© Copyright 2000 - The Goldman Sachs Group, Inc. - All rights reserved.
Goldman, Sachs & Co. Investment Research
Reducing Microsoft estimates and investment rating to Market Outperform
from Buy
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* Microsoft reported disappointing third (March) fiscal quarter revenues *
* and recalibrated investor expectations downward for next year. Revenues *
* of $5.66 bil. were below street consensus est. of $5.95 bil. and also *
* below our recently revised estimate of $5.75 bil. Corporate PC demand *
* was up only about 5% in the quarter, with overall PC demand estimated at*
* 10-12%. Earnings of $0.43 per share was above our $0.41 est., but *
* included $0.05 per share of investment gains. We have reduced revenue *
* growth to 16% for fiscal 2001 and EPS growth to 10%-15%, both *
* disappointing in a year of relatively good new product cycles for MSFT. *
* We have reduced our investment rating to MO from U.S. Recommended List. *
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Rick G. Sherlund (New York) 1 212-902-6790 - Investment Research
Nils Tristan (New York) 1 212-902-4077 - Investment Research
===================== NOTE 8:20 AM April 24, 2000 =====================
Stk Latest 52 Week Mkt Cap YTD Pr Cur
Rtg Close Range (mm) Change Yield
--- ------ ------- ------- ------ -----
Microsoft Corp. MO 78.94 120-74 408659. -32% 0.0%
--------------Earnings Per Share---------------
MSFT (US$) Sep Dec Mar Jun FY CY
2001 FY 0.43 0.50 0.46 0.48 1.88 2.10
2000 FY 0.38A 0.47A 0.43A 0.43 1.70 1.78
1999 FY(A) 0.28 0.36 0.35 0.40 1.39 1.60
-Abs P/E on- -Rel P/E on-- EV/NxtFY LT EPS
Cur Nxt Cur Nxt EBITDA Growth
----- ----- ----- ----- -------- ------
MSFT FY 46.4X 42.0X 1.8X 1.8X NA 16%
CY 44.3 37.6 1.7 1.6
===========================================================================
* Corporate PC demand was very sluggish in January and February. The
question investors have struggled with over the past several weeks has
been the strength of business in the month of March. Microsoft
management indicated that the last three weeks of March showed some
acceleration but business was not characterized as strong. We had
previously reduced our March and June quarter revenue estimates,
directionally reflecting our concerns about a more sluggish than
anticipated month of March, and have now reduced our June quarter
estimate even further given the actual disappointing March quarter data.
* We believe corporate PC demand benefited in 1999 from a replacement
cycle in anticipation of Y2K, followed by a retrenchment in demand
beginning last November and continuing through the March quarter.
Tougher comparisons are likely through the September quarter, so even
with the re-accelerating corporate PC demand, growth this year may
likely remain below trendline growth rates. Corporate PC's (accounting
for about 40% of total PC's) generate much higher revenue per PC for
Microsoft, given the preponderance of Windows NT (at about $90 per PC)
versus Windows 98 (at about $45 per PC) on corporate PC's. Microsoft is
highly dependent on the growth of the corporate PC market given the
higher prices for its Windows NT operating system sold into this market.
Also, the corporate market is the primary market for Office
applications. The Windows 2000 and Office 2000 upgrade cycles are
dependent on more vibrant corporate PC demand.
* We have reduced our June quarter revenue estimate to a range of $5.84
bil. to perhaps $6.0 bil., down from $6.17 bil. previously, reflecting
assumptions of more sluggish corporate PC growth, and perhaps the
additional near term fact that new products to be shipped this summer
might cause some temporary slowing in June quarter demand. Our June
quarter revenue estimate reflects only 1%-5% growth over last year, or
about 4%-8% growth if we exclude the $190 mil. benefit in the prior year
quarter from the recognition of Office 2000 coupon revenues. For fiscal
(June) 2001, we have reduced our revenue growth estimate to 16% from 18%
previously, reflecting greater concerns about long-term corporate PC
demand versus consumer demand. It is our view that the corporate market
is maturing at a much faster pace than the consumer market, with
negative implications for Microsoft's revenue growth. Some on the street
have forecast over 20% revenue growth so management's guidance of 'mid
teems' revenue growth may be more damaging to sentiment than our more
moderate growth rate estimate reduction might imply. Our 2001 EPS
estimate has been reduced to $1.88 from $1.93 previously. It is possible
management is extrapolating from two weak quarters and may be too
pessimistic about 2001, but even if the upside were from 10% earnings
growth now forecast to say 20%, this would reflect benefits of a
stronger than usual product cycle and reaffirm that longer term growth
is decelerating at the company.
* There is a increasing risk that Microsoft might atrophy on the PC
platform as IBM did on the mainframe platform, while robust growth
shifts to hand-held and wireless devices. Bill Gates is expected to
articulate a vision to reposition the company with Next Generation
Windows Services in a press and analyst meeting expected in June. This
may be beneficial to investor sentiment, but product delivery is
expected to stretch out over 2-5 years, implying a lengthy transition
for the company. If the stock were to decline to $65-$70 per share, this
would imply a valuation of about 36-39 times estimated calendar 2000
earnings of $1.78 per share, appropriate for a company capable of
sustaining about 15% growth versus our earlier 20% estimate.
===========================================================================
Near term issues include slower corporate PC demand, the implications of
which include a mix shift to lower revenue producing consumer PC's. Also,
these are significantly less of a driver of demand for Windows 2000 and
Office 2000. There is an upcoming new product cycle beginning in the
September quarter for a new version of Windows 98 (Windows Me), SQL Server
2000 and Exchange Server 2000. Anticipation of these new products could
actually slow business in the June quarter and depending on the timing,
possibly have some dampening effect on the September quarter as well. Year
over year comparisons begin to ease up in the December quarter and
hopefully corporate PC demand strengthens to enable Microsoft to benefit
from a richer product cycle. Our model reflects under 10% revenue growth in
the September quarter, accelerating to 14% in December and 20% by the March
quarter. Earnings growth may lag behind given that the strongest growth is
increasingly coming from product lines which are less profitable (consumer
PC's) and the Internet/consumer sector which continues to lose money.
Longer-term, the growth rates for Microsoft will depend on corporate PC
demand, ongoing healthy demand for its server business (which we estimate
can grow at 20% long-term) and success in repositioning the company onto
other platforms where Microsoft is unlikely to enjoy monopoly market power.
Revenues in the March quarter reflected 23% growth, but excluding the $404
mil. of Office 2000 upgrade coupons which was deferred last year, this
would imply 13% underlying growth. Importantly, revenues from PC
manufacturers increased only 5%, reflecting the mix shift to lower revenue
producing consumer PC's and some price cuts for systems builders and
international hardware manufacturers where prices have been well above
average historically. Deferred revenues increased $200 mil. during the
March quarter, showing on-going conservative accounting practices. The
quarter did, however, benefit from unusual investment gains of about $450
mil. or about $0.05 per share in earnings. We anticipate that investment
gains will be sustained at this or somewhat higher levels through fiscal
2001. The company's Visio acquisition during the March quarter precludes
the company from repurchasing shares, although the company could likely re-
institute a share repurchase program later this summer.
Important Disclosures (code definitions attached or available upon request)
MSFT : CF, CS, M
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Prepared Mon 24 Apr 2000 08:23 © Copyright 2000 - The Goldman Sachs Group, Inc. - All rights reserved. |