Is Microsoft (MSFT) really overvalued? Although the common wisdom is that it is -- after all, the company has underperformed the tech sector all year -- there are at least three important signals that the company could grow in ways investors may not expect:

  • A survey of major distributors by Fulcrum Global Partners, a boutique research shop, found that Microsoft's larger customers are renewing licenses at a rate well above historical averages.

  • Dell ( DELL), the world's largest direct seller of computers, now expects the PC market to grow by about 7%, significantly more than Microsoft projected in its more recent earnings call.

  • Sales of Microsoft's database products soared by 17% in 2002, while Oracle's ( ORCL) dropped by nearly 21% and IBM's ( IBM) sales were off by 1%, according to a report released Wednesday by market researcher Gartner.

    Conceding that many in the market view Microsoft's multiples as inflated, analyst Jamie Friedman of Fulcrum nevertheless on Wednesday raised his rating of the company to buy from neutral and raised his fiscal 2004 revenue estimate by $200 million, to $33.9 billion. "The multiples are the multiples, but what drives stock prices are increases in estimates," he said in an interview.

    Friedman left his income projection for the year at $1.09 a share, 2 cents higher than the Wall Street consensus, saying that expenses will rise because Microsoft is likely to add employees in its Business Solutions division. His revenue number is in line with analysts polled by Thomson First Call. Fulcrum doesn't do banking.

    Although Friedman's bump in Microsoft's numbers is modest, there are a number of analysts who believe the company is poised to move in the opposite direction. "I don't think Microsoft will necessarily hit the October lows (about $21.81 adjusted for a split), but it could well test them" said Richard Williams of Summit Analytic Partners.

    Microsoft, Williams said, is trading at roughly 23 times forward earnings, but is growing only in single digits. "It would take a massive recovery to support its current valuation ($24.63 on Tuesday when he spoke), and that's obviously not in the cards." Summit has not done banking for Microsoft.

    A lot of investors would agree with Williams. Despite a strong tech rally in the last six weeks, Microsoft has been a laggard. Microsoft has appreciated just 8%, while both the Nasdaq and Goldman Sachs software index gained 17% each. Even Oracle, coming off of a weak quarter, is up 14%. And for the year so far, Microsoft is off 8%, while the Nasdaq and the Goldman index are up 8% and Intel ( INTC), a barometer for the tech industry, has gained 12%.

    Even so, Microsoft is still too pricey for some analysts, and because it is a large component of a number of important indices, a stumble could hurt a wide swath of the market. "No matter how you slice it, Microsoft has a bad pattern: It's still below a downward-sloping trend line in force since mid-2001, and it's back below its 50- and 200-day moving averages," John Roque, the technical analyst at Natexis Bleichroeder and a Real Money contributor wrote Tuesday . Roque went on to say that he thinks the stock might be a better buy at about $20.

    Signs of Strength

    Fulcrum found a higher-than-average renewal rate when it surveyed major distributors whose customers collectively hold licenses for more than 100,000 users. Fulcrum found that companies on Microsoft's enterprise, or EA licensing plan, are renewing at a rate of 60% to 70%, at least 10 points better than historical rates. The EA plan is designed for large companies who are standardizing on Microsoft software. Also up is the renewal rate for large businesses that use software from Microsoft and its competitors, Fulcrum found.

    The gains from higher renewal rates will begin to show up over the next few quarters under the heading of unearned revenue, called deferred revenue by other companies.

    To see the importance of volume licensing, look at the company's financial report for the March quarter: Total revenue was $7.8 billion, while unearned revenue was $8.53 billion. And volume licensing accounted for $4.97 billion of the unearned total.

    Also significant, said Friedman, is the fact that the latest version of Microsoft's major enterprise product, Windows Server 2003, is getting a good reception at a time when significant numbers of licenses will soon be up for renewal.

    Meanwhile, despite a shrinkage of 7% in the overall market, Microsoft's revenue for databases running on Windows, Unix or Linux was up 17% in 2002, from $1.02 billion to $1.19 billion. Much of the gain, said Gartner analyst Colleen Graham, came at the expense of Oracle, which saw its revenue in the same category decline to $2.21 billion from $2.78 billion. Microsoft's share of the market rose to 22.8% while Oracle, still the leader, saw its piece of the market drop to 42.5% from 49.2%, she said.

    IBM, with flat sales of $1.26 billion, has a share of 24.2%.

    Although Graham doesn't expect Oracle's share of the market to continue to drop so steeply, she believes that Microsoft will continue to make gains. "We're in a tight IT-spending environment. While Microsoft's SQL Server (or database) isn't as good as Oracle's, it's much better than it was, and good enough for many companies needing to cut expenses."

    Microsoft shed 60 cents, or 2.4%, to $24.03 on Wednesday.

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