Weighing Software Stocks : After the Microsoft Settlement
After the federal government and AT&T; announced their historic antitrust settlement late in the day Friday, Jan. 8, 1982, the lifting of that cloud was widely expected to re-energize the slumping stock market the following Monday.
Instead, investors’ excitement about a Bell System breakup and their relief that the government had concurrently dropped its antitrust case against IBM Corp. were overcome by concerns about rising interest rates.
The Dow Jones industrial average tumbled 16.07 points to 850.46 that Monday, even though AT&T; shares jumped $1.875 to $60.50 and IBM closed unchanged at $56.75 after trading as high as $58.75.
The past weekend’s landmark antitrust settlement between the Justice Department and Microsoft Corp., while not on the same scale as the AT&T; case, nonetheless has technology analysts using the same sort of language when they talk about the potential fallout.
They see a weight removed from Microsoft’s shoulders now that the case is history, while at the same time predicting a more level playing field for the software giant’s many competitors, including Novell Inc., Lotus Development and Borland International.
From the viewpoint of investors, guessing how the stocks will react today--and picking the longer-term winners and losers based on the Microsoft settlement--naturally is fraught with high risk. These are technology stocks, after all; they are extraordinarily volatile and inherently speculative even without the government’s hand in the marketplace.
But given the sharp declines in most tech stocks over the past few months, while Microsoft shares have actually strengthened, the market backdrop suggests that a settlement that weakens Microsoft even marginally (as this one purportedly will) could hurt its shares in the near term, while helping those of other software companies.
Longer term, however, Microsoft is still the 800-pound gorilla in personal computer software and potentially in the interactive electronic world that is evolving by the second. The payoff in dominating this new world will certainly be measured ultimately in the billions--in the number of users and the number of dollars of sales and earnings they will generate.
The question isn’t whether Microsoft is an attractive investment, but at what share price. Odd as it may sound, price was rarely a worry for Microsoft investors between 1989 and 1992; the stock closed each year far above the prior year’s close as sales mushroomed thanks to the company’s virtual lock on its markets.
Here is a look at some of the issues facing investors as they weigh the near-term and longer-term prospects for software stocks, in the wake of the Microsoft antitrust settlement.
* For Microsoft’s competitors: After battering many tech stocks in April, May and June on worries about slowing computer sales, investors just last week began to pile back into the sector, looking for bargains.
That change in mentality, coupled with the expectation that the Microsoft settlement will boost the prospects of some of its competitors, could give a further broad lift to tech shares in the short run.
Last week, bullish second-quarter earnings reports from semiconductor giant Motorola, computer networker Chipcom and disk-drive maker Seagate Technology sparked a wave of buying in the beaten-down tech area.
Seagate stock, for example, rose $2.875 for the week, or 13%, to $24.75 as the company’s earnings report helped allay some of the concerns about a slower economy translating into sharply lower computer sales, and thus lower earnings for tech companies.
But on Friday, investors’ rising goodwill toward tech shares was deflated again, after semiconductor maker Texas Instruments warned that it indeed expects its growth rate to slow in the second half of the year. TI’s stock tumbled $6.125 to $80.25 on Friday.
Still, there’s a reasonable argument that many of the software stocks, at least, have nowhere to go but up--especially with an antitrust settlement that bars kingpin Microsoft from some sales practices that had clearly hurt its rivals.
Novell shares, which have plunged from $26.25 earlier this year to $16.75 now, are trading for just 15 times estimated 1994 earnings per share. Yet Novell could be a big winner with its personal computer networking systems, with Microsoft no longer able to bind computer makers to lengthy contracts that restricted their ability to use other operating software systems.
Microsoft’s stock, in contrast, sells for about 24 times the $2 a share it is believed to have earned in the fiscal year ended June 30.
Meanwhile, Lotus’ stock has been pummeled from $86.50 at its spring high to $39.625 now, in large part because the company warned in late June that it wouldn’t meet analysts’ second-quarter earnings expectations. One of Lotus’ problems has been its inability to keep up with Microsoft in desktop software development, especially for spreadsheet programs.
