Mister Softee's Fallen and He Can't Get Up

Equity investors can't find a safer haven than Microsoft ( MSFT). That's the conventional wisdom, and it was probably true in the past. But in the last three months, Microsoft has lost 15% of its value, more than twice the decline of the Nasdaq as a whole.

What's more, the world's largest independent software company has performed worse than 10 other software companies see chart with market caps of $4 billion or more, and worse than other "mega-cap" companies (valuations over $90 billion), including General Electric ( GE), ExxonMobil ( XOM), Intel ( INTC), Wal-Mart ( WMT) and Cisco ( CSCO).

Even Hewlett-Packard ( HPQ), which earlier weathered a grueling fight over the Compaq merger and is now enmeshed in the PC slump, is performing similarly, down 17% over the same time period.

Microsoft investors are being punished for a variety of problems, most of which are the products of the prolonged slump in IT spending.

The serious bloodletting began after the company announced solid second-quarter results -- and disappointing guidance -- on Jan. 16. The stock closed that afternoon at $55.35 (presplit) and by Jan. 22 it had tumbled $4.35 a share, or 8%, to $51.

The biggest disappointment: Rather than projecting earnings of $1.98, Wall Street's consensus, Microsoft said it expects (presplit) earnings per share of between $1.90 and $1.93 in fiscal 2003.

But that's not all:

  • Some investors took the company's decision to issue its first-ever dividend (16 cents) as a sign that Microsoft's growth days are behind it.
  • Because Microsoft is so widely owned by mutual and index funds, the general flight away from equities has hit the company hard, says Daniel Morgan, research director for the $100 million Noble Financial Group.
  • The company is trading at about 23 times forward earnings. That may be too rich at current growth levels. And there's no obvious catalyst that would stimulate near-term growth.

  • Software and the Comp
    Microsoft leads the pack downward
    Company %Performance since Dec. 10
    Microsoft -15
    PeopleSoft -12.3
    SAP -7.6
    IBM -6.3
    Intuit -6.1
    Nasdaq -6
    Veritas -4.4
    CA -1.5
    Oracle -0.6
    Adobe 2.3
    Siebel 3.5
    Symantec 7.2
    Source: Company reports

    Shortly before Microsoft executed its 2-for-1 stock split on Feb. 18, shares bounced up, leading some analysts to say that investors were done punishing the company. It's more likely that the run-up was based on expectations that retail investors would jump into the stock when the absolute price dropped by half, Morgan said.

    Any lift the company received has largely evaporated. "It's not time to back up the truck and load up on shares," said Peter Miesk, software analyst with Scotia Capital. Long term, Miesk is bullish on the stock, with a target price of $30. "But on the way we may well see lower prices," he said in an interview. Scotia does not have a current banking relationship with Microsoft.

    Mega-Cap Misery
    It's been an ugly three months
    Company % Performance since Dec. 10
    Hewlett-Packard -17.1
    Intel -12.3
    Wal-Mart -10.2
    General Electric -9
    Cisco -6.6
    Exxon Mobil -2
    Source: Company Reports

    Microsoft closed lower, off 61 cents, or 2.6%, to $22.95 on Monday, hit by continuing concerns over war and the downdraft of Intel's cautious midquarter update. Intel CFO Andy Bryant said the company hasn't glimpsed signs of a sustained recovery in the chip business.

    "Our visibility to see what's coming certainly hasn't improved much," he said in a call with analysts. And if Intel's mainline CPU business doesn't pick up, computer sales will stay soft, and so will software sales.

    Granted, there are those in the relatively optimistic camp who believe economic firming in the second half of the year could give business a lift. One theory holds that companies will upgrade their PCs at the same time they move up to Windows XP, thereby lifting chip demand.

    Lending support to that idea, a Merrill Lynch survey released last week found that about 62% of respondents plan to upgrade their operating system and PC at the same time. The trouble is, nearly three-fourths say they won't do it this year.

    Although Intel executives say they believe Microsoft's decision to lower support levels for some versions of Windows later this year will drive operating system and PC upgrades, Gartner group vice president Martin Reynolds disagrees. "Companies still using Windows 95 or 98 have a stable platform and aren't likely to upgrade until they need a more advanced version," he said. Moreover, Reynolds doesn't expect a corporate upgrade wave until the economy turns and companies begin planning new projects that need more horsepower.

    The sum of those factors led Richard Williams of Summit Analytic Partners to pour cold water on the company's short-term prospects in a note Friday afternoon. "We would be sellers of MSFT in the near term on a lack of catalysts and growth. The chart is negative and by breaking the Feb. 13 low of $23, the next stop could be $20 and then $18."

    Longer term, however, there are reasons to be bullish about the stock, not the least of which is its ownership of the PC software market and $43 billion in cash.

    Ken Kiarash of Buckingham Research Group says Microsoft is in the midst of "one of the most product-rich years the company has had in some time." Windows Server 2003 will be released next month, and Office 2003 should be out this summer -- both major products that could drive significant revenue.

    According to Kiarash, Microsoft's recently released customer relationship management products are doing well in the distribution channel. Margins on the CRM products are respectable, but probably somewhat lower than other Microsoft products because of additional sales and marketing money spent on launch, he said.

    Short term, it doesn't look like the company has either an upside or downside surprise in the works. "Microsoft has laid everything on the table," said Brian Skiba, global strategist for Deutsche Bank North America. Certainly, a better-than-expected third quarter could be a catalyst for an uptick. "But given Intel's numbers, I don't expect it," Skiba said.

    If so, that safe haven might not be so safe for a while.

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