Updated from 7:01 a.m. EDT A raft of legal settlements, steady quarterly sales growth and the likelihood of higher dividends have thus far failed to breathe life back into Microsoft's ( MSFT) stock. The tech bellwether's stock has traded virtually flat from a year ago, as the Goldman Sachs Software Index gained 41.7%, and the Nasdaq Composite jumped 38.9%. So what will it take to revive shares of the world's largest software maker? Investors looking for answers in Thursday's third-quarter earnings report may be disappointed. "I think it will be an in-line quarter," said Tony Ursillo, an analyst with Loomis Sayles & Co., which has pared back its Microsoft holdings this year. "I think there are better opportunities within the tech sector, based on growth prospects. "I don't see a lot of catalysts," Ursillo added. "I don't see meaningful benefit from various legal settlements
or a lot of leverage to the economy and ... I think the hype around a dividend increase is overblown." Microsoft stock was recently up 34 cents, or 1.3%, to $25.79, but Wall Street has largely ignored the firm's historic settlement with archrival Sun Microsystems ( SUNW) and a smaller legal agreement with privately held InterTrust. Even record quarterly sales of more than $10 billion earlier this year failed to woo Wall Street. But Microsoft bulls cite a number of potential catalysts, although some are more than a year away: A rebound in Microsoft's declining unearned revenue, expected in the current quarter. Action on the software titan's massive $53 billion cash hoard. Microsoft has said it would discuss a dividend increase at its annual analyst day meeting, scheduled for July 29. New products. But Microsoft's next release of its SQL Server database, called Yukon, has just been delayed to 2005; and the widespread release of its next operating system, dubbed Longhorn, is not expected until 2006. recent quarters . Unearned revenue is expected to continue its slide in the just-completed third quarter and then begin to rise again in the June quarter. And just the discussion of unearned revenue improvement during Microsoft's conference call Thursday evening could help the stock, suggested Pat Adams, chief investment officer at Choice Funds, which holds Microsoft shares.
Expecting a ReboundMicrosoft's unearned revenue -- a measure of Microsoft's subscription sales -- will likely be the most closely watched metric Thursday, as has been the case in
"If they say this is the bottom here, the stock will start to react positively," Adams said. But Ursillo noted that investors already are expecting a rebound. The magnitude of the rebound, which won't be apparent until Microsoft reports June-quarter results, is less certain and could affect the stock more, he said. One thing is for certain: Analysts will ask about Microsoft's hefty cash stash during the conference call. But again, it's doubtful that Microsoft will give any concrete answers until its analyst day this summer. Among the options Microsoft is believed to be mulling over: a higher regular or special one-time dividend, a bigger stock-buyback program, or a combination of the three. Already there's a sizable gap between what investors think Microsoft should do and what the conservative company is likely to do. "I know what they should do: They ought to pay the whole thing out." Adams quipped. "It's such a cash cow." But a 2% dividend yield combined with stock repurchases is the more realistic expectation, and even that may be more than Microsoft is willing to share. Currently, Microsoft is paying 16 cents a share, representing only a 0.6% yield. Goldman Sachs software analyst Rick Sherlund has suggested that Microsoft would pay a massive one-time dividend of $10 billion to $20 billion. But other analysts say that's unlikely. (Sherlund has an outperform rating on Microsoft; the firm has done banking for the software maker.) Smith Barney Citigroup analyst Tom Berquist noted that such a one-time dividend would amount to a big bonus for Microsoft employees who hold shares, giving them an excuse to leave the company. "My feeling is Microsoft wouldn't want to reward employees to that degree," said Berquist, who has a buy rating on Microsoft. (His firm has done banking with Microsoft.)
In addition, a strict strategy for dividend increases -- rather than a one-time dividend -- would be more appealing to value investors and would consequently boost the stock more, said Pacific Crest Securities analyst Brendan Barnicle. Still, he believes that Microsoft initially would only double the dividend, resulting in a 1.3% yield. (Barnicle has a buy rating on Microsoft. His firm hasn't done banking with the company, but Barnicle holds Microsoft shares.) On the product front, even bulls acknowledge that there's little to get excited about in the near future, given Microsoft's schedule for Yukon and Longhorn. "There's not a major new product delivery coming up in the next couple of quarters that will really change perceptions," says SG Cowen analyst Drew Brosseau, who is recommending Microsoft. (His firm hasn't done any banking with Microsoft.) That may explain in part why Microsoft CFO John Connors cautioned investors in January to expect slower growth in fiscal 2005, which begins in July. Microsoft is expected to offer its first detailed 2005 guidance during Thursday's call. Estimate trimming has already begun. On Tuesday, Sherlund lowered his 2005 revenue growth forecast to 6% from 8% to reflect a waning currency benefit, and said that 5% to 10% earnings growth is a reasonable expectation. The consensus estimate calls for revenue growth of 7.4% in 2005, to $38.51 billion, and earnings growth of 6.7%, to $1.28 a share, according to Thomson First Call. That's a far cry from Microsoft's glory days of as much as 50% annual revenue growth in the 1990s -- and one reason some investors are avoiding the name. But Brosseau argues that investors are ignoring Microsoft's outperformance relative to other major software vendors. "Frankly, to be talking about Microsoft slowing down is pretty boring," Brosseau said. "I think the more interesting point these days is Microsoft is growing faster than anyone else in software, despite their size." In addition, with products such as Xbox and MSN, Microsoft is the only major software maker expanding its reach in the consumer market to attract a broader swath of new customers, Brosseau noted. Choice Funds' Adams, meanwhile, acknowledges that other tech names may be poised to jump higher than Microsoft but he still likes Mister Softee because it's less volatile. "This thing hasn't moved in such a long time that as soon as it starts to move,
everyone will pile on," he says. But without more clarity on when that comes, Microsoft's stock may remain adrift.
|Microsoft's Revenue Is Still Growing |
The software giant's revenue growth is still higher than most large-cap peers.
|Company||Latest Quarter Growth||Latest 12 Months Growth||5-Year Revenue Growth|