Investors reacted calmly to Microsoft’s Wednesday announcement that it would use its mammoth cash hoard to double its dividend, buy back $30 billion in company stock, and pay a special one-time $3-per-share dividend in December. Microsoft—which owns Slate and thus supplies a significant chunk of my income—saw its stock rise less than 2 percent on the news.
Microsoft hasn’t inspired its stockholders for years. For more than a decade after the company went public in 1986, Microsoft was the ur-growth stock. It paid no dividends, and shareholders were happy to take their returns in the form of massive capital gains. But in the past five years, Microsoft isn’t just down, it has underperformed both the Nasdaq Composite Index and the S&P 500. It no longer resembles a classic growth stock like eBay or Dell. Yet it’s not quite a value stock either—it trades at 22.5 times 2004 estimated earnings, compared with about 17 for the S&P 500. So what is it?
At the risk of biting the hand that feeds me: Microsoft looks a little something like—gulp!—AT&T in the early 1980s. It is a lumbering giant, viewed with suspicion by consumers, rivals, and the government. While its core near-monopoly business throws off cash as ever, the beast remains hamstrung by its size, its legacy of enormous profitability, and its market position.
Of course there are significant differences between Ma Bell and Mr. Softee. Microsoft faces competition in its core operating system business from Apple and Linux, while AT&T monopolized the local telephone service market entirely and faced only marginal competitors in the long-distance sector. Unlike AT&T, Microsoft survived its long-running anti-trust battle with the government.
But like Ma Bell was, Microsoft is too big and too rich for its own good. Microsoft piles up cash the way snow collects in Buffalo each winter. Aggressive, rapidly growing companies can put free cash to work by buying other companies. But Microsoft today can’t make truly transformative acquisitions. Few software or technology companies are large enough to make an immediate impact on Microsoft’s bottom line. And approaching any of the biggies—Oracle, German software firm SAP, or a service company like IBM—would surely raise hackles in the industry and set off alarms in the Justice Department. Microsoft’s aborted merger talks with SAP earlier this year are evidence of its constrained position.
Like AT&T, Microsoft is running out of room to grow its main business. Microsoft’s bread-and-butter is selling operating systems and software to personal computer makers. But since it holds a near-monopoly position in the mature PC market, the potential for further growth in these areas isn’t great. In recent years, Microsoft has used some of its cash to diversify. The company now breaks down seven lines of business, which include Mobile and Embedded Devices (Pocket PCs); MSN (e-mail and content services, of which Slate is a tiny part); and Home and Entertainment (Xbox). But Microsoft’s most recent quarterly report shows that in the nine months ended March 31, 2004, the three core operating system and software divisions accounted for about 80 percent of revenues and essentially all the operating profits. Perversely, there’s a degree to which diversification works against the company. Microsoft’s margins are so high in its core businesses that its less profitable sectors lower its overall margins.
With comparatively little to gain in new realms, with a great deal to lose in its established lines of business, and with a constant flood of lawsuits to contend with, the company has perhaps inevitably become somewhat risk-averse. It clamps down on costs and spends a great deal of energy lobbying and fending off lawsuits. For the American public, Microsoft finds itself in much the same role AT&T found itself in the early ‘80s. Its service is a great enabler of commerce and personal communication. It enjoys universal name recognition and near-complete market penetration. And yet it is not beloved. Customers know it doesn’t always provide the best value or the best product; they often use it because they have no other choice. On the other hand, the company generates cash reliably. Its stock, not particularly volatile, pays a steady dividend. It’s a widows-and-orphans stock, the sort of equity that can be reliably placed in 401(k)s, in trust funds, and in the most conservative portfolios.
Twenty years ago, the federal government helped AT&T shareholders and customers by successfully prosecuting it for antitrust violations. The 1984 breakup spurred innovation, competition, and growth. Microsoft, which has been more effective than AT&T in litigating and lobbying, beat back its antitrust challenge. Its shareholders will need to find a different salvation.
