short or flashy story. It promises to go on for a long time. PHIL PONCE: Not conducive to a 12-second sound bite. JOHN McCHESNEY: Not at all. PHIL PONCE: One of the things that people speculated about that might happen during the course of this recess was a settlement, possible settlement. What happened there, do you know? JOHN McCHESNEY: Well, all I know is that they met a couple of times but there is a grand canyon between these two parties, starting with the question of whether or not Microsoft has a monopoly with its Windows operating system. Microsoft says it doesn't, the government says it does. So, you've got -- right at the very fundamental issue you have a disagreement. So, it's very hard for them to come to some agreement, particularly when Windows 98 is out with its browser integrated into it. You know, one of the principal issues has been the browser market and Netscape. PHIL PONCE: The browser market being the software that allows you to go on the Internet. Before the break happened, Microsoft was perceived on being on the ropes; the government was perceived as having momentum. What is the government trying to do -- expected to do now that it's on rebuttal - that it gets another bite at the apple? JOHN McCHESNEY: Well, you know, one of the central allegations here has been that Microsoft has abused its monopoly power in Windows, and it's done that by using predatory pricing, by using exclusionary contracts with computer makers and Internet service providers and other people and it's also bundled its browser together with its Windows operating system, as it's done with some other software, in order to put Netscape out of business. PHIL PONCE: Tied it up -- when you say bundling - in other words - JOHN McCHESNEY: Put those two together, integrated them and put them on the market as one product. PHIL PONCE: And Netscape being a competing browser company. JOHN McCHESNEY: Was. I guess it still is. Actually, they still have some considerable market share in the browser thing, but they're now owned by AOL and we'll talk about that in a little bit. What the government is going to do this time - they're bringing out -- both sides are rolling out economists. So we have dueling economists. We had Franklin Smith today from MIT who came on for the government. And the eyes glaze over in some of these arguments because we're getting down to definitions of words, definitions of markets, arguments about data and figures. They're very important, but it's very difficult for me to encapsulate those in any kind of quick rendition for you. PHIL PONCE: I won't impose on you to attempt to do that. JOHN McCHESNEY: The heat that will be generated in this rebuttal section will come from two witnesses. One of them is being called by the government; his name is Gary Norris. He represents IBM. IBM is the first computer maker to come forward in this trial to testify against Microsoft. It's interesting that it's happening in the rebuttal phase and not in the central part of the trial. I'm not sure why that happened. I'm not sure why IBM decided to come forward -- perhaps because it saw, as you said, that things seemed to be going against Microsoft so it's a little safer to come out and speak its piece now without fear of retaliation from Microsoft, which some computers makers have said they do fear. PHIL PONCE: And on the Microsoft side, once Microsoft gets its chance for a rebuttal, what is Microsoft expected to argue? JOHN McCHESNEY: Well, Microsoft is going to make a big deal out of the deal - that is, the deal between AOL and Netscape. Now, AOL during the trial in December purchased Netscape for $10 billion in stock and cash. PHIL PONCE: Again, AOL is the leading - JOHN McCHESNEY: America Online, the leading Internet service provider and online service. PHIL PONCE: It's a private company, you pay and they get you on the Internet. JOHN McCHESNEY: You pay 21 bucks a month now, I think, and you can stay within the AOL contained world, very nice place, or go out on the Internet -- 16 million subscribers now, I think. PHIL PONCE: That's important -- the AOL/Netscape deal is relevant to this case why? JOHN McCHESNEY: Microsoft said it's changed the whole competitive landscape on the Internet; that AOL has picked up the Netscape browser. Not only that, they've picked up what's called the Net Center Portal that Netscape has, which is one of these big Internet sites -- and if you don't change your default home page on your Internet browser, you go straight to that Netscape Net Center and there's a lot of advertising there and a lot of content. Microsoft says that deal changed everything, that the whole case against them has been made moot by that deal. It's a tricky proposition because there are other things that have gone on in the meantime, too. Microsoft invested $5 billion in AT&T to get on board