Judge Ruled on Microsoft, so It’s Our Turn

Microsoft (MSFT)

JIM: (Don’t Buy)

MIKE: (Buy)

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Jim: Well, Mike, we’re taking another look at Microsoft today, and it’s only the second time we’ve revisited a stock we’ve already reviewed.

Mike: Ironically, the first time was when we reconsidered Microsoft’s archrival, Apple Computer. We both recommended Microsoft’s stock last summer, but it seems there’s been a spot of news lately that warrants a chat about whether the stock is still a buy.

Jim: A spot that’s taken tons of newsprint and gallons of ink to explain.

Mike: With many more gallons to come. But we’ll cut to the chase. As our readers know, a federal judge surprised no one last week by finding Microsoft guilty, guilty, guilty of violating the antitrust laws by trying to parlay its monopoly on the Windows operating system for computers into a monopoly on other products. You could say this was a case of a “new-economy” company discovering that it still has to play by the “old economy’s” rules.

Jim: Whether that’s fair is debatable. But let’s start with the fact that the judge, Thomas Penfield Jackson, simply reaffirmed a decision he’d previously made. He had to because Microsoft and the U.S. government couldn’t come to terms on an out-of-court settlement. Even so, it knocked Microsoft’s stock for a loop, and helped trigger the recent more general train wreck in tech stocks.

Mike: Right, Microsoft plunged 17% in the two days after the ruling.

Jim: Here’s the really sad part: Remember when Microsoft made headlines a while back because its total market value topped $500 billion? Well now, I’m sorry to report, it’s back down to about $450 billion.

Mike: OK, as I wipe a tear from my eye, let’s consider the legal situation. We’re probably looking at a year or more of appeals after Jackson this spring figures out the penalties or remedies for Microsoft’s behavior. Eventually it looks like this thing’s heading for the Big Nine in D.C.--the Supreme Court.

Jim: That’s a long time for this cloud to keep hanging over the stock.

Mike: It’s certainly debatable whether Microsoft is worth 17% less just because of this decision. But there’s more trouble for Microsoft than simply one judge’s opinion.

Jim: Such as?

Mike: That this could open the floodgates to lawsuits from lots of others, namely competitors who feel aggrieved by Microsoft’s actions--and now have Judge Jackson’s decision on their side. He’s effectively created a long litigation tail for this company.

Jim: Geez, you make it sound as if Microsoft’s in danger of becoming the next Philip Morris or Dow Corning, with potentially billions of dollars of liabilities staring at it.

Mike: No, those companies face huge liabilities over health and environmental claims that are on a much greater scale, Jim, and the dollar amounts of the consequences are really unknown and could take years to uncover.

Jim: We don’t know what this could cost Microsoft, either.

Mike: No. But in those cases involving tobacco and breast implants, there are emotional and political components attached to their liabilities that are really fearsome. That probably will make the ultimate cost of those cases much higher than what we’ll have here.

Jim: Speaking of consequences, let me tell you what I find most notable about Microsoft’s legal mess, at least from an investor’s view. When we first talked about the stock, we debated whether Microsoft might get broken up, like AT&T; was in the mid-1980s. But now everyone’s saying that a breakup of Microsoft is unlikely. So if I look at the stock, I feel pretty sure that at least the company will be intact going forward.

Mike: Even if Microsoft was broken apart, I’m not sure that would be bad for its stockholders.

Jim: Me, neither. Microsoft’s holders might be better off. I’m just saying it’s one less uncertainty if you’re debating whether to buy the stock.

Mike: Fair enough. Now let’s look deeper at the company. There’s no question that Microsoft, through Windows--which includes a now-infamous Internet browser that was the instrument of its extended monopoly, the judge said, along with the Word writing application and the Excel spreadsheet--has a monopoly on desktop PCs. But it’s also true that in many other areas where Microsoft competes, it doesn’t have that kind of advantage--either because the operating system on the desktop is irrelevant or because it faces tough rivals.

Jim: I know. A fellow named Hiltzik has written about how, beyond Windows, Microsoft isn’t Tyrannosaurus rex.

Mike: Which is not to say that it’s staggering around, either. But there’s a big difference between having 90% of a market and having 12%, which it does in some of these other sectors.

Jim: And it takes a different set of management skills to get that share up from 12% than it does to protect your 90% share.

