Wall Street's jury still out on Microsoft breakup plan

7 min read

Pardon Wall Street for yawning Wednesday at Judge Thomas Jackson's rubberstamping of the government's remedy proposals in its ongoing antitrust saga. The truth is the stock's already absorbed the "bad" news and most analysts still don't see a break-up on the horizon.

Late Wednesday, Jackson ordered the software giant to be split into two companies, one for its operating systems and the other for its applications and Internet businesses.

He also ruled the company would remain intact until the appeals process is exhausted.

"Microsoft, as it is presently organized and led, is unwilling to accept the notion that it broke the law or accede to an order amending its conduct," Jackson said in his 23-page remedy order.

Microsoft shares moved up to 72 in after-hours trading after closing up 7/8 to 70 1/2 ahead of the announcement.

"We will be appealing this decision, and we have a very good case on appeal," said Microsoft Chairman Bill Gates in a video news release.

Of course, we're months or even years away from anything resembling a break-up of the software giant. In the interim analysts expect the stock to tread water until the crucial appeals process begins, a battle Microsoft (Nasdaq: MSFT) fully expects to win.

Vindication could come even sooner, some say, if the case is fast-tracked to the U.S. Supreme Court.

"Given the major factual and procedural and legal disagreements throughout the record, this is clearly a case that would benefit from a thorough review by the appeals court," Microsoft spokesman Mark Murray said.

Experts say the Supreme Court would be highly reluctant to intervene in the case before the appeals court. They agreed the Supreme Court most likely would prefer that the appeals court first sift through the extensive record in the case and that the justices would benefit from the analysis by the appeals court of the antitrust and technology issues.

The law provides for the Supreme Court to directly hear cases of ``general public importance in the administration of justice.'' If the Justice Department asks the Supreme Court to hear the case quickly, the justices would have to decide whether to grant the request or deny it and send the case to the appeals court.

Microsoft CEO Steve Ballmer reiterated what the company has been saying all along Wednesday.

"A break-up of Microsoft, I think, would be an awful thing for consumers and for the industry," Ballmer said during a speech to Norwegian computer honchos in Oslo ahead of Jackson's decree. "The real issue in a possible break-up would be the harm it does to innovation."

From Wall Street's perspective, the recent decline in Microsoft's stock can only be partially attributed to the uncertainty of having the limitless resources of the federal government focused on splitting up perhaps the most important company in the information technology universe.

While there's no question that some investors have decided to pass on Microsoft in recent months, it's important to recognize that most technology stocks have suffered similar declines since Jackson initially found it had violated federal antitrust laws.

Microsoft isn't the only tech leader to tumble

Since Jackson made official what most observers had long anticipated on April 3, Microsoft shares have slipped from 90 7/8 to a 52-week low of 61 1/2. The stock's recovered some ground in the past two weeks, but during that period the stock fell 32 percent.

That's a precipitous drop but Microsoft shareholders weren't the only investors in pain during that rocky period.

Cisco Systems (Nasdaq: CSCO), an undisputed leader in its market, watched its stock fall from 72 15/16 to 54 1/2 in that same period. That's a 25 percent slide without any antitrust issues hanging over its head.

Yahoo! (Nasdaq: YHOO), another leading tech bellwether, saw its shares tumble from 160 1/8 to 115, off 28 percent, in this same two-month window. No one is trying to split up Yahoo!-- yet.

Those who argue that Microsoft's woes somehow are responsible for the overall decline in technology stocks should take a look at Oracle's (Nasdaq: ORCL) stock.

The database software developer is one of the companies that ostensibly has the most to gain from Microsoft's unraveling. Yet even one of Microsoft's biggest competitors and detractors has slumped from 76 7/8 to 66 1/2, or 13 percent, during this same period.

Linux fans should also know that Red Hat (Nasdaq: RHAT) shares plummeted from 42 1/8 to 16 3/4 during this same stretch, a 60 percent collapse.