If nothing else, the share price declines already experienced by Novell, Lotus, Borland and other Microsoft rivals this year may leave them less vulnerable than Microsoft to what is still the great market fear in the short term: that the U.S. economy will slow enough in the second half to put a meaningful dent in the growth rate of personal computer sales.
* For Microsoft: It remains to be seen whether Wall Street will make any adjustments in its 1995 and 1996 earnings forecasts for Microsoft based solely on the antitrust settlement. But it’s hard to imagine that any adjustments that might be made will be upward, rather than downward.
No longer, for instance, will Microsoft necessarily earn a per-machine fee from major personal-computer makers even if they use a rival’s operating system in their machines.
While the early line from analysts over the weekend was that Microsoft’s earnings won’t be materially affected by the settlement’s terms, an element of doubt has been injected into the immediate outlook.
At the same time, of course, the simple fact that the settlement clears the air for Microsoft has some intangible value for the company and thus the stock.
But unlike shares of Novell, Lotus, Borland and others, Microsoft’s stock has been holding up well in advance of the settlement. At $48.625, the stock is well up from its 1994 low of $39, though down from the high of $54.625.
Part of the reason for the stock’s relative strength this year was Standard & Poor’s Corp.’s decision in the spring to add Microsoft to the S&P; 500 stock index. That sparked buying in June by investors whose portfolios are set up to mimic the S&P; 500.
That buying demand, however, should now be exhausted. Which leaves Microsoft investors dealing solely with the impact of the settlement, and with other fundamental issues.
One continuing negative is the company’s delay in introducing its long-awaited upgrade to its ubiquitous Windows software program, which runs on an estimated 50 million personal computers worldwide. The rollout for the upgrade, code-named Chicago, has been pushed from this spring to later this year.
And rumors abound that Microsoft will announce at its annual meeting on Thursday that Chicago will again be delayed.
With Chicago’s problems and the antitrust settlement’s apparent promise of a tougher competitive environment in the years ahead, Wall Street may simply become much pickier about the valuation it affords Microsoft stock.
How much is too much to pay for Microsoft? If Wall Street is correct in expecting earnings to advance about 20% in fiscal 1995, the stock’s current price-to-earnings ratio of 24 means the shares are vulnerable to any disappointment.
Still, there’s also a good argument that the stock isn’t dramatically overvalued today for long-term investors.
This is still Microsoft, after all; with its dominance in the personal-computer market, and the still-mushrooming nature of that market, Microsoft probably deserves a richer stock premium than its rivals for a simple reason: It can promise consistent, if slower, earnings growth in the years ahead, and consistency is increasingly a rare quality among technology companies.
* MAIN STORY: A1
How Software Giants Stack Up
How major software and computer networking stocks have fared this year, and the companies’ estimated sales and earnings per share (EPS) for 1994. Also shown are the stocks’ price-to-earnings ratios (P-Es), which is current stock price divided by estimated 1994 earnings per share.
1994 Fri. ’94 Stock high-low close Sales* EPS* P-E IBM Corp. $65-51 3/8 $56 7/8 $64.00 $2.85 20 Microsoft 54 5/8-39 48 5/8 4.60 2.00 24 Computer Assoc. 44 7/8-27 3/8 41 2.48 2.85 14 Oracle Systems 40 1/8-26 1/4 39 1/8 2.45 1.20 33 Novell 26 1/4-14 16 3/4 1.40 1.15 15 Lotus Devel. 86 1/2-33 39 5/8 1.14 2.15 18 Borland 16-8 1/2 10 1/8 0.35 -1.00 NA Broderbund 49 1/2-31 1/2 48 3/4 0.11 1.65 30
Sales in billions NA: not applicable All stocks trade on Nasdaq except IBM and Computer Assoc. (NYSE). ** Estimated ’94 Source: Value Line Investment Survey