with this broad band connection to the Internet that AT&T is going to provide through cable television. I suppose people could come back and argue, my goodness, this changed the market as much as the AOL/Netscape deal. PHIL PONCE: And the point of Microsoft's argument just to clarify is what -- that competition is continuing, not withstanding anything that Microsoft may or may not have done? Is that the argument they're making? JOHN McCHESNEY: The argument is that, if you go back to the fundamentals, and in fact they don't have a monopoly because anybody can challenge them quite easily if they have enough money and talent. That's all it takes, Microsoft says, to break in and challenge them. They point to the B operating system, the small operating system being developed - or has been developed in California, Lenox, the open source operating system that you're hearing more about. They're pointing to these, saying these -- PHIL PONCE: Other developments out there that could conceivably challenge Microsoft. JOHN McCHESNEY: They could challenge Windows. Now, the problem with that is now they don't even show in the chart in terms of market share. Microsoft's Windows is the ruling -- the ruling operating system. And there's no -- very few people will tell you that in the foreseeable future that is going to be seriously challenged by anyone. PHIL PONCE: And in the foreseeable future, there's no indication this is looking to be wrapped up quickly either, is that - JOHN McCHESNEY: Not at all. The way it's going to be wrapped up is we have this rebuttal phase they say will be over by the Fourth of July. I don't believe it. I haven't believed any of this schedule so far, and we've been right. Then we have findings of fact. This is an argument by both sides, the judge makes his finding of fact and findings of law, closing arguments, et cetera, et cetera. Then the judge goes away and decides and then we have a penalty phase and it just goes on and on. PHIL PONCE: Well, we'll have to have you back. Thank you, John. JOHN McCHESNEY: Thank you. Copyright © 1999 MacNeil-Lehrer Productions. All Rights Reserved. regards

To: Jill who wrote (23556)	6/2/1999 10:27:00 PM
From: Maverick	Read Replies (2) \| Respond to of 74651

ML reinstates cov, immed Acc, LT BUY, target $86 12 Month Price Objective: $86 Estimates (Jun) 1998A 1999E 2000E EPS: $0.89 $1.36 $1.49 P/E: 86.5x 56.6x 51.7x EPS Change (YoY): 53% 10% Consensus EPS: $1.34 NA (First Call: 26-Apr-1999) Q4 EPS (Jun): $0.25 $0.35 Cash Flow/Share: $1.00 $1.50 $1.65 Price/Cash Flow: 77.0x 51.3x 46.7x Dividend Rate: Nil Nil Nil Dividend Yield: Nil Nil Nil Opinion & Financial Data Investment Opinion: A-2-1-9 Mkt. Value / Shares Outstanding (mn): $424,424 / 5,512 Book Value/Share (Mar-1999): $4.67 Price/Book Ratio: 16.5x ROE 1999E Average: 27.8% LT Liability % of Capital: 0.0% Est. 5 Year EPS Growth: 20.0% Stock Data 52-Week Range: $95 5/8-$41 7/16 Symbol / Exchange: MSFT / OTC Options: Pacific Institutional Ownership-Spectrum: 34.6% Brokers Covering (First Call): 25 ML Industry Weightings & Ratings** Strategy; Weighting Rel. to Mkt.: Income: Underweight (07-Mar-1995) Growth: Overweight (07-Mar-1995) Income & Growth: Overweight (07-Mar-1995) Investment Highlights: · We are reinstating our investment opinion on MSFT with intermediate-term Accumulate, long-term Buy and $86 12-month price objective. · Given quality of earnings stream, tremendous R&D machine and breadth of solutions reach, MSFT should be a core holding for long-term technology portfolios. · We believe MSFT can sustain current 57-58 P/E on FY 99 EPS, rolled forward onto FY 00 EPS est. yields $86 price objective (+12%). Fundamental Highlights: · Microsoft continues to build its “Digital Nervous System,” expanding its reach beyond the desktop into high-end corporate environments and consumer devices. · Wealth of new product cycles over next 12 months (Windows 2000, Office 2000, and BizTalk Server) sustain growth model. · Trading volatility could increase as antitrust outcome remains uncertain, Y2K drag and product cycle pause possible 1H FY00. · Microsoft drives the Digital Economy at all levels and will become increasingly involved in enterprise computing, e-commerce and broadband access with aggressive investments. A New View of the Digital Economy Summary We are reinstating research coverage of Microsoft Corporation with an intermediate term Accumulate, long-term Buy opinion with an $86 price objective. We believe that Microsoft should be a core technology holding for long-term investors, given the company's outstanding management execution, high-quality earnings stream, unparalleled breadth of technology platform and increasing influence beyond the corporate desktop. Microsoft, like any technology juggernaut, combines a daunting market presence with an ability to adjust quickly to changing