Dueling Fools A Microsoft Duel
Bear Argument

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Dueling Fools
By Rick Aristotle Munarriz (TMF Edible)
October 17, 2001

Define a growth stock.

By any definition, there should be some degree of consistent and pronounced, well, growth. Right? It's an open audition and Microsoft takes the stage. Let's see. The company's earnings per share grew by a scant 5% in fiscal 2001 and is expected to inch up a paltry 3% here in fiscal 2002. Yes, we're just days away from the official launch of Windows XP and a few days further removed from the Xbox debut and we're talking 3% growth. That's inflation's spar partner. That's a bad money market fund. That's not good.

Well, maybe Microsoft is just a growth leader in a sluggish sector. Let's look at the Pollyanna long-term growth rates of Microsoft and its competitors. It's 16% for Microsoft. Who is lower? Oracle (Nasdaq: ORCL)? Siebel (Nasdaq: SEBL)? Veritas (Nasdaq: VRTS)? Nah. Nah. Nah. Gonna have a good time?

We've got the Fat Albert gang rounded up here and guess who is the titular hefty being left behind in the footrace? Or maybe we're talking Mushmouth here, given the company's unintelligibly defiant actions of the past?

Define a value stock.

Maybe I've misread the Graham and Dodd teachings, but I don't think that fetching 40 times earnings or 34 times cash flow would find good ole Benjamin Graham chomping at the bit. I can't imagine that going for 12 times sales or 6 times book value would make the stock any more endearing. 

Define a story stock.

Well, now you're talking. You have a sweet balance sheet and killer margins with Mr. Softy, plus you have two revolutionary product line launches in the weeks ahead. Let's dig in.

By most advance accounts, XP is a beauty. It's the first substantial upgrade to the Washington-based company's operating system since Windows 95. Unfortunately, it looks like it knocked over a few chairs at the antitrust gala along the way. More software application makers and service providers are screaming foul at XP's bullying ways.

But while Microsoft has always pushed around its peers, XP is also receiving some negative press for the way it kicks customers in the shins. Because the operating system takes an imprint of the installed computer's configuration, it is no longer a breeze to upgrade your system's hardware or move your XP copy to a different machine. It's a greedy anti-user stance that is bound to cost the company some upgrades.

The timing of XP's rollout couldn't be much worse. The corporate space that is in no position to even retain human beings is not going to pony up the bucks for an upgrade. The consumer space is also running short on cash, and Microsoft's history of buggy and delayed system launches won't find anyone in a rush to be paying for test balloons.

Then we have the Xbox. Billed as the only video game manufactured in North America (yes, Guadalajara, Mexico, is in fact in North America), it's got a huge uphill battle to win over the diehard gamers. Despite the Americana rhetoric, the last stateside-developed console system was 3DO's (Nasdaq: THDO) namesake system and it crumbled under the Japanese dominant pressure.

The problem here is that the industry has never had room for more than two legitimate contenders at any given time. Sony (NYSE: SNE) has its PlayStation brand well-entrenched as the market leader. It's not going anywhere. That means the public is going to have to vote off either the $199 Nintendo GameCube with its established game character franchises or the $299 upstart Xbox. Where are you going to vote today?

Define a hybrid stock.

If it isn't less filling and it doesn't taste great then it has to be a hybrid, right? Not really. The company just isn't making a dent in either pigeonhole and it's actually better classified as a flat-out unattractive stock. There are risks involved, as over the weekend a federal judge appointed a mediator to the U.S. Justice Department's antitrust case against the software behemoth. It's a lose-lose situation because, unhindered, Microsoft is still only squeezing out low single-digit growth. Shackling financial stagnancy is a moot practice at this point.

But, like I noted earlier, Microsoft has the "I'm not worthy" cash balance and profit margins. As rich as Microsoft is, cash is cash. The fact that the company has over $8 in cash and investments for every share outstanding is really only a valuation issue if and when Microsoft stock gets that low. I don't expect that to happen.

You also have margins, which have already peaked and it's going to get worse. Do you think the Xbox is going to command 86% in gross margins? If so, I'm outsourcing every aspect of my daily living to Guadalajara. 

And, yes, Microsoft has savvy, aggressive management but how well do you know Steve Ballmer? Shareholders, this is your CEO. Do you like what you see?

I like him. Quite a bit, despite my bearish stance, but the company's future is not something I am comfortable banking on at these price levels. From damaging antitrust waves to slow XP acceptance to eventual Xbox failure, if the old Microsoft slogan -- Where Do You Want To Go Today? -- comes up, I know my answer: Not here. 

Rick Aristotle Munarriz has both Microsoft and Apple fueled computers at his home. This Duel was written using Microsoft Word, but, hey, let's not hold that against him. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.

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