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Broken Up, Microsoft Might Be Worth Only $65 a Share

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W hat a difference a week makes.

The Friday before last, it looked like mighty Microsoft was being brought to its knees by the unforgiving, one-sided federal court finding that rendered it a monopolist. But late last week, investors seemed to shrug off the ruling and were infatuated with Microsoft's surprising plan to shack up with Texas-based Tandy Corp.

Of course, the long-term impact on Microsoft probably won't be known for more than a year. Only when Judge Thomas Penfield Jackson prescribes remedies to the case, or the software concern agrees to a settlement with the federal government, will the picture become clearer. Until then, Microsoft shares are likely to trade in a relatively constrained range, fund managers say.

Table: Are the Parts Weaker Than the Whole?

One of the widely accepted explanations for the stock's resiliency is that Microsoft shareholders think they will make out just fine, thank you, even if the company gets busted up into a bunch of Baby Bills.

Microsoft fans contend that history is on their side. The conventional wisdom is that Microsoft's parts, once they are divested, would be worth more as separate operating companies than they are as a single corporation. This conclusion is based on precedents established in the landmark break-ups of Standard Oil and AT&T.

But at least one long-time observer of Microsoft is saying: "not so fast."

"This is not Standard Oil of Ohio, where there are underlying assets stored in the ground," says David Readerman, a sell-side analyst at Thomas Weisel Partners in San Francisco.

"The pieces are worth less than the whole," says Readerman, who has been following Microsoft since before it went public in 1986.

In his break-up analysis of Microsoft, Readerman concludes that the sum of the company's three major operations add up to a combined value of only $355 billion, which is roughly 31% lower than the company's current market capitalization of $517 billion based on 5.8 billion shares at Friday's close.

Readerman divided Microsoft into three primary business segments: Windows-related operations, which includes the company's controversial Internet Explorer Web browser; development and applications, which consists largely of the company's Office software products; and its Internet business, which includes WebTV and MSN.com.

The reason Readerman included the browser business in the Windows-related segment, as opposed to the Internet business, is because Microsoft bundled the two products together, arguing that they were inseparable. Of course, Judge Jackson didn't see it that way, ruling that Windows and Explorer are two independent products, which is why we are talking about a break-up in the first place.

Here's Readerman's breakdown: Using a median average industry multiple of 5.3 times estimated revenues for 2000, Readerman valued Microsoft's Windows related business at $57.04 billion. Using the same forward revenue multiple, he valued the applications business at $54.83 billion. Lastly, he pegged Microsoft's Internet businesses at about $243 billion based on an industry median average multiple of 60.5 times revenues.

After $18.9 billion in cash and $4.13 billion in deferred revenue are added back, his total estimated value of the company rises to $377.9 billion, or about $65 a share. That's about 27% lower than Friday's close of 89 3/16.

"Microsoft already has the highest market value of any company. Breaking it up will just destroy shareholder value," Readerman argues.

That's not to say that he thinks a break-up is in the cards. Readerman actually is betting against a court-ordered divestiture. Nor does he think Microsoft will agree to one in a settlement.

After the initial jolt, investors seem relatively nonchalant about Judge Jackson's findings. As one might suspect, Microsoft shares got knocked down several points in the immediate wake of the ruling. But by the end of trading on the following Monday, the first full session following the news, the software behemoth's shares rebounded strongly to regain much of its ruling-spurred losses.

What's more, by the middle of last week, it was seemingly business as usual in Redmond, Washington. Microsoft chief executive Bill Gates took time to talk about his personal fortune on CBS' weekday edition of "60 Minutes." Meantime, the company's online travel service, Expedia, took advantage of the super-charged IPO market by raising $73 million in a spin out (See "Offerings in the Offering" ). And this Monday, Microsoft employees should be further distracted by a scheduled visit by Vice President Al Gore. The fact that his employer is the one suing Microsoft might not be totally lost on everyone in Redmond, however.

Yet, it was last Thursday when Microsoft truly managed to deflect attention away from its antitrust woes. It grabbed headlines by announcing plans to invest $100 million in Tandy's RadioShack.com Website, which will get choice real estate on Microsoft's MSN.com Internet portal. Under the deal, Microsoft also will set up kiosks inside most of Radio Shack's 7,000 stores during the third quarter of next year. Microsoft says it hopes the partnership will make its Internet products, such as WebTV, more readily available to new computer users.

Microsoft President Steve Ballmer says that his company's "store within a store" at Radio Shack would eventually offer walk-in customers various options for Internet access, including digital-subscriber lines (DSL), high-speed cable modems, wireless devices and satellite transmissions -- all presumably geared toward linking users with Microsoft's MSN.com Web portal.

If the deal delivers on its promise, "it would go a long way toward catalyzing Microsoft's shift from the desktop to the Internet," says Chris Shilakes, an analyst at Merrill Lynch in San Francisco.

Needless to say, by the time Microsoft unveiled its sexy Web deal with Tandy, investors were no longer thinking about the antitrust case, Weisel's Readerman surmised.

But as the case continues to drag on, Wall Street should still monitor Microsoft closely, he says. Because of his belief that the break-up value of Microsoft is weaker than its current valuation, Readerman predicts that new flows of money into mutual funds will get steered away from Microsoft until the consequences from the ruling bear out.

"It is going to be difficult for analysts and portfolio managers to go before their committees and explain why new funds should be invested in Microsoft when there is all of this risk," Readerman says.

I n the next week, Oracle chief executive Larry Ellison will be everywhere, or so it may seem.

Oracle has been on an investor-relations and marketing rampage lately, attempting to convince Wall Street and corporate America that it is a 'Net play. And next Tuesday, Oracle is holding a seven-hour analysts' meeting in Los Angeles, where it's apt to beat the same drum.

While such briefings are standard operating procedure, it's the first time that Oracle has invited the financial press to attend such an event. The program, which is tied to the company's annual client confab, is slated to include questions and answers with Ellison.

Obviously, there shouldn't be any downside surprises unloaded if the fourth estate has been invited in to the tent. The stock has had quite a run from its April low in the mid-20s, jumping nearly 5% Friday to 65 1/16.

To be sure, Ellison isn't shy about the resurgence. Tuesday's dog-and-pony show is one of many Oracle has been holding lately. The company flogged its new relationship with data storage titan EMC at a news conference recently in San Francisco, and Chief Financial Officer Jeff Henley hyped the company's Web strategy at last week's American Electronics Association tech conference in San Diego.

Oracle handlers insist that there will be more meat on the bone at next Tuesday's briefing, including demonstrations and explanations of the company's new Internet-related offerings. And next Thursday, its annual meeting will also take place in Northern California. And if that isn't enough, Oracle will be launching a $100 million television advertising campaign to compete with IBM's ubiquitous marketing presence on the tube.