Archive for Sunday, March 16, 2003

Microsoft seeks fiscal fountain of youth

Maturing powerhouse’s attempts to enter new markets have yet to produce profits

March 16, 2003

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— They're stats to die for: Market share of 90-plus percent. Profit margins of 80 percent. Stocks that have created thousands of millionaires in the Seattle area alone.

But behind those figures is Microsoft Corp.'s biggest challenge for the future: Just what is a monopolist to do next?

As growth slows for Microsoft's main products, the Redmond, Wash.-based software superpower has been aggressively expanding into new realms, investing billions in everything from selling videogame consoles to loaning small businesses money to buy its software.

Those new ventures, however, are losing millions of dollars -- and creating tensions with such big-name companies as IBM and Sony.

Meanwhile, slower profit growth and a now-listless stock price has intensified pressure on Microsoft to find a fiscal fountain of youth.

"It's become extremely critical for them to grow these other segments," said Rob Enderle, an analyst with Giga Information Group. "Otherwise the (stock) market will not be kind to them."

Microsoft maintains its growth prospects are strong. At an analysts' conference recently, chief financial officer John Connors pledged "incredible products that change the world."

Still, Connors acknowledged the question that has been hounding Microsoft lately: whether "those products translate into the kind of profitability we've had from some of the very incredible products we've done historically."

To be sure, the company remains the envy of businesses around the world.

Its rise to power

At 28 years old, the world's largest software company owns the market for desktop operating systems with Windows. Its co-founder, Bill Gates, is a virtual rock star, and the company's phenomenal rise in stock price is legendary: One share of Microsoft purchased for $21 in its 1986 stock-market debut, with nine stock splits over the years, is now worth about $7,000.

A group of people dressed as butterflies skates down the street in
New York en route to promote MSN.com. As growth slows for
Microsoft's main products, the Redmond, Wash., software company has
been aggressively expanding into new realms, investing billions in
everything from offering Internet access service to selling
videogame consoles. It's even loaning small businesses money to buy
its software.

A group of people dressed as butterflies skates down the street in New York en route to promote MSN.com. As growth slows for Microsoft's main products, the Redmond, Wash., software company has been aggressively expanding into new realms, investing billions in everything from offering Internet access service to selling videogame consoles. It's even loaning small businesses money to buy its software.

Microsoft also continues to outpace the rest of the industry, pulling out profits while others desperately try to stem losses. For the second half of 2002, Microsoft earned a $5.3 billion profit on record revenue of $16.3 billion.

"They truly have been defying gravity by showing growth and strong financial performance at a time when (information technology) spending was down," said Eric Upin, software analyst with Wells Fargo Securities.

But that strong showing may be a sign of leaner times to come, analysts said. The record revenue stemmed mostly from a change last year in how Microsoft charges bulk-purchasers of software.

The windfall from the shift to a subscription model won't continue forever, Upin said, and some companies are considering alternatives to Microsoft software. Upin thinks Microsoft has "a couple quarters left in the gas tank."

In addition, with the market for personal computers drastically slowing, there are fewer customers for Windows. Analysts also say Microsoft will have a tougher time showing customers why they need costly upgrades to their Windows or Office software.

Its first dividend

Perhaps the biggest sign of Microsoft's maturing came in January when the company announced its first dividend, which analysts see as a response to increased frustrations among investors over the stagnating stock price while Microsoft hoards $43.4 billion in cash reserves.

But some say issuing a dividend is like admitting you can't throw a fastball. And Microsoft's decision to split its stock in February -- at prices lower than previous splits -- was seen by some as an effort to jump-start trading and regain the pattern of acrobatic leaps of the stock's younger days.

Money losers

The moves are focusing attention on where the money is coming from -- and where it's not.

Microsoft's Windows, Office and Server businesses collectively provided 81 percent of company revenues for the second half of 2002. The three sectors also boast huge operating profit margins of 83 percent, 78 percent and 32 percent, respectively.

From there, it's all about pouring money into areas Microsoft believes will someday deliver profits.

The four money-losing businesses -- its MSN Internet Service, Home and Entertainment segment including Xbox, Business Solutions for smaller companies and CE/Mobility software for wireless devices -- brought in a $3.2 billion combined in revenues but lost a little over $1 billion for the six months.

Those figures don't include another $905 million in losses that can't be attributed to any one business unit.

In many of its businesses, Microsoft is doing battle with some established competitors, including AOL Time Warner in the Internet access market, Sony in the video-game business, Nokia and Palm in wireless and IBM in selling software and services for companies.

Many have been bruised in previous brushes with Microsoft, and none intend to let a company synonymous with monopoly gain a dominant foothold in their industries.

Marty Shagrin, a research analyst with Victory Capital Management, wonders: How far are those money-losing Microsoft businesses from profitability -- and are they worth the effort?

"I don't think they're out in left field in what they're doing," Shagrin said. "It's just the economics of it aren't clear yet."

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