Microsoft's Strategies

0 Comments | Insight on the News, June 4, 2001 | by James P. Lucier

As Microsoft awaits an appellate court decision on whether to force a breakup of the software giant, it plans to offer a slew of new products that take advantage of rapidly developing Internet technology.

Coming soon on some Tuesday afternoon, or perhaps on a Friday after the markets close, the U.S. Court of Appeals for the District of Columbia Circuit will hand down its decision in the case of U.S. v. Microsoft. The betting in the nation's capital is that the panel of nine judges largely will overturn the ruling last June of U.S. District Judge Thomas Penfield Jackson that the Microsoft baby can be saved only by cutting it in two. The appeals case was heard in February and the judges, who were sharply critical of Jackson at that hearing, have been taking their time crafting a decision.

Yet the markets are serene. Despite the threat to break up the most successful corporation of our time, and despite the plunge of technology stocks in general, Microsoft stock, trading as MSFT, continues a modest rise in the opposite direction of the NASDAQ downtrend, passing $80 a share as this magazine went to press. And why not? Microsoft is a company with more than $379 billion in market capitalization, no debt and $30 billion in cash equivalents and short-term investments, Wall Street sources tell Insight. Even with the general economic slowdown in the first quarter, Microsoft announced its sales had increased by 14 percent over the same quarter last year (see An Investors Why MSFT Is a Good Value Today)

An Investor Explains Why MSFT Is a Good Value Today

Larry Abraham is a Seattle-based investor and investment adviser who has been an independent Microsoft watcher from its earliest beginnings. Insight sat down with Abraham to find out why Microsoft succeeded where others failed.

Insight: Why is Microsoft successful?

Larry Abraham: It is a classic example of Josef Schumpeter's dictum that successful enterprises always engage in creative destruction. That is, Microsoft constantly is reinventing itself. Its officers spend a great deal of money on research and development. There's no way to compare it to a company of the past: It is creating its own history. They spend copious amounts of money working on whatever they're calling the new "new thing." Sometimes the ideas behind those buzzwords don't develop, and sometimes they do.

Insight: But what about the future?

LA: I think Microsoft is going to continue to be a dominant company, and as an investor you have to like it: They have somewhere between $22 billion and $25 billion in free cash with zero debt. Their cash is piling up at a rate of around $5 billion to $6 billion a year. The beauty of their business is that, once incremental costs are covered, 90 cents of every dollar made in revenue falls to the bottom line. They're like the coach who opts to draft the best athlete -- they set out to hire the best minds.

Insight: Why hasn't Microsoft been affected by the dot-com bust like Sun Microsystems, now down to $12 a share, or Cisco Systems, which just posted a $2.9 billion loss for the first quarter of 2001, including $2.2 billion for obsolete inventory?

LA: It is typical of how Microsoft views itself. Before putting its weight behind something, Microsoft always asks: Who's going to buy this, what are they going to pay and will they make money with it? That's been axiomatic to the tremendous success of the company. They look at it and say, "Here's the approximate market, and here's the market ceiling on the price." They were able to anticipate that, yes, there would be a market for it, and here's the approximate price ceiling. And if they miss, they've got so much margin they can deal with it.

Insight: As an investor what do you look for in a technology company?

LA: I am enough of a technophobe that I don't get romanced by technology because I ask myself all along, "Do I understand this?" and "Would I buy this?" and "Who do I know that would buy it?"

Next you ask yourself, "How capable is the management?" You bet the jockey rather than the horse. Then, take a look at their business plan, and their execution of that business plan, and how they are doing at getting to profitability. A lot of these dot-coms didn't have a business plan that spoke to profitability.

So when I go looking for a technology company to invest in, I still look at the basics: Is it a good buy? How skilled is the management? What is the price of the stock versus its earnings? Are those price/earnings ratios valid considering how it's been growing its equity year to year? If this market cycle and this bust out have taught us anything, it is that the virtues of value investing are as applicable to technology as they are to old industrial companies.

Insight: Is Microsoft a good value?

LA: MSFT at the height of the boom was around $115, and it's about half that now. It probably was overvalued then, and it's probably fairly valued now. At $60, based on what would be a reasonable price/earnings ratio, I would think that around $70 would be a fair price for Microsoft. It's hard to say because there still is the overhang of the court battle, and they are doing exciting things with new products.