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Technology > Tech Biz
Microsoft IS worried about Linux
For the first time, the company offers a real assessment of the Linux threat in its annual report.
September 9, 2004: 2:17 PM EDT
By Eric Hellweg, CNN/Money contributing columnist

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BOSTON (CNN/Money) - The "risks" sections of most company SEC filings are usually pretty tedious reads, written as they are by members of the legal staff hoping to cover the company's behind should an investor lawsuit arise.

"See!" you can almost hear the lawyers respond. "We told you on page 37 that the CEO may get struck by lightning." Every potential threat or problem is desiccated and described in detail. Hardly tendentious stuff.

Microsoft acknowledges a risk

Tipped off by a recent eWeek article, I decided to check out Microsoft's most recent annual report filing.

In it I found a segment that gave me pause: "We believe that Microsoft's share of server units grew modestly in fiscal 2004, while Linux distributions rose slightly faster on an absolute basis. The increase in Linux distributions reflects some significant public announcements of support and adoption of open source software in both the server and desktop markets in the last year."

Folks, this is news. Microsoft is acknowledging the Linux threat. Really acknowledging it.

The company first used the word "Linux" in an annual report in 1998, citing the software twice and stating only that "over the past year the Linux operating system has gained increasing acceptance."

In 2002 there were six mentions of Linux. Last year Linux was cited 15 times, and the threat of competitive Linux-based applications warranted a mention. While the number of Linux citations dropped to 13 this year, the 2004 annual report is notable because Microsoft put some statistical heft behind its warnings, stating that Linux servers outpaced Microsoft's for the first time in terms of growth percentage.

Analyst reaction

How do the analysts react? Jim Mendelson, analyst at Schwab Soundview, rates Microsoft a neutral and says "Linux is a factor" in his rating. "It represents a big question mark."

Given Linux's steady encroachment in the server space ("like Chinese water torture," Mendelson says), others say it's unclear whether Linux should represent a question mark or an exclamation point that calls Microsoft to arms.

None of the five analysts I spoke with for this story could cite a response Microsoft has given that's been effective in stemming Linux's growth.

Consider the following statistics from research firm IDC: Two years ago Linux server operating system shipments made up 23 percent of the market; by 2007 that number is expected to reach 32 percent. Using a different methodology, Gartner has Linux at 7 percent of the server market this year, growing to 16.4 percent by 2009. While these numbers differ wildly, one thing is clear: Linux is growing and, to some extent, doing it at Microsoft's expense.

As an investor, what should you make of this? It's clear, as evidenced by Microsoft's plateau-like stock chart over the last few years, as well as by its recent decision to issue a dividend, that the company's days as a growth stock are ending.

The server space is one of Microsoft's greatest successes outside its desktop monopoly, so Linux's continued encroachment is troubling on a number of levels. It could result in significant price drops for Microsoft server software.

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Microsoft Corporation
Corporate Governance

It could result in some unlikely alliances between Microsoft and open-source-friendly applications developers. Microsoft is hardly out of the game yet, but how it manages this threat in the next year could determine the company's future growth prospects.

While its MSN music launch brings the glitz, investors would be wise to keep their attention focused instead on the area that brings in the cash.

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