Microsoft Endgame?
Experts discuss the DOJ-MSFT settlement and XP.

By Edward B. Driscoll, Jr., a tech writer living in San Jose, Calif.
November 5, 2001, 9:45 a.m.

icrosoft finally caught a break last week when the Justice Department decided to settle with the software giant, apparently shutting the antitrust case that began in 1998 (although a total of 18 states have until Tuesday to decide whether or not to sign on to the DOJ agreement). Tech sector analystys discussed with NRO Financial the potential impact of the settlement on both the company and the Nasdaq, as well as Microsoft's prospects following the recent launch of its Windows XP operating system.

Jeff Taylor, Reason magazine
The settlement puts limits on Microsoft business practices, gives more freedom to OEMs, but does not touch Bill Gates’s line-in-the-sand of “freedom to innovate.” The only thing I don't see is discussion of a fine, which I would think Redmond would be more than happy to part with to give the state attorney generals a trophy. Preferential treatment of software makers sounds like an open-ended invitation to continued litigation, as no software developer ever thinks his or her code is rejected on the merits. That could be very attractive to anyone who wants to keep Microsoft in court, and Microsoft may regret this provision real quick.

The state AGs essentially have a political decision to make. Do their constituents — trial lawyers — want them to continue a high-profile fight the rest of world doesn't understand? Attacking Microsoft has already achieved the goal of creating plenty of work for lawyers in the tech field, and the prospect of at least five years of close supervision of Microsoft means full-employment for tech lawyers. I believe the AGs, perhaps with some noisy dissent, would make sure the agreement is vigorously enforced.
— Taylor is the editor ofReason’s weekly email newsletter, Reason Express.

Jonathan Rudy, Standard and Poor’s
Out of all Microsoft’s recent products, the XP operating system is definitely the surest thing that they have, and going forward, that’s probably the biggest positive for their stock. UltimateTV doesn’t seem to have taken off, and I’m not too sold on the X-Box as far as it being the bang-up success a lot of people think.

The real benefit for XP will be in the install base on the consumer side, for the Windows 95/98/Me users. That’s the real immediate opportunity for Microsoft. Not that corporations won’t upgrade to XP, but it’s more of a gradual process than anything else. The roll-up and the upgrade to Windows 2000 happened a lot slower than was anticipated, so you still see reports of companies that, within the last six months or so, just upgraded to Windows 2000, or are in the process of doing so now. And Microsoft also appears to be keeping Windows 2000 in production, but with the new licensing plan, they’re trying to push people towards XP.

At this point, the ongoing trial is the source of the real hesitancy. As far as performance, Microsoft’s stock is as well positioned as anyone in software, just with their upgrade and the incremental revenues from X-Box. They have been putting a lot of money into R&D for X-Box and getting into new initiatives (e.g., .Net, Hailstorm, etc.).

That being said, it’s pretty difficult to assess the long-term impact of the settlement on the company. You’re really looking at a trading range. Depending upon some of the valuation metrics, they’re not cheap at these levels. Based on their discounted cash flow, their fair value is anywhere from the mid- to low-60s. The company still trades over ten-times sales, which certainly isn’t cheap. Earnings-wise, they’re approximately 35-times our estimate for their next fiscal year, so it’s definitely not a cheap stock. It’s a question of what sort of multiple do you want to pay for their growth going forward. From our perspective, you’re not going to see that high-teen consistent growth rate that you’ve seen in the past with Microsoft.

You also have to say that an unfavorable ruling couldn’t help but impact the Nasdaq as a whole. Microsoft really has been a stalwart in the market in the past couple of months; it’s shown some solid leadership, and if something like that were to happen, I couldn’t see it not taking down the Nasdaq with it.

But the flip side is that any sort of positive event could easily benefit the market. I feel comfortable with the fair value for Microsoft being somewhere in the mid-60s. But with a favorable ruling, all bets are off: the stock could easily trade to new highs, at least new 52-week highs.
— Rudy is a software analyst for Standard and Poor’s.

Neal Goldman, the Yankee Group
It’s unclear what percentage of consumers are really going to upgrade to Windows XP, for a variety of different reasons. Are there enough compelling features in XP to drive somebody to say, “I’m going to spend $100 for the home version or $200 for the pro version, plus an extra $30 to $50 for memory”? So far, I think the answer’s probably no. XP is a more stable OS than Windows 98 or Windows Me, but I’m not sure somebody is going to spend $99 to go out and buy a more stable operating system. On the other hand, it’s really saying something when Microsoft says: “Windows XP is thirty to forty times more stable than Windows Me.” What does that say about Windows Me?

XP will probably not spur any major new software sales in and of itself. So Microsoft is spending a lot of money, but it’s unclear what the long-term impact is going to be for them. In some ways, it’s just what they have to do: they keep raising their bar. At some point, they’d have to upgrade their systems, otherwise they risk losing market share.
— Goldman is the director of the Yankee Group's Application Infrastructure & Software Platforms Planning Service.