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Blodget cuts Microsoft rating, questions growth

Influential analyst Henry Blodget initiates coverage of Microsoft by cutting Merrill Lynch's long-term rating on the company and questioning whether it can dominate the Internet.

    Influential analyst Henry Blodget initiated coverage of Microsoft on Thursday by cutting Merrill Lynch's long-term rating on the company to "accumulate."

    The previous Merrill analyst to cover the stock, Christopher Shilakes, had it rated at "long-term buy."

    In a lengthy research note, Blodget acknowledged Microsoft's financial prowess, but questioned whether the company can dominate the Internet marketplace in the same way it has the PC industry.

    "Technology paradigm shifts have a way of derailing the growth of even the most dominant technology companies," he wrote. "If it turns out that the company that dominated the last technology revolution (the PC) goes on to dominate the next one (the Internet), this would be unusual."

    Investors did not race to sell their shares on Blodget's downgrade. In early trading, shares of Microsoft slid $1.12, or 1.7 percent, to $63.56.

    Microsoft's stock has suffered in recent months following a far-reaching slowdown in PC sales. In December, the company issued a rare profit warning, saying it sees PC growth of 10 percent for 2001 rather than growth in the low to mid-teens as had been expected earlier in the year.

    In his report, Blodget wrote that Microsoft has not expanded enough into other markets to protect it from the maturation of the PC market. He estimated that 95 percent of the company's operating profit comes from sales of desktop operating-system and application software, and predicted modest growth of 5 percent to 7 percent for desktop products over the next five years. Microsoft derives more than one-third of its revenue from Office, its suite of desktop applications.

    "Microsoft's current dependence on the PC is well known, but we believe it is often understated," he wrote.

    The software giant has also had limited success with its Windows 2000 operating system, which it spent millions to develop and market. Microsoft claims it has sold more than 1 million copies of the server version of the software. But only a fraction of buyers have implemented a key Windows 2000 technology, called Active Directory, seen as vital to the adoption of the company's other software products.

    Blodget wrote that long-term earnings growth of 15 percent to 17 percent for Microsoft--the consensus estimate--seems unattainable. "Our analysis suggests that dependence on Desktop will make sustainable (earnings-per-share) growth of faster than 10 percent/year very difficult, even if Consumer and enterprise are successful," he wrote.