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Mathew Ingram

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Being Microsoft

Mathew Ingram

TORONTO (GlobeinvestorGOLD)—It's not easy being Microsoft.

The largest maker of software for personal computers and the second-most valuable company by market cap may also be the world's largest corporate punching bag. But that's not the most important thing to consider when looking at the stock, since it tends to recover after each blow it takes from regulators, competitors and other critics.

Microsoft's big problem is that it's getting harder for the company to get any bigger—the so-called "law of large numbers" is taking hold. And in a sense, old age is slowing it down.Microsoft over three years

Last year, Microsoft overcame one of the biggest obstacles in its long tenure at the top of the computer software heap: the mammoth anti-trust investigation launched by the U.S. Department of Justice. The suit alleged that Microsoft had used its illegal monopoly in operating systems to oppress its competitors, including Netscape Communications (now part of AOL Time Warner).

Although the company was found guilty, the decision was later watered down on appeal, and instead of being forced to break itself up the company agreed to a number of changes in its behaviour.

Perhaps worn out by the fight, Microsoft co-founder and CEO Bill Gates decided to step down and become chairman, giving the position of chief executive to his right-hand man, Steve Ballmer. Although he is a volatile and high-energy man known for his passionate speeches, Mr. Ballmer has helped make Microsoft a more easy-going company in many ways. Instead of picking fights, the company seems to try harder to reach a compromise—although it is still competing head-on with a host of competitors, including free software standard Linux and AOL's on-line division.

Never say never

Among the changes that have taken place at Microsoft are two developments that Mr. Ballmer and Mr. Gates earlier said would never occur—namely, the introduction of a common-share dividend and the expensing of stock options. The dividend, which many investors have been lobbying for given Microsoft's massive $40-billion (U.S.) cash hoard, may have been spurred by the U.S. government's move to eliminate the tax on corporate payouts. The stock option change was likely driven by the relentless