market conditions. We find Microsoft's agility in the software market impressive, especially with a $424 billion market capitalization. In particular, we see a continued stream of new product cycles and new market entries over the next 12-18 months opening new growth avenues for the company. We will explore later the implications of Microsoft's Digital Nervous System platform, and the broader market impact Microsoft can bring to bear through this vision. We do not expect MSFT's path to new highs to describe a straight line; rather the volatility of this relatively stable stock could increase as the interest in competing Linux operating systems and the still-unresolved DOJ trial weigh in over the next 6-12 months. We believe these issues may stall MSFT's near-term upside, but present opportunities for investors looking to build a core technology portfolio for the long-term. We expect MSFT to hold its current premium 57-58 P/E multiple on FY 99 EPS of $1.36. Rolling that forward onto FY 00 EPS of $1.49 implies a 12-month price target of $86, or 12% upside from current levels, warranting an Accumulate opinion. Risk Factors 1. Y2K Drag and near-term pause in product cycle— While Microsoft will be rolling out a raft of new products (Windows 2000, Office 2000, BizTalk, etc.) in the next 12 months, there will be a transition period which could soften revenue strength in the near-term. 2. DOJ antitrust resolution—We are now moving into the rebuttal phase of the Microsoft trial, with many familiar faces returning to the stand. Microsoft will be looking to reestablish momentum in the trial, while the government seeks to drive home some of Microsoft's earlier missteps. 3. Linux and the Internet camp—The Internet's openness has given a competing operating system like Linux an opportunity to establish itself on corporate servers as an alternative to WindowsNT (and an alternative to Unix). While still a relative rounding error in terms of Windows NT unit installs, Linux's growth rate on corporate platforms is gaining investors' attention. 4. Premium valuation adds to volatility. 3Q 99 Results Microsoft reported 3Q 99 (March) results which exceeded consensus estimates. Revenues grew 15% to $4.33 billion, excluding $400 million in unearned revenues from Office 2000 upgrade coupons, which should flow back over the next two to three quarters as customers upgrade. Operating margins were an industry-leading 51.5%, up 40 basis points from prior year. Net income was $1.92 billion, or $0.35 per share, a 40% increase over 3Q 98. Platform revenues remained strong, growing 26% in the quarter to $2.05 billion, Applications/Tools revenues grew 4% to $1.9 billion, with OEM revenues ahead 29% to $1.6 billion. By geography, Europe/Mid-east/Africa grew 4% to $932 million (“solid” growth in France and Germany) while Americas/South Pacific increased 6% to $1.33 billion, with “moderate” growth in the US and a flat performance in Latin America. Asia revenues were up 22% to $475 million as Japan firmed. On the 3Q 99 balance sheet, cash/investments totaled $21.8 billion, with cash flow from operations of $2.7 billion. The company has no long term debt. Unearned revenues (which are recognized as certain technology upgrade and service obligations are fulfilled) totaled $4.2 billion. Deep Pockets and The Digital Nervous System Microsoft customers have captured massive amounts of data in their Microsoft-based enterprise application servers, messaging systems, database, e-commerce site servers, etc. Unifying this information, making it palatable and more usable to a broad user base, and linking the extra-corporate world to corporate intranets is the goal of Microsoft's Digital Nervous System (DNS). At the core of this positioning is linking emerging Internet technologies, decision support applications, and “bullet-proof” messaging to bind all Microsoft-centric technologies together. Critical to bringing the DNS beyond the corporate walls and into customers and partners hands (and extending the reach into the home consumer market) will be the role Microsoft plays in the proliferation of software to power new net-based devices and to deliver content via expanded broadband media. Microsoft has opened its war chest of nearly $22 billion in cash and investments to take equity stakes in both AT&T and Nextel in the past few weeks, signaling its broader intentions in broadband and wireless services. The 2K Product Cycles: Windows and Office Windows 2000 (Win2K), currently in its third beta release, will represent a watershed product release for Microsoft later this calendar year, as the company attempts to break into high-end corporate computing environments. Win2K will be the next-generation operating system for the corporate environment, unifying desktops and servers on a common “code base” for the first time. The benefits here will be a standard administration model enterprise-wide, enhancements to directory services, a common user interface and application programming interface (API) compatibility, improving integration efforts and system stability. We expect Microsoft will offer three Win2K server platforms: Server for dual CPU systems, Advanced Server for up to four CPUs and Datacenter for more than 4 CPUs. Many Windows NT application developers are anxiously awaiting the release of Win2K as a more stable alternative to NT 4.0, which has been plagued with stability issues limiting its usage to smaller applications servers and file serving responsibilities. We understand that the scalability and memory usage of beta versions of Win2K are significantly improved, but it will take time for corporate customers to let the new operating system prove itself as worthy of the “glass house” and some application compatibility issues remain. We expect final release of Win2K in October. We do not expect Office 2000, the company's next generation desktop applications suite, to be a major revenue accelerator in this calendar year, as the installed revenue base is a massive $5.8 billion year-to-date. However, with Office 2K now shipping, Microsoft will be able to recognize approximately $200 million in 4Q 99 upgrade “coupons” that will be redeemed by existing Office customers. E-commerce and BizTalk While Microsoft has turned its Microsoft Network (MSN) franchise into a significant portal on the Web, we think the recent moves in business-to-business e-commerce with BizTalk Server signify Microsoft's acknowledgement of the significantly greater revenue opportunity of business-to- business e-commerce when compared to the consumer market. In particular, it appears to us that Microsoft will have to partner more aggressively and support more e-commerce standards such as Extensible Markup Language (XML) to gain a presence in this segment; Microsoft will not carry the day alone here. Case in point, Microsoft's recently-announced BizTalk Server, an XML server that sits on top of its application server to help businesses to share transactions with supply chain partners over the internet, replacing expensive EDI solutions. Microsoft will license webMethods B2B software to facilitate the XML brokering. We expect BizTalk to ship beta later this summer, but no date for general availability has been set. DOJ Antitrust Update Microsoft's epic antitrust trial against the US Government resumes in June, with rebuttal witnesses being called. Microsoft made several missteps during the most recent phase of the trial. Most familiar with the case believe some kind of ruling against the company is likely, and that begs the question as to what possible remedies the government might have? The government is likely seeking a breakup of the company or opening up Microsoft source code to forced licensing. “Conduct” remedies, a more temperate move, would require intense, long-term government monitoring of the company's business practices, not much more desirable than a break up into “Baby Bills”. Should the trial move against the company, we expect Microsoft to make a case that such dramatic remedies would raise user costs, as applications would have to be developed for differing code bases, hurting the consumer. At any rate, we believe that an initial ruling, followed by an appeal phase will prevent any potential penalties until 2001. The Linux Groundswell We assume most investors are aware of the recent explosive fervor for the “open source” movement, and the commercial inroads made by Linux, the “poster child” of open source operating systems. Linux unit installs grew by over 200% last year according to IDC, compared with 28% Win NT growth in 1998 on a much, much larger base. Linux proponents have argued against Microsoft's dominance of desktop computing with its closed-source Windows offering and Linux has been used as an anti-Microsoft rallying point. While we believe Linux will continue to grow in popularity as an enterprise server, Microsoft's powerful application developer channel will continue to drive NT sales of mid-market, departmental and (increasingly) higher-end corporate applications deployments. Earnings Outlook Our initial MSFT earnings model anticipates 4Q 99 (June) quarterly revenue growth of 21% to $4.85 billion and EPS growth ahead 41% to $0.35. For FY 2000 (June), we project annual revenues of $21.2 billion (+17%) and EPS of $1.49 (+10%). In typical Microsoft spirit, we believe that our estimates over the next four quarters to be conservative and reflective of the usual “cautiously optimistic” indications about Microsoft's core business. As we mentioned under risk factors, the lack of material near-term product cycles and a Y2K demand slump could temper significant earnings breakouts like the 2Q 99 posted by the company.