Microsoft's True Tragedy

First things first: I am not afraid. When you are writing things on the fly, trying to get them done, you aren't as sensitive to punctuation and ordering as you should be. "Terrible transition and terrible timing for Microsoft, I am afraid," the killer last line of my on-the-fly brief last night, should have read "I am afraid this is a terrible transition and terrible timing for Microsoft."

But if you only knew the half of it.

We came Thursday long Microsoft (MSFT Quote). We are always long Microsoft. It is not a big position, but I have insisted that we be long Microsoft for as long as we have had this firm, and for before that, when I worked at Goldman Sachs and the company came public. It, along with Intel (INTC Quote), Cisco (CSCO Quote) and SUNW (SUNW Quote) have long been my favorite companies. If you go back to when I was the stock columnist for Manhattan Lawyer magazine in the late '80s, you would know this for all but Cisco, and that exception is only because it hadn't come public yet. By the time I moved on to SmartMoney, my bias was on my sleeve about all four companies.

My history with Mister Softee goes back to the '70s -- pre-Soft -- during the summer of my third year at Harvard when Microsoft's now-president Steve Ballmer was my roommate and he ran the business side of the Crimson when I ran editorial. I am always proud of the fact that we had great editorial and we turned a profit under Ballmer. We had been a money-losing institution for years, but Steve and I collaborated on a new section that brought entertainment and restaurant advertising to the Crimson for the first time and we turned the financial ship around. He is the best businessman I have ever worked with and he is a fabulous guy. I remember when he was debating P&G (PG Quote) vs. Microsoft at some Christmas party we were both at almost 20 years ago and I know where I stood -- "Go West, young man." I regard him as a friend for life, even though we haven't spoken in some time. Just to nail this long history timeline home: We both had a ton of hair during that conversation!

In other words, I love Microsoft.

But I am not a dictator at my firm. I am a partner. Jeff Berkowitz is my partner. We are teammates, and Jeff is "primary" on Microsoft, not me. (These days I am primary on everything but tech, covering the 70% of the S&P that is not tech. It is my job to be on the P& G and Clorox (CLX Quote) and Citicorp (CITI Quote) and Chase (CMB Quote) calls, and some of the dot-coms. Jeff handles tech with profits. Matt handles tech with losses. Just my short-hand, but it works.)

In other words, I listen to and take Jeff's counsel on 'Soft. The week before, when Rick Sherlund at Goldman Sachs had trimmed revenue forecasts, Jeff had sold a chunk of Microsoft without even checking with me. That was sure right. I would have only agreed.

We don't like revenue cuts. We care more about revenue than we care about earnings because revenue shows a truer picture of growth. True, just true. Go with me on this. But we didn't sell it all, and I think we didn't out of Jeff's respect for me and my love of the company. In a business where love is a costly line item, we still show a modicum of it for certain companies because of respect for the money-making culture they have created. 'Soft is one of a few. So is Yahoo! (YHOO Quote), by the way. And of course, so is Cisco.

So last night I was late man, having left early the night before. I was on the Microsoft call. I was, reluctantly, primary. I always like to be on the call, but I am usually a sightseer as opposed to Jeff, who is in charge.

The call started at 5:30 p.m. EDT. Jeff was still on his way home. But he got on it immediately and he went on AOL (AOL Quote) Instant Messaging as I did -- we are always on, so we can stay on the phone -- and we listened and watched together.

Conference calls start with generalities about the past quarter, then go to specifics about the last quarter, then switch to outlook and then guidance. Think of them as plays where you get involved with the characters and know their histories in Act One, find out what they've done most recently in Act Two, and then in Act Three you find out what is going to happen and how things end. As the quarters are continual, it is more like a series of ongoing plays then a one-off production. A continuum.

During the first act of last night's call, I felt quite good about Microsoft. You forget how strong this company is. How its gains quarter over quarter are more than most companies will ever make. It's like comparing the annual gross domestic product of this great nation to the total sum of all of the gross domestic products of 100 other nations for a year and knowing we still exceed it. Makes you proud. Makes you proud to be a shareholder.

Act Two was more difficult and a tad worrisome. Act Two was about how business demand for the second quarter was not so hot. I had heard this before from IBM (IBM Quote) and Unisys (UIS Quote), mostly because of that now-wacky Y2K thing. (Don't email me, I am kidding.) I didn't want to hear it from Microsoft.

In the middle of Act Two, I penned a piece to my editor, Jane Penner, that said that while things were not great, they weren't bad, but more later.

I wanted to give a real-time kind of insight. I dashed it off in the middle of Act Two.

Act Three began around 6 p.m. I was conscious of the time because we had exercised Microsoft calls, the April 75 calls, which would make us long Microsoft Monday. The exercise was automatic. The stock was three points in-the-money (meaning it was three points above the strike price when the market closed). I was conscious because I knew when Act Three began that it would be a mistake to have exercised those calls. It would have been worth it to have them go out worthless, to write off the three points of stock that we would get in order not to have to come in long this stock on Monday.

It would have been worthless because Act Three was a disaster, a tragedy when I thought we were witnessing a history. Most of Microsoft calls are a comedy in the true Shakespearean meaning of comedy, so I didn't expect to run into this spiraling down drama.

In Act Three, the analysts learned that everything they had thought about the future of Mister Softee was too rosy. Revenue, earnings, growth rate, they were all too high. Those who were thinking 20% growth rate learned they were dealing with a 15% growth rate. Those who thought that the slowdown in PCs was just temporary learned otherwise. Hundreds of millions of dollars of prospective revenue got vaporized on that call. Sherlund, the most conservative 'Softee, was still too high. As this part of the call went on, I hastily flashed "Urgent Kill Piece," to my editor. It hadn't been posted, but I knew that this call was too much of a work in progress to draw any conclusions yet. My editor killed the piece. The wonders of the slowness of net technology; it hadn't been posted yet. Phewww!

The call droned on. Time to be more conservative. Time to be more guarded. Time to be less optimistic. Time to be all right already, I wanted to say into the muted phone.

We were in disbelief.

"A disaster" came the Instant Message from Jeff.

"Wait," I wrote. "Too soon to judge."

"No, it is bad. You know it."

"Y" I wrote back, for yes, I knew. "Disastyer," 'cause nobody spells anything right on IM.

"Are you selling it all?"

"Leaving some."

"N!"

"Wait"

"N!!"

"OK, Gone"

And with that, Microsoft vanished from our sheets. Microsoft. Fixture on the sheets like the names Cramer and Berkowitz on the top. Root of the sheets. Sheet bedrock.

While we were still selling, I sent off that piece that you read, the "I am afraid" piece, which was meant as a heads up to our readers that this was no ordinary conference call. This was the true tragedy, the one we had never had from Mister Softee. This time the piece went up immediately. Glad it was this one that went up, I thought to myself. "Softee Melts" if the Post were on it.

After the Act Three's guidance, the critics get their shot in the Q&A. How many times have I heard "Congratulations, gentlemen, on a great quarter" from this production? How many times have there been lovefest Q&As?

This one felt like the what the Q&A would sound like after "Springtime for Hitler" in the Mel Brooks movie, "The Producers."

By the time it was over and the smoke had cleared, we were short 10,000 Microsoft, confident we could cover at the opening on Monday into the prospective downgrades that would certainly come.

After I posted, I went home and went to bed. It was 8:00 p.m. I woke up 12 hours later to dozens of e-mails calling me a sellout and a traitor.

Some insisted that I was a fool for believing that Microsoft was doing anything other than posturing as a wounded dog rather than a powerful monopolist as a way to gain sympathy with the American public in its titanic battle with the Justice Department.

Give me a break. This is business, not law. Microsoft is cautious. I am not supposed to believe them? I am supposed to believe that this company that has always forecast conservatively but never guided down before is just posturing?

Almost every email said I was selling out at the bottom. To which I say, "I sure hope so," because if it is the bottom I will buy it right back and get long again. We didn't own that much anyway. But why get in front of the freight train? Why not wait till the accident to play out and then cross the tracks? You have to put yourself back in that theater the first time you saw "The Fugitive." Do you want to be on that bus with Harrison Ford, or do you want to be Tommy Lee Jones?

Now you understand.

I long to be long Mister Softee come Monday. I long to buy it in the 60s and own it for the rest of my life. I long to have that opportunity. But in the end Microsoft's stock, like those of Cisco, like Intel, like SUNW, is just a stock. You don't ride through damage, you bolt from it.

Loss avoidance, not pride and love determines things in this market right now.

That, by the way, is why I am not afraid. I will buy my Merck (MRK Quote) and my General Mills (GIS Quote) and my Bestfoods (BFO Quote) on Monday into the futures-led decline that will come from Microsoft's giant overweighting in every conceivable index. Maybe I will scoop up some more Cisco or Nortel (NT Quote). Maybe I won't.

In the end, this business comes down to judgment. Our judgment was that Microsoft could be a train wreck on Monday. If it isn't, that's fine too.

But I slept soundly last night and I wouldn't have had I not taken action. So maybe all I bought myself was a good night sleep. I think I bought myself a clear head for Monday. That's what's needed more than anything right now.

And I have one.

Random musings: You have to read two things on this site. First is the excellent Brett Fromson wrap-up piece at the top talking about the damage done here. I have known Brett for 12 years. He did a piece about me and my wife in Fortune a decade ago calling us "The New Warren Buffetts" when that was the most treasured accolade in the universe. Brett is the single greatest markets writer in the country right now and I am thrilled to see him in our cyberpages, bolstering a team that is the envy of our competitors. ... Then go to Gary B. Smith's piece about what he is seeing in the Nasdaq. This is the best piece of technical research I have ever seen on our site and you must understand it to know what is going on. I am making everyone at my firm read it and study it so they know why someone who has the pulse of this market has gotten so negative. Grazie! to Gary and Brett!