Mike: Exactly. One of Microsoft’s biggest challenges is developing managers who can compete where they’re not already No. 1. That creates a big question about how well this company fares going forward.

Jim: That’s not all. There are several areas where Microsoft’s alleged monopoly with Windows . . .

Mike: Alleged? That’s like calling Willie Sutton an alleged bank robber.

Jim: All right, all right.

Mike: They’re not exactly in a position to sue us for libel.

Jim: My point is, there are threats to Microsoft surfacing every day, and I’m talking about the Internet. Look at all the stuff you can download, often for free, that supersedes what Windows provides.

Mike: And look beyond the Internet, at all the wireless devices, such as phones and hand-held organizers and so on, that don’t even involve a desktop computer and make the desktop operating system irrelevant.

Jim: So can we actually talk about what all this means for the stock?

Mike: We’d better. I see you’re looking at your watch.

Jim: Well, when we recommended the stock last summer it was trading around $84 a share.

Mike: And today it’s trading for . . . hey! Around $86 a share, thanks to all this news. But, with all of the additional information we now have, would you change your mind about buying the stock?

Jim: Yes. I’d pass on the stock today. Here’s my case: Not for a moment do I think Microsoft’s business is hurting. The company keeps kicking out double-digit gains in sales and earnings, and it’s not likely to stun Wall Street with some sudden news or a disappointing quarter. It’s got an amazing balance sheet, with more than $17 billion of cash.

Mike: Then what’s the problem?

Jim: Even with its recent slide, the stock still sells for 51 times Microsoft’s expected per-share profit for 2000. Now, I know that’s not terribly high compared with some tech giants, but it’s still a pretty penny to pay for Microsoft--especially when you consider that lots of investors are skittish about the stock’s future.

Mike: You mean because of the antitrust case?

Jim: It’s more than that. Let’s say Microsoft ultimately prevails, or at least doesn’t get hit with penalties that are really punitive. It still faces all the competitive threats we just cited. So Microsoft’s got its hands full on the legal side and on the performance side. That’s a lot weighing on the stock.

Mike: So you’re doing exactly the opposite of what you did with Apple?

Jim: That’s right. When we revisited Apple, we stopped being bearish and recommended the stock. And I’m happy to say we got that one right--Apple took off. But with Microsoft I’m going the other way. How about you?

Mike: I’ll be honest, I’ve been on the fence with this stock . . .

Jim: Jump off, or I’ll start looking at my watch again.

Mike: OK, yes, I’d buy the stock. Microsoft’s earnings will keep growing; it’s fundamentally in great shape, as you said; and I see the main problem being investors’ perception that this stock is in trouble. But that perception will soon change. Plus, I’m betting on something else: that Bill Gates & Co. are finally going to get religion and make some serious moves to get this legal case behind them.

Jim: You don’t think they’ve made serious moves so far?

Mike: Absolutely not.

Jim: So they’ve just been stubborn.

Mike: Stubborn? They’ve been like Balaam’s ass.

Jim: I beg your pardon?

Mike: You know, Balaam’s ass, the Biblical stereotype of the obstinate animal. Gates could have settled this case by now. But I see Gates and Steve Ballmer, his chief executive, soon realizing that there’s no percentage in squeezing this case until it squeals. Look at Intel, for instance. They got hit with an antitrust case about the same time as Microsoft, and they decided that it didn’t matter who was right and who was wrong, just that having a federal lawsuit hanging over you was bad news. Result: They settled that case in six months. And as soon as Gates & Co. show they’ve figured this out, the stock will move up.

Jim: I’m not so sure. Even if Microsoft settles, that doesn’t change the fact that it’s not a giant elsewhere. Take the new Windows 2000, for instance. It’s mainly aimed at the corporate market for big computers, but you well know it’s got its work cut out in that market because several makers of those big machines, like Sun Microsystems, use a different operating system than Windows.

Mike: Yes, but Windows 2000 will still be a successful product.

Jim: I’m not saying it will be like “New” Coke and be a huge flop. It’s just that, for the next 12 months at least, I don’t see Microsoft or its stock setting the world on fire, especially if this antitrust case keeps dragging on.

Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age” (HarperBusiness). They can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.

You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the “KFWB-Los Angeles Times Noon Business Hour” on KFWB-AM (980).