Microsoft May Dance After Settlement

The deal under discussion is far less drastic than feared.
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Updated from 3:10 p.m. EST

Get ready to see a lot more of

the dancing Ballmer.

Microsoft

(MSFT) - Get Report

reportedly is near a tentative agreement with the Justice Department to resolve its antitrust case, and analysts up and down Wall Street are saying the terms are about the best the company could have hoped for.

Now if those pesky states would just agree.

According to various reports, the agreement would require the Redmond, Wash., software maker to drop various restrictions it places on personal- computer makers that had virtually forced them to preload the Windows operating system on new PCs.

The agreement would not, however, require Microsoft to stop bundling certain other software with Windows, an issue that could be unacceptable to states that also are negotiating a settlement with the company. It could, however, require Microsoft to make at least some of the underlying computer code for its operating system available to competitors, which would let them easily write software programs to run on top of it. That's something Microsoft generally has been loath to do.

"That is one of the trickier things to negotiate," says James Lucier, an analyst at Prudential Securities who's followed the case closely from his office outside of Washington. "That's why people are saying the devil's in the details. That's actually a point on which the early settlement talks under Judge Posner collapsed." (His firm rates the company a buy, and hasn't done underwriting for the firm, though analysts at Prudential have personal positions in Microsoft shares.)

The two sides failed to reach a settlement in March 2000 after months of talks. U.S. Circuit Court Judge Richard Posner, who mediated those talks, indicated later that the states resisted that settlement's terms. In June of this year the U.S. Court of Appeals found that Microsoft had illegally maintained a monopoly in the computer operating system market, and sent the case back to the U.S. District Court to decide what penalties should be levied against the company. In September, the judge presiding over that portion of the case told the sides to try to come to a settlement agreement, and set a deadline of tomorrow for them to do so.

It was unclear Thursday if lawyers representing the 17 states and the District of Columbia involved in the suit would agree to the pact, but the Justice Department reportedly was pitching the deal aggressively to them. If they decide to oppose the deal, the states could challenge the agreement in court during public hearings or they could continue with their own antitrust proceeding against the company.

However, observers said that doing so likely would be an uphill battle. After all, with a proposed settlement, Microsoft and the DOJ are doing what the presiding judge, Colleen Kollar-Kotelly,

asked them to do after the Sept. 11 terrorist attacks, when she said it had become imperative for the country to get the case behind it. The parties are scheduled to appear in court Friday to tell her how those settlement talks have gone. So, given the current environment in Washington, and the dour economic environment nationwide, the states could come off as unyielding if they spoil this settlement, too.

"I would speculate that the states are going to be under a lot of pressure not to be too Draconian in what they're looking for from Microsoft," says RBC Capital Markets analyst Sarah Mattson, who rates Microsoft a buy. "Obviously, the reach of the settlement is far less than what

the states were looking for, but given the current state of the PC business and the economy, I can't imagine that the DOJ is not going to put pressure on them to come in on this settlement." (Her firm hasn't done underwriting for Microsoft, and Mattson said she did not own shares of the company.)

Prudential's Lucier said the states were not dealing from a position of strength.

"The states have lost a lot of leverage since the first settlement talks," Lucier said. "The fact that Microsoft is offering this up and the DOJ stands on the verge of accepting it would stand very well for Microsoft in the courtroom. The states are clearly in the back seat right now, and there's not a lot they can do to stop this."

The New York Times reported on its Web site Thursday that the states were urging Justice to press for tighter restrictions on Microsoft's business practices. Microsoft rivals and consumer groups berated the government throughout the day for going soft on the company, in their view.

On Thursday, three such groups, the Consumer Federation of America, Consumers Union and the Media Access Project, railed against the reported settlement.

"It is outrageous that the federal government, armed with a 7-0 decision by the U.S. Court of Appeals that Microsoft illegally quashed rival software makers, would decide to settle in this fashion," the groups said in a statement. "The reported settlement fails to address the fundamental issue of Microsoft's efforts to mingle its code with its software applications. This effort threatens to prevent independent programmers from offering their own applications to compete with Microsoft."

Lucier said one possible offshoot would be for five hardline states -- New York, California, Iowa, Connecticut and Wisconsin -- to go it alone with further litigation, or to appeal to the Supreme Court. Without the Justice Department's support, however, that also would be difficult. Last week, the states hired high-profile attorney Brendan Sullivan to represent them if the case continued on in court, a move some saw as an indication that the states are willing to go to trial.

Bob Brammer, a spokesman for Iowa Attorney General Tom Miller, declined to comment on whether the states would accept the settlement or whether they were involved in hammering it out, though he did say Miller has been in Washington over the last few days.

Microsoft spokesman Jim Desler said the company is trying to get a deal done.

"I would just say that we are still working very hard to try to achieve settlement," Desler said. "We believe settlement is in the best interest of consumers and good for the economy. But we are not commenting on any aspect of the still ongoing, confidential discussions."

On Wall Street, analysts were calling the proposed settlement a "near slam dunk" for the company. RBC Capital Markets' Mattson said the development is "a win for Microsoft."

Accordingly, the software firm's shares inspired the broader market to rally. The stock was up $3.26, or 5.6%, at $61.41, something that should give Microsoft's boogying CEO Steve Ballmer all the more reason to dance, dance, dance.

But while the settlement could be the beginning of the end of Microsoft's antitrust travails, it's not a complete victory for the company. Short of being broken up, an option that the Justice Department in September said it would not pursue, the company fears most the possibility of having to share the underlying code of its operating system with its competitors.

But, depending on the terms of the settlement, the company could make such sharing a little more palatable. Microsoft already has started sharing its code base with some of its larger customers, an act that analysts see as Microsoft's philosophically being open to such action.

But even if Microsoft does open up its code to competitors, that doesn't mean those firms would automatically benefit from it.

"It's not a question of seeing it, but a question of modifying it or having it explained to them by Microsoft," says Nicholas Economides, a professor of economics at New York University's Leonard N. Stern School of business who has

followed the case closely. "After all, this code is 30 million lines, so just seeing it I don't think is very useful."

With access to the code, computer manufacturers could hide programs that Microsoft has bundled into its operating system, and competitors could more easily write software to run on top of it, something that might be a hard pill to swallow for Redmond. Other possibilities are that Microsoft is required to show the code, but wouldn't have to allow competitors to change it.

Whatever the specifics of the settlement turn out to be, though, Thursday's news would seem a good reason for Microsoft's Ballmer to have even more spring in his step.