Microsoft stock down

Microsoft's strong earnings report yesterday met analysts' expectations but evidently not investors'; the stock drops 6.6 in morning trading.

4 min read
Although Microsoft (MSFT) yesterday posted an 86 percent jump in fourth-quarter earnings, its stock ended today down 6 percent.

Shares of the software giant fell to 140-1/2 at the markets' close, down 9 points from yesterday's close.

Analyst Rob Owens of Pacific Crest Securities downgraded the company to a "hold" from a "buy," based on the share price's run up over the past three months.

But Michael Stanek, an analyst with Lehman Brothers, reiterated his "buy" recommendation on Microsoft.

The company, which reported its earnings after the market's close yesterday, announced strong sales of its BackOffice products and Windows NT servers.

Microsoft posted quarterly earnings of $1.06 billion, or 80 cents a share, for the period ending June 30, compared with $559 million a year ago. Analysts had expected net income of 79 cents a share, according to First Call.

For the just-completed year, Microsoft boosted revenue by 31 percent year-over-year, ending with earnings per share of $2.63. Revenue for the year came in at $11.36 billion, a 31 percent increase. Meanwhile, total earnings jumped to $3.45 billion for the year from $1.71 billion for fiscal 1996.

Microsoft said adoption of the company's server software continued to be strong, with sales of the popular Windows NT Server operating system driving that sector.

The company noted that the results represented the third best showing in the history of the company, as far as earnings growth, with other high water marks in the late 1980s.

Microsoft is expected to ship a new version of Windows, code-named Memphis, late this calendar year or early next year. Its ship date has slipped several times. Greg Maffei, the incoming CFO at the company, said revenue from the highly anticipated upgrade should make a significant dent in the final two quarters of the new fiscal year, but he hedged on whether the adoption rate would rival Windows 95.

"Will it achieve the Windows 95 level? We should only be so lucky," Maffei said.

But moving forward, the company's financial team warned that Wall Street should expect a slowdown in the company's exponential growth, due to desktop "saturation," potential margin pressures, and a down period for new product releases.

Wall Street analysts have come to expect greater things from Microsoft than simply meeting their estimates in light of past quarterly surprises. However, Microsoft officials have insisted that the company is due for a growth slowdown, feeding the perception that the days of the company beating estimates by 10 cents or more per share may be drawing to a close.

"As they used to say back on the farm, next quarter just ain't going to be like this one was," said Mike Brown, Microsoft's outgoing CFO.

Brown said he expects a "product cycle valley" in the next fiscal year, in which results may dip but could get stronger in the last two quarters of the year. "There will be some bumps along the way, but the long-term trend is up," he said.

But industry analysts estimate Microsoft's earnings growth could slow to 20 percent in the year to come. The release schedule is devoid of products expected to match the blockbuster performance of bestsellers like Windows 95 and Office 97.

"This is probably the last of the real strong growth quarters benefiting from recent new product cycles," said analyst Rick Sherlund of investment bank Goldman Sachs. "I do anticipate over the next year you'll see a slowing in momentum."

Microsoft has continued to rocket into the financial stratosphere because of its strategy to extend the Windows operating system environment to small devices and large enterprise networks. A petite version of Windows called CE runs on numerous handheld computing devices; Windows NT Workstation and Server have continued to grow in popularity.

The Redmond, Washington-based company is due to ship an enhanced version of the NT operating system this quarter, complete with enhancements to handle transaction-intensive environments. Though there is considerable debate as to whether Windows NT is ready for prime time in the world of industrial-strength software platforms, there is no doubt that NT will drive the company's future growth, according to industry observers.

Last year, more copies of NT were shipped than all flavors of Unix, according to data from market researcher International Data Corporation.

Also buoying the company's future is its rapid embrace of the Internet and drive to unseat Netscape Communications as the primary provider of browser software for PCs and server-based software to deliver Web content to users. Though Microsoft offers such software for free, its Internet strategy is expected to feed sales of Windows NT and the BackOffice suite of products.

However, the next new version of NT will not ship until next year, feeding speculation that there could be a slowdown in growth for the company.

In addition, analysts say investors are betting that Microsoft's investment in the Internet, including news, entertainment, and television, will put it at the hub of the coming "digital convergence."

Indeed, Microsoft could begin seeing significant revenues beginning in fiscal 1999 if it succeeds in providing the operating system for a new generation of television set-top boxes and in generating fees from transactions completed over the Internet, McAdams said.

But as Microsoft diversifies from its core business in software it will become increasingly difficult for investors to assign it a valuation, analysts say.

"Typically, the stock market has a hard time valuing enterprises that are not pure plays," Sherlund said.

Reporter Dawn Yoshitake and Reuters contributed to this report