It looks like Microsoft ( MSFT) has cried wolf too many times. Investors shrugged off the software behemoth's conservative outlook for 2005, bidding up the stock Friday in the wake of the firm's
strong top- and bottom-line third-quarter results. After all, many noted, Microsoft gave similarly conservative guidance a year ago -- only to prove itself wrong with revenue growth on track to reach an impressive 13% this year. On Friday, Microsoft shares jumped $1.59, or 6.1%, to $27.54 with more than 255 million shares changing hands -- about four times its average daily volume. Simply put, investors and analysts weren't buying Microsoft's line about it facing difficult comparisons next year. While Microsoft forecast 2005 sales would range from $37.8 billion to $38.2 billion, or growth of 3.6% to 4.9%, the average analyst estimate edged up Friday to $38.6 billion, or growth of 5.9%, vs. $38.5 billion on Thursday, according to Thomson First Call. "There are also things that work in Microsoft's favor that could make their guidance prove a little bit on the conservative side," pointed out Marty Shagrin, a software analyst with Victory Capital Management, which holds Microsoft shares. Topping that list are PC sales. Microsoft estimated PC shipments grew 14% in the fiscal third quarter ending in March. In comments that bode well for the rest of the tech sector, CFO John Connors declared businesses were finally opening up their purses and projected PCs would grow 10% in the company's fiscal fourth quarter, which ends in June. But Microsoft management forecast PC growth would drop to about 8% in fiscal 2005, which begins in July. That's considerably lower than the 11% to 12% growth estimated by research firms Gartner and IDC, Goldman Sachs analyst Rick Sherlund noted Friday. "I don't disagree with them that it's going to be a slower growth year," Sherlund said in a conference call Friday morning. But "maybe there's upside to these numbers."
The analyst agreed with Microsoft that it can't rely on various one-time events in fiscal 2005 that helped boost results in 2004, including currency exchange rates and some subscription sales. But after backing out those items, Sherlund still came out with projected 5.5% revenue growth in fiscal 2005 -- well above the high end of Microsoft's range. Consequently, he decided to lower his 2005 revenue estimate by only one percentage point, to 5%. (Sherlund has an outperform rating on Microsoft and his firm has done investment banking with the company.) Some upside could come from a stronger economy in such regions as Japan or Europe, analysts said. PC growth in the single digits in Japan, for instance, trailed the overall average in the third quarter. Similarly, some also believe Microsoft can surpass its bottom-line 2005 target of $1.31 to $1.33 a share -- even though they already exceeded analyst estimates by 3 cents to 5 cents. Choice Funds chief investment officer Pat Adams believes Microsoft can boost its margins more than the 2-point improvement projected by the company. "I think because of all the legal issues that they've had, they were probably pretty wise not to show these incredible margins," Adams said. With the vast majority of its business essentially a monopoly, he said, there's no reason to increase corporate overhead. "Overhead should stay flat or shrink in my opinion," said Adams, whose firm holds Microsoft shares.
Sherlund pointed out Friday that Microsoft's cash horde is actually $70 billion, when you throw $15 billion in equity and other so-called strategic investments into the mix, which the company appears to be doing. Because it's so much money, Microsoft simply raising its dividend to even a 4% yield would only take care of about $12 billion a year and not really solve the problem of rewarding shareholders, Sherlund said. That's why he's anticipating a special one-time dividend of $10 billion to $20 billion plus share repurchases to the tune of $10 billion a year. But many investors are less than enthusiastic about a one-time dividend. "That's a total waste," said Ian Murray, a portfolio manager with Straus Asset Management. "You spend all the money and the stock goes right back down," as demonstrated by academic studies of dividend payouts. "Hopefully they
Microsoft are using Sherlund as a trial balloon and hearing back from everyone: 'Don't do that,'" said Murray, who is long Microsoft. For now, "the stock is stuck between the value and the growth camps," he conceded. But the fund manager -- like other investors who cheered the stock Friday -- remains impressed by Microsoft's growth, even if the company projects it will be more modest next year.