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Microsoft and investors
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November 8, 1999: 8:10 p.m. ET
What does the antitrust decision mean for stock holders?
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - What does the Microsoft finding mean to investors? Would a forced breakup of the company be good news for holders of the stock? Though the details of how the software maker will respond to a federal court's finding that it is a monopoly aren't set, investors are definitely fretting about how to respond.
The initial reaction to the decision was not good, sending the stock down around 5 percent on Monday morning. But shares rallied and closed down 1-5/8, or 1.8 percent off its previous close, on Monday. That was the first trading day for investors to respond to U.S. District Judge Thomas Penfield Jackson's finding. The release was timed to give investors the weekend to mull over how they wanted to act.
Many stock watchers had expected worse and analysts remained bullish on the stock. "No Reason To Overreact," was Salomon Smith Barney's headline on its reiteration of its "buy" rating. Microsoft's loss in the first round of the fight was expected, Salomon's analysts wrote, though the language of the finding was surprisingly harsh. A settlement is likely, they say.
A buying opportunity?
Other analysts agreed that the furor makes for a good buying opportunity for Microsoft (MSFT) stock, and Volpe Brown Whelan & Co. was alone in downgrading Microsoft from a "strong buy" to a "buy."
"You've got a gorilla here that's attractively valued," said Andrew Roskill, senior software analyst at Warburg Dillon Read. He reiterated his "buy" on the stock; he has a 12-month target of $110.
Roskill feels the stock is a good buy because it has underperformed other large-cap technology companies such as Cisco Systems (CSCO), Motorola (MOT), Oracle (ORCL) and Texas Instruments (TXN) as a result of the government's case against it.
"Microsoft has gone nowhere for the last three months," Roskill said. So whatever penalty or settlement agreement is reached is already priced into the stock, he said. "If you're a long-term investor, this is a really good time to get in."
Antitrust experts said a forced split-up of Microsoft would be unlikely, though speculation that the software company would be divided into as many as three or four different entities ran rife. Dividing Microsoft would be difficult given the business it is in.
"I would be loath to impact, with such draconian measures, an industry in which it is so important for people to have a single standard," said Carole Handler, an antitrust lawyer with Kaye Scholer Fierman Hays & Handler. Handler suggested that the Justice Department would be more likely to try to prevent the software company from linking products, from requiring Windows to have Microsoft icons and so on.
Would a divided Microsoft be better?
But a split up of the company isn't out of the question. If that were to happen, it could be divided into four businesses: the operating systems business that is the focus of the case; an applications business; an e-commerce and Internet business; and an investment, venture-capital-like business, Roskill said.
"The big question in evaluating this is the operating systems business," he said. That provides a third of Microsoft's revenues and around half the company's profits. The other parts of the company would be easier to value, he said. Its investments in other companies are worth around $20 billion at book value, for instance, he said.
If precedent holds, a divided company would produce good returns for investors. For instance, 100 shares of AT&T in 1984 would have cost $6,150 at the time of the break up. That would now be worth $56,144, the company said. The same investment in a Standard & Poor's Index fund would now be worth $49,048.
Another advantage of a divided Microsoft is that investors would be able to concentrate their holdings in the parts of the company they feel have the best prospects -- the e-commerce side, for instance.
Investors that held 100 shares of AT&T prior to the breakup still had 100 shares of AT&T (T) post breakup. But they also had 10 shares each of seven regional Bell companies, the Baby Bells: Bell Atlantic (BEL), BellSouth (BLS), U.S. West (USW), Nynex (since acquired by Bell Atlantic), and Ameritech, Pacific Telesis and Southwestern Bell (all now part of SBC Communications (SBC)).
With subsequent divestitures such as AT&T's decision to spin off its manufacturing arm to form Lucent Technologies (LU), investors would now have stock in nine companies. Many of the Baby Bells have performed much better than the parent company.
Though it wasn't happy with the decision forcing it to break up at the time, the company feels the separate entities have performed well for investors. "The lessen is that sometimes the parts are worth more than the whole," Burke Stinson, an AT&T spokesman said.
AT&T news wasn't all good
But investors lose the convenience of holding one stock. They also have to become better pickers to decide which to sell. Many AT&T shareholders simply kept all their shares in response.
And a California State University business forum concluded that AT&T performed worse as a business after its breakup. For instance, while its revenues grew 35.6 percent in a decade post split, or 3.5 percent a year, it had been growing at 11.5 percent pre-breakup. Net income was also comparatively worse.
"Investors and creditors do not appear to have received benefits worthy of the significant costs associated with the divestiture," the forum found.
But though the companies performed worse divided, the stock returns were better. Pre-breakup AT&T averaged an 11.9 percent total return, including price appreciation and dividends. That rose to 14.1 percent after the breakup, mainly thanks to stock-price gains rather than dividends. The better performance came at a price. The stocks were more volatile and behaved more like growth stocks than income stocks.
Situation bad if it drags on
Any divestiture would take some time. In AT&T's case, the government first filed to force it to split up in 1974 and the company fought the case until losing in 1982. Then it took two years to divide.
The Microsoft trial has proceeded surprisingly quickly, according to merger and antitrust experts. But the longer the case drags on, the more it damages investors.
"I think it will be quite a while before the uncertainty is cleared. And uncertainty is always the enemy of the long-term investor," said Stephen Blum, a partner with KPMG who specializes in mergers and acquisitions. "If this drags on, it will not be good for investors."
The clarity and strong language of the decision may speed matters, though. Blum said the issue could be resolved "in a year or two" if the blunt opinion forces the software company into a settlement.
A divided Microsoft would make it easier for investors to manage their portfolios, concentrating on the e-commerce portion of the business if they wanted to. "But I'm looking at the silver lining of a very gray cloud," Blum said.
The AT&T split up created a great deal of price competition that benefited consumers but it lowered the quality of service provided by the companies, Blum said. A similar drop in Microsoft's service if it is forced to split would be likely.
Besides the breakup of AT&T, another similar breakup of a monopoly came in 1911, when the Justice Department forced John Rockefeller's Standard Oil to divide. Because that happened so long ago and the oil industry is so different from the software industry, that precedent is little use in judging how Microsoft might perform, divestiture experts said. More recently, IBM fought off a Justice Department antitrust action in the early '80s.
Forcing Microsoft to divide might be bad for investors in general. The stock market never likes signs of Big Brotherhood from the government. In fact, the AT&T divestiture prompted a 21 percent decline in the stock market over the next six months, Hugh Johnson, chief investment officer for First Albany, pointed out.
When then-President John F. Kennedy confronted U.S. Steel in 1962 and prevented it from raising prices, the turmoil also prompted a decline in stocks in general, which dropped 16 percent in around three months, Johnson said.
Johnson worries that the Microsoft ruling might breathe new life into the government's antitrust division, which could then chose to target the rapid consolidation in the drug industry or take a critical look at financial-industry mergers prompted by the banking-reform bill.
"Does this signal a policy change in Washington?" Johnson wondered. He said he thinks the answer is 'no' but that he will be watching for other antitrust cases or signs that the U.S. Department of Justice is getting more active. "It's a qualitative thing," he said. "You just have to make your own judgment."
He pointed out that penalties such as fines against Microsoft amount to penalties on their shareholders. He also does not like the prospect of Microsoft being forced to split, which he feels would also penalize shareholders "but to a lesser extent," Johnson said.
"Part of what makes Microsoft Microsoft is this synergy between lots of very young and very creative people," he said. Those links would die if the company was forced to divide. "I wouldn't want to see the culture broken up."
Management issues too
Another concern for investors in a split up of the company would be the role of Chairman and CEO Bill Gates. Unlike other monopolies that have been forced to divide, Gates is a central and powerful figure with Microsoft.
If it were forced to split, he would likely be prevented from having significant ownership or management links with all but one of the surviving entities. Without his talents, the divided entities could struggle. As it is, Microsoft will find it hard to attract top talent with the Justice Department case hanging over its head, merger specialists said.
But Johnson, who has around 3 percent of his asset-management portfolio in Microsoft, is keeping the stock and he doesn't think the decision means investors should sell. "I don't believe the damages will be extraordinary." he said. "We don't see a compelling reason to sell the stock."
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