Without Bill Gates, Microsoft (MSFT) - Get Report looks even more adrift.

Though the two-year

leadership transition announced Thursday was designed to cushion the impact of the co-founder's departure, not all observers were convinced the news can be seen as anything but a blow to the Redmond, Wash., software titan.

"It's a negative," says one New York money manager who tries to short Microsoft on any rally. "Gates is leaving at the wrong time."

Microsoft shares hit a two-year low of $21.46 Tuesday ahead of the Gates announcement. The stock traded as low as $21.79 Friday before recovering at midday to trade at $22.07, flat with Thursday's close.

While it remains the dominant software shop on the planet, Microsoft faces big challenges on nearly every front.

Upstarts like

Google

(GOOG) - Get Report

have clear ambitions to deliver software services via the Net that would shove Microsoft off the desktop. And the continued popularity of Linux operating systems has spread beyond servers into new growth areas like wireless.

This week, for example, a group of cell phone makers including

Motorola

(MOT)

and

Samsung

said they were developing Linux-based phones. The move threatens to outflank Windows on smartphones, which are fast becoming the future of the PC market.

No big deal, say some industry watchers. Microsoft has always been able play catch-up with new trends, either through in-house development or acquisitions. Some may recall that Netscape invented the Internet browser, but Microsoft managed to vanquish the company, if in heavy-handed fashion.

Sony's

(SNE) - Get Report

Playstation and

Nintendo's

Nintendo 64 seemed to have had a formidable lock on the video game console business, but Microsoft managed to crack the market with the Xbox.

And there's no reason to think Microsoft, with all its resources, can't develop a search-and-software service to counter Google and

Yahoo

(YHOO)

.

But investor confidence was rocked in April when the company announced that it was planning to

boost spending by $2 billion in fiscal 2007. To many observers, the decision to take on heavy costs instead of returning more capital to shareholders was a distress signal.

Being adrift is bad enough, but adding high costs to the indecisiveness was too hard for some to bear.

The shares fell 11% in one day in the wake of the news, as margin and earnings estimates were slashed dramatically. "Something happened that made them panic," one analyst says of the leadership in Redmond.

So now with Gates planning to leave his day-to-day duties and act as a figurehead, shareholders see one less steady hand on the wheel.

"He's a great leader. I know people that worked directly for him and who had him do their performance reviews," says the New York money manager. "The idea is that everyone knows or at least behaves like they could be interrogated by the most knowledgeable person in the company.

"I don't know what happens when that stops," says the money manager.