As you can tell from the mug shot, I've been around for a while, and I've been thinking about a story I covered back in the early 1980s: the decimation of heavy industry in California. The causes were legion, but remember that this was long before trade agreements such as NAFTA, outsourcing and digital technology created the global economy. Simply put, American managers, particularly those in the steel industry, traded long-term growth for short-term profits, and in the end got neither. I'm reminded of this because of a conversation about Microsoft ( MSFT) I had this week with Marc Klee, a portfolio manager with American Fund Advisors. We were discussing Microsoft's announcement that it will
spend approximately $2 billion more than expected in fiscal 2007, and the market's sharply negative reaction to the news. Klee noted that the stock took an 11% hit the day after the earnings report, a swan dive that chopped some $30 billion from the software giant's market capitalization. "American companies, he mused, "get criticized for not investing in the future. And it appears that they also get criticized for investing in the future." See the parallel? Investors have been all over Microsoft -- and with good reason -- for some time, complaining that management hasn't done enough to unfreeze the company's stock. Now it appears that Ballmer and Gates have gotten the message, and what's their reward? A $30 billion slap in the face. Sure, there are plenty of reasons to be skeptical. Microsoft does not have a great track record of delivering innovative new products, particularly when it strays from its core Windows/Office/SQL Server business. "Given Microsoft's 's recent struggles in the Internet space, many investors question the utility and wisdom of spending even more money to pursue what appears to be a losing battle," said Sanford W. Bernstein analyst Charles Di Bona. "In the absence of greater insight into the spending, its necessity and its potential returns, the concern is that the spending is a waste," he continued in a note to clients this week. (Di Bona, by the way, has an outperform rating on Microsoft, and is not negative about the company's new direction.)
Other analysts, including Mike Marzolf, a portfolio manager with Thrivent Financial, were bothered because Microsoft dropped a $2 billion spending bombshell and didn't specify where the money would go. But that question was largely answered this week,
when CEO Steve Ballmer unveiled adCenter , the company's new Internet search advertising service, and said Microsoft will increase R&D spending for MSN by 57% to $1.1 billion and increase capital spending for the Web portal to $500 million from $300 million this year. That's plenty of cash, but remember: Ads related to Internet searches pulled in some $5 billion in revenue last year. And Google ( GOOG), of course, is a formidable competitor, with a very long lead over Microsoft, which leads investors to ask if Microsoft can defeat Eric Schmidt & Co. But that's the wrong question to ask. The right question is this: "Can Microsoft make money competing with Google and Yahoo! ( YHOO)? The answer remains to be seen, but Goldman Sachs analyst Rick Sherlund framed the question well in a recent note. "To be big it may not be necessary to beat Google. Perhaps the view is that Microsoft will be broader in directing ads than Google or Yahoo! by leveraging a broader array of services including video games with Xbox directed advertising, mobile, small business hosted services (Office Live), and third-party generated content built with Microsoft's tools." Fair enough. But investors are running out of patience with the company, and it had better show some results -- or at least convince investors that good results are coming before too long. "I'm going to give Microsoft a few more quarters," says Daniel Morgan, portfolio manager for Synovus Investment Advisors. Asked why he can't a bit more patient, Morgan spoke for many hard-pressed managers, saying: "I'm judged on my results and I've been in this stock for a long time."
Microsoft needs to do something different. Its core business is a cash cow, but everyone knows that the days of hyper growth for PC-related businesses are over. The way I see it, Microsoft either follows through on its commitment to the Internet and related businesses or goes the way of Bethlehem Steel and the West Coast ship-repair industry. If you don't think the company should spend serious bucks in the Internet-advertising space, what's the alternative? Email your suggestion to me at and I'll try to find the space to reprint a few next week.
RIM ShotThe embattled management of Research In Motion ( RIMM) didn't get much time to savor the end of legal hostilities with NTP. Within 10 days of the settlement, nearly all of the gains made by the company's shares had been erased amid worries over fundamentals like subscriber growth. The stock has yet to recover from the mid-March slide, and there's no indication that good times are just ahead. The lawsuit initiated this week against RIM by privately held Visto "may be obscuring important competitive dynamics working against RIM in its efforts to step market share losses to rivals," says Rich Williams, chief software analyst for ICAP. (It's worth noting, by the way, that unlike NTP, Visto ships real products and its patents have been upheld.) On its latest earnings call, management talked about pent-up demand for the Blackberry, which sustained stalled sales due to the threat of an NTP injunction. But Williams says his research shows no such thing. "The pent-up demand appears to be focused on Motorola's ( MOT) 'Q' product, a smart phone competitor to BlackBerry that supports Microsoft's Windows Mobile v5 for smart phones." What's more, "various customers in the process of acquiring and deploying mobile email and Connected Device capabilities, according to industry experts we polled, are no longer viewing BlackBerry as the go-to provider. Instead, rivals like Palm ( PALM), Nokia ( NOK) and Motorola are garnering significant interest and landing deals."
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