Investors have had a full three days to mull over Microsoft Corp.'s (Nasdaq: MSFT) mediocre quarter and subsequent warning about slowing growth. But the debate over Microsoft's future will continue. Should you believe Microsoft's latest caution flag?
Microsoft is likely to be a big drag on tech stocks Monday. Aside from a shabby-by-usual-standards quarter, the bad news is piling up in the antitrust trial. The government is reportedly seeking a breakup of the company. That solution may not be so bad -- especially if Microsoft's warning about slow growth is believable.
Microsoft: Believe or bail?
Since the antitrust remedies aren't known at this point, let's focus on what we know -- Microsoft posted weak growth in its latest quarter.
The software giant used investment income to pad earnings of 43 cents a share in its fiscal third quarter and missed revenue targets with sales of $5.66 billion. The quarterly results would have been acceptable had the outlook been better.
Analysts expected a so-so quarter, but were hoping for a strong calendar second half surge due to Windows 2000 sales.
Whoops. Wall Street analysts have shrugged off the antitrust trial, but they can't discount slowing growth.
CFO John Connors said during a conference call Thursday that the company's fourth quarter earnings could be a "penny or two" short of the 43 cents a share consensus.
Microsoft also took its customary caution a bit farther. The company sees fiscal 2001 revenue growth in the mid-teens, which would be below its growth rate of 20-plus percent in recent years. First Call consensus had been predicting earnings per share of $1.93 for fiscal 2001. "The consensus estimates (for ༽) that are out there are a little high to me, maybe by as much as a nickel," Connors said.
Connors is wary about growth for a reason. In the third quarter, business PC sales were sluggish (we'll see if that assessment is valid as PC makers report earnings). Customers are also holding out on Windows 2000 upgrades until the company rolls out new server applications beginning in June.
But the most valid reason for a slowdown is the law of large numbers. With Microsoft revenue nearing $22 billion for the last 12 months, it isn't easy to put up the usual 20 percent growth.
"If you look at relative growth rate, it's just hard to grow a number that big by 20 percent," he said. "Growing that total revenue number in 20 percent plus kind of ranges is just a heck of a lot of new businesses ... It's (still) a lot of revenue (growth), even in the mid-teens."
The law of large numbers argument makes a lot of sense.
But, we've heard this Microsoft spiel before. Even while Connors was talking down Wall Street, he left the door open for better things.
"Demand for business PCs remained slow in the quarter, and we remain guarded about near-term growth,'' said Connors. "However, PC demand appeared to pick up late in the quarter.'' As Microsoft rolls out its applications for Windows 2000 in June, revenue could simply spill over into the September quarter.
And it's not like Connors said Wall Street estimates were totally out of whack. He talked analysts down a nickel over a fiscal year. Microsoft probably envisioned a scenario where the company would merely meet expectations at the current consensus estimates. Microsoft may be lowering the bar so it can keep its string of upside surprises intact.
However, one of these times Microsoft's cautionary fairy tales will become reality. In upcoming quarters, keep an eye on Microsoft's investment income line. The company had realized gains of $442.5 million on its investment portfolio, which is about 4 cents a share. Total investment income was $885 million. Like Intel (Nasdaq: INTC), Microsoft can pad earnings with investment gains.
Will we be talking about Microsoft's third quarter outlook in two quarters? Probably not. We'll probably be talking about some upside surprise, and the three Baby Bills. The debate will continue.
Whenever Microsoft is on the antitrust ropes, the competition usually does pretty well. That means keep an eye on Sun Microsystems (Nasdaq: SUNW), Oracle (Nasdaq: ORCL) and Red Hat (Nasdaq: RHAT). Also watch Corel (Nasdaq: CORL), which has enough problems of its own, and Be Inc. (Nasdaq: BEOS).
Meanwhile, Microsoft's concerns about slowing business PC sales may hit box makers. Watch Dell (Nasdaq: DELL), Compaq (NYSE: CPQ) and Hewlett-Packard (NYSE: HWP) for aftershocks.
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