NEW YORK (CNN/Money) -
Microsoft is still one of the more boring tech stocks out there -- shares have barely budged in recent weeks and are down 7.5 percent for the year.
But on the eve of its fiscal third quarter earnings report, there might finally be some cause for optimism, if not full-blown excitement.
Demand for PCs and servers has begun to pick up, as evidenced by solid guidance from Hewlett-Packard and Dell. In addition, IBM's hardware division reported healthy first quarter sales gains last week. All that is good news for Microsoft, the world's largest software company.
In fact, Drake Johnstone, an analyst with Davenport & Co., said that there's a good shot Microsoft will beat consensus estimates of 29 cents a share in earnings (excluding the cost of Microsoft's restricted stock compensation program for employees) and sales of $8.66 billion.
Still, Wall Street is already starting to focus its attention on what Microsoft (MSFT: Research, Estimates) can do in its fiscal fourth quarter, which ends in June. Analysts are predicting earnings of 27 cents in the fourth quarter and sales of $8.88 billion.
There is even some hope that Microsoft will give a first stab at guidance for fiscal 2005. Current estimates call for earnings of $1.28 a share and sales of $38.5 billion.
Where's the growth?
Of course, Wall Street will want to see Microsoft raise these targets. If Microsoft merely reaffirms fiscal 2005 estimates, that amounts to just 7 percent earnings and sales increases from current fiscal 2004 estimates, not exactly the type of growth most tech investors are accustomed to seeing.
And that's a big reason why Microsoft's stock has done very little during the past year even as many other tech stocks with significant exposure to the PC market have soared. Despite a rebound in the sector, investors are looking for Microsoft to come up with a new growth strategy.
"Microsoft is at or nearing a stage of maturity. Analysts are expecting slower growth rates and so is the market," said Michael Cohen, director of research with Pacific American Securities.
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In order to prove to Wall Street that there is a solid foundation for growth, Microsoft will probably need to ease investors' concerns about a persistent decline in unearned revenue, which measures the sales from software license renewals that Microsoft expects to book in coming quarters.
Unearned revenue fell $395 million in Microsoft's fiscal second quarter to $7.85 billion and the company said in January that it should fall by an even greater amount in the third quarter. However, Microsoft said unearned revenue would increase by a similar amount in the fourth quarter. So when all is said and done, Microsoft expects unearned revenue to remain at about $7.85 billion as of the end of this fiscal year.
So if unearned revenue falls by about $500 million to $600 million in the third quarter, investors would probably not be too concerned, Johnstone said, as long as the company maintains similar guidance for the full fiscal year. "People will breathe a sigh of relief," he said.
Time to spend
Investors will also be looking for more clarity about what Microsoft intends to do with its sizable cash position.
Microsoft has taken several steps recently to resolve some of its numerous outstanding legal issues, which could finally free up the company to use some of its $52.8 billion in cash for more productive reasons, such as increasing its dividend, investing in new growth areas or even making acquisitions.
Since mid-March, Microsoft has agreed to settle lawsuits with Sun Microsystems, InterTrust and the state of Minnesota. The company was also fined more than $600 million by the European Union last month. Microsoft is appealing the fine, as well as tough sanctions that the EU is imposing on it for violating anti-trust law.
But even if Microsoft were forced to pay the EU fine, that fine, in addition to the monetary settlements from the other cases should work out to just under $3.5 billion, a drop in the bucket for the company. (Exact terms of the Minnesota case were not disclosed but prosecutors were asking for more than $400 million.)
Carl "Clay" Peterson, president and CEO of Parkway Advisors, which owns Microsoft in the Memorial Value Equity fund, said Microsoft could easily afford to boost its dividend, which currently yields just 0.63 percent, one of the lower dividend yields for Dow stocks.
He said if Microsoft doubled its dividend (even though it just did so in September) that would make the stock a lot more attractive to investors. "With a 1.25 percent yield, you could park your money in Microsoft and have a nice dividend and potential for equity gains," he said.
More importantly, Microsoft should be able to concentrate more on reinvigorating growth as opposed to courtroom dramas and Wall Street's constant clamoring about what it will do with the cash.
"Getting these cases settled will give Microsoft an opportunity to focus on competing in its core business," said Peterson.
That's crucial as the open source operating system known as Linux continues to emerge as a viable alternative to Microsoft's Windows. To that end, Lindows, a small private company that sells a version of Linux for use on desktops, filed to go public Wednesday.
Cohen said Microsoft shareholders don't need to be overly concerned about Linux just yet but added that it is the biggest threat to the company's future growth prospects.
Analysts quoted in this story do not own shares of Microsoft and their firms have no investment banking ties to the company.