Drawn-Out Battle Leaves Microsoft Longing for Swift Justice

Shareholders are left with uncertainty, and competitors smell opportunities as the software king's battles continue.
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SAN FRANCISCO -- Bring in Judge Judy. If the justice with an attitude were presiding over the Microsoft (MSFT) - Get Report case, it would have been over and done with a half-hour after the opening statements.

The endlessness of the battle between the

U.S. Justice Department

, 19 state governments and the world's largest software company has dragged down Microsoft stock for months. On Monday, investors bailed out of the stock as settlement talks collapsed. The stock dropped 15 1/2, or 14%, to 90 3/4, which erased a year's worth of gains.

That had investors like Toby Levitt, portfolio manager of

Albion Management Group

of Salt Lake City, groaning. His firm has held a small Microsoft stake for the last eight years, and he was waiting eagerly for a resolution of the legal battle. "I was thinking about buying more had they settled," he says. Now he's holding on to the shares in the firm's portfolio, because he believes Microsoft will show solid growth over the long term. But the stock likely will stagnate until the legal wrangling ends, and that likely won't happen for months, if not years, he says.

Morgan Stanley Dean Witter

analyst Mary Meeker encouraged investors to hold on to Microsoft, but her report was discouraging. "The DOJ investigation continues to be a negative not only because it's a serious cloud that creates uncertainty, but also because it is a serious morale hit for MSFT employees," Meeker wrote. "We believe that MSFT's business is solid, but not

a blow-away. Again, at the margin, we are a holder of MSFT shares, but not an aggressive buyer." Morgan Stanley is an underwriter of Microsoft.

What might change that picture for Meeker and others is a better view of where Microsoft wants to go on whatever day the final appeal is over with. Tellingly, in the postverdict press conference today, Microsoft President Steve Ballmer spoke about Microsoft's quest to take its business beyond the

PC -- beyond the monopoly that has provided all those lush profits. Indeed the real issue overhanging the stock going forward may be doubts about how well Microsoft is performing in promising new markets, including wireless communications, Internet commerce and home entertainment.

Long before the April 3 ruling, many portfolio managers have been thumbing their nose at Microsoft, and putting money instead in Internet infrastructure companies such as telecommunications-equipment maker

Cisco

(CSCO) - Get Report

and communications chipmaker

Broadcom

(BRCM)

.

Critics question Microsoft's ability to compete against

AOL

(AOL)

and

Yahoo!

(YHOO)

for Internet audiences and shoppers,

Sony

(SNE) - Get Report

in home entertainment, and

Ariba

(INTC) - Get Report

and

Commerce One

(CMRC)

in business-to-business e-commerce.

A number of Microsoft's ventures have turned into clunkers. Its

WebTV

venture has just about 1 million subscribers, a small piece of the interactive TV market. It recently pulled the plug on its

TaxSaver

tax software released in January and announced it will distribute

H&R Block's

TaxCut program online. And its mainstay, the Windows operating system, has generated fierce opposition because of a tendency to freeze up. Microsoft has all but admitted the flaws in its advertising campaigns for

Windows 2000

, which touts reliability.

The company's profit growth -- at 48% a year from 1996 to 1999 -- is predicted by financial analysts to slow to 22% this calendar year and to 14% next year, according to a

Thomson First Call

survey of analysts, and that's not high enough for many tech investors these days. The reason: Despite the efforts to generate new revenue in the hot, fast-growing segments of high tech, Microsoft's business is still wed to what now looks downright Old Economy: personal computers and servers.

"The fun days for Microsoft are over," says one portfolio manager, who asked that his name not be used. "Why bother with Microsoft when there are so many other opportunities?."

While Microsoft shares have stagnated, investors have been flocking to Microsoft's emerging competition. They snapped up shares of

VA Linux Systems

(LNUX)

when the packager of Unix-based operating systems went public Dec. 9, and of

Palm

(PALM)

the

3Com

(COMS)

spinoff that makes the popular

PalmPilot

hand-held computer without Microsoft technology. And investors are expected to similarly snap up shares of start-up

Handspring

, another maker of inexpensive hand-held devices without Microsoft software. It filed March 31 to go public.

Given a plethora of fast-growing companies with rapidly rising revenues and earnings, many tech investors say they'll wait not only for Microsoft's legal headaches to end but for the company to show that it once again can be a market leader.

The frustration for Microsoft holders is that they believe the company can do just that. Because of the legal battle, however, the stock likely won't show any such promise for some time.

"Microsoft has done an awfully good job building a great company," says Levitt, of Albion Management. "I think the selling is a little overdone."