June 7, 2000 2:50 PM PDT

Microsoft investors face split decision

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Today's court order to split Microsoft in two may leave investors with a tough choice: put their money in a proven software business with a limited future, or pin their hopes on a new, perhaps riskier, Internet company with vast growth potential.

For a growing number of Wall Street analysts, the decision is becoming clearer by the day. Several say a new Net business, which would include applications housed on the Web rather than on the individual PC, seems a far better bet than an operating system company that one day may be relegated to selling a commodity product. And they believe that key players within today's Microsoft are thinking the same thing.

"We would expect all key management to go with the applications company, given that the operating systems business as configured by the DOJ would effectively be neutered, stripped of nearly all exciting opportunities to expand the market," Rick Sherlund, a closely followed analyst with Goldman Sachs, wrote in a recent research paper.

Microsoft's stock price has been cut almost in half since its 52-week high of $119.93 in December. Although many on Wall Street had been bullish on the company's long-term prospects, the number of analysts touting it as a "strong buy" has declined while the number with a "hold" rating has risen slightly.

The main reason for concern: an end to the unparalleled leverage afforded by Windows, the ubiquitous operating system that Microsoft has effectively used to enter and command other businesses by offering new products along with it.

Special coverage: Breakup "I believe that in a breakup case, the sum of the parts does not have a value greater than the whole," said Paul Dravis, an analyst with Banc of America Securities.

Current shareholders are also pondering their fate. But company spokesman Jim Cullinan said Microsoft can't shed any light at this time.

"The way it was laid out is if you own a certain amount of shares, you can't own stock in both companies," he said. "We don't know how this would be implemented and don't believe it ever will."

The government proposal calls for prohibiting ownership in both companies for current and former employees, officers and directors who hold greater than a 3 percent stake in Microsoft. Investors who do not fall in this category may receive shares in the new company, according to the government proposal.

Chris Mortenson, an analyst with Deutsche Banc Alex Brown, estimates that Microsoft would be worth 15 to 20 percent less if it were broken in two as proposed by the Justice Department and 19 states in their landmark lawsuit.

But if so many agree that the "old" Microsoft would be worth less, what do they say about the new company that would be created if the breakup ruling survives all anticipated legal challenges?

Melissa Eisenstat, a CIBC World Markets analyst and one of two Wall Street soothsayers with a "hold" recommendation on the current company, favors Microsoft's Internet and applications operations that would be run by the new company. Based on projected price and earnings ratios, as well as cash and equity investments, she estimates that the Internet business would grow 100 percent annually over the next several years and that the applications operation would rise 15 percent.

By contrast, the total growth of the operating systems company would grow an estimated 20 percent.

Windows 2000: The next generation "We are liberal in our Internet and consumer growth rates because the market has been placing a liberal premium on Internet plays," Eisenstat wrote in a report released in April.

The applications and Internet company would have a stock price of $40.16 for calendar 2000, with an estimated earnings per share of $1.05, according to her research. The operating systems company, meanwhile, would have a stock price of $17.70, with an estimated 73 cents earnings per share.

Mortenson, too, likes the prospects of a new Internet company, citing the limitations on Windows' future. He said the operating system is expected to account for 52 percent of Microsoft's operating income for fiscal 2000 results but will contribute an estimated 41.5 percent of revenues.

"The applications company will have more interesting stuff," Mortenson said. "All the Internet stuff would be in this company, and it would be less regulated than the operating system company."

 

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