a famously bullish forecast for
Henry Blodget on the map, the
analyst has been inextricably identified with Internet stocks. So it was with some surprise Thursday morning that people learned Blodget was assuming coverage for
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Talk about a fish out of water! For most of the companies that Blodget has followed, a net income is something vaguely off in the future, like that career as a rock star we always keep meaning to launch. If you added up the net income from every single money-making company in the Internet sector (ignoring the unprofitable majority), you'd get aggregate profits of somewhere around $4 billion. By itself, Microsoft's net income is more than double that figure.
So what's a Net analyst doing in a space like this? We asked Blodget that question, and some more.
TSC: How did you end up covering Microsoft?
Microsoft's kind of an oddball, just because it is the PC software industry in and of itself. And it obviously has big arms in both the Internet and the enterprise. As we look to the future, I think you will see a lot of their software and services become very much Internet-enabled, and certainly they're moving toward a services model.
It basically seemed to fall between enterprise and Internet. And we had the interest in doing it and so we assumed coverage for it. But no major strategic reason.
TSC: How long did it take for you to get up to speed on Microsoft?
We've been working on it for about three months. With a company that is this old, this well-covered and this well-understood by so many different analysts, what you try to do is see if there's an area that you can add some value to. I mean, obviously, there are many, many analysts who have far greater knowledge of the company and far greater relationships within the company than we've had.
So what we've tried to do is look at it from a couple of different perspectives. The main perspective was trying to really look at a potential long-term growth rate for the company and say, "How is Microsoft strategically positioned for the next few years?"
The main point of our report this morning is effectively that we think we are in the midst of a transition in computing and technology paradigms from the PC-centric paradigm to the Internet-centric paradigm. And that's not a surprise to anybody. But what you normally find when you look at technology from a very high level is the dominant leader in one wave of technology very rarely makes the transition to be the dominant leader in the next wave.
When most people hear that, what they usually think is that the dominant leader gets dumped on its butt by some upstart in the new technology. And that's not the case. Often what happens is the growth of a particular technology business starts to mature, and the new paradigm is so small, on a relative basis, that even if the dominant player is big -- in the Internet, in this case -- the growth of it just is not enough to offset the slowdown in the main business.
So, when we look at Microsoft, we see a company that has ridden the PC wave extraordinarily successfully for 15 years now. And it obviously went on to become the most valuable company in the world, has an extraordinary $11 billion dollars in operating profit every year, and also over the last five years has been building businesses in enterprise software and in consumer on the Internet side.
But if you look at the total profit of the company, 95% of the profit is still coming from the PC. So even if enterprise grows very quickly, if consumer continues to grow quickly, it still doesn't really affect the overall growth rate that much.
And so obviously it's important to think about how fast the PC business will grow for the next several years. Basically, our conclusion is that the PC business is gradually maturing, and that it will grow perhaps in the low double digits for the next several years, and that Microsoft's PC-related software business will grow a little bit more slowly than that.
So, when you add up all the numbers, we conclude that Microsoft will grow at perhaps a 10% rate over the next five years on the earnings line, relative to the existing consensus growth rate, which I think is in the 15% to 17% range. So we assume that Microsoft is going to grow a little bit more slowly than people think.
TSC: And that's where you think you add value -- looking at Microsoft's growth in the face of this transition?
I think so. In reading a lot of the other research that's out there, there's exceptional research on the near-term events that affect Microsoft, and everyone's very focused on the launch of Office XP and Windows XP, as they should be, because those things clearly will drive the stock over the next six months. But what we hadn't seen anybody do is really just step back and say, "OK, where are we? We're 15 to 20 years into the growth of the PC industry, we're effectively passing the baton to the Internet industry; how well is Microsoft positioned for that? And our conclusion is they're positioned well, but they're not positioned well enough to sustain a 20%-or-more growth rate, which is I think what some people were expecting that they would eventually resume.
TSC: Your coverage of Internet companies, it seems, puts you in an awkward position: You're saying Microsoft's an accumulate and you're saying DoubleClickundefined is an accumulate. I think, if you ask, nine out of 10 people on the street would rather put their money in Microsoft than in DoubleClick.
The way we deal with that is something I think a lot of people don't often focus on in terms of Merrill Lynch research. We actually do have risk ratings that we put on every stock. Microsoft is less risky than DoubleClick, and we have an above-average risk rating of a "C" on Microsoft, and we have a high risk rating
"D" on DoubleClick and every other Internet company we cover. And "high risk" obviously means "could go to zero." We don't think Microsoft is going to zero.
I would say that DoubleClick at $14 -- if Internet advertising does resume its climb, which we expect it to after we get this god-awful transition over the last year or two -- I think DoubleClick can be a $30 stock, a $50 dollar stock in a couple of years. ... If things go well for DoubleClick, we think the stock could triple over the next two years, and we think if things go well for Microsoft, the stock could be up 20%, 30%, 40% max. So that's where you see the difference.
Basically, relative to Microsoft -- Microsoft might as well be a treasury bond, in terms of safety, relative to DoubleClick. But the potential for growth above the current valuation -- I would still say it's higher at DoubleClick.