During his speech, Ballmer said a decline in Microsoft's share price on the Nasdaq index, was partly triggered by investors' antitrust concerns. But he said the company was still extremely strong.

"The whole Nasdaq went down and we went down with it, or you could say the Nasdaq went down when we went down, and we went down when the judge started talking about breaking us up," he said. "Some people might say -- I wouldn't -- but some people might say that the judge drove us down, he helped guide the Nasdaq down."

Fund managers betting Microsoft comes out on top

As individual investors and fund managers struggle to predict what, if any, impact these proceedings will have on the stock in the long run, they first must determine if the proposed remedies are likely to happen at all.

"If you believe Microsoft will be broken up, which I don't, you shouldn't be buying it now," said Christopher Mortenson, analyst at Deutsche Banc Alex. Brown. "I could understand the argument that three or four years from now a broken up Microsoft will be worth more than it is today, but to get there from here will be ugly."

Mortenson said he expected Jackson to endorse the government's break-up plan in the hopes of rapidly moving it to the appeals process. For now, he maintains a "buy" recommendation on the stock.

Even in a worse-case scenario, assuming the break-up plan survives the appellate courts, Thomas Weisel Partners analyst David Readerman sees the stock falling to between $50 to $55 a share, valuing the operating system business at $20 a share and the applications unit at $25 a share.

Readerman assigned an additional $5 to $10 a share for associated "unearned revenue, intellectual property patents and associated assets."

That's a fancy way of saying that even if this break-up occurs, the stock will likely only lose another 10 to 15 percent of its value in the near-term.

Assuming Readerman's valuation model is on target, most fund managers are steadily adding Microsoft to their portfolios. If Jackson's decision is overturned, they stand to make a killing as Microsoft shares undoubtedly will take off.

"There is a lot of uncertainty on the table," said Jeffrey Van Harte, senior vice president at TransAmerica Investment Management. "It's probably one of those points in time when you can smell an opportunity. The fundamentals are there, it's still a great franchise."

According to Morningstar Mutual Funds, 1,022 separate mutual funds own Microsoft.

"I'm going to be buying it all day today," said Fred Sears, manager of the Investors Capital 20 Fund, back in late April. "I'm not trying to catch the bottom but I don't think this is going to go a lot lower."

Sales and earnings still king, analysts say

Although CFO John Connors said the company was in "the best position as anyone with Windows 2000," the antitrust trial has been a lingering headache.

"I don't think it's accurate to say the lawsuit like this doesn't have an effect on morale," he said. "It has increased overhead on expenses, management time and the sales force has to work much harder."

Connors said the company has maintained its focus. "We do have to tell a better story with partners," he said.

In fact, many analysts are more concerned with Microsoft's fundamentals than its antitrust squabble.

Last quarter, Microsoft managed to beat the official consensus estimate but missed the so-called "whisper number" by a couple cents a share.

In the quarter, Microsoft earned $2.39 billion, or 43 cents a share, on sales of $5.66 billion.

Analysts were a bit put off by the revenue figure. Most were expecting total sales of between $5.75 billion to $5.9 billion.

At the time of the earnings release, Connors said weak sales of PCs to business customers in the wake of concerns about the Y2K computer bug hurt the top line.

"OEM revenue was light as demand for business PCs remained slow in the quarter, and we remain guarded about near-term growth," Connors said at the time. "However, PC demand appeared to pick up late in the quarter, and with the launch of Windows 2000, we are excited about the opportunity to help customers migrate to this new generation of platform products."

Connors reiterated those concerns, saying that despite strong PC demand it company sees industry-wide personal computer sales growing 12 to 15 percent for its fiscal year beginning July, not the 20 percent jump enjoyed in recent years.

First Call Corp. consensus expects Microsoft to earn 42 cents a share in its fourth quarter and $1.88 a share in fiscal 2001.

Despite all the alleged uncertainty surrounding the stock, 29 of 32 analysts following the stock rate it either a "buy" or "strong buy."

Larry Dignan contributed to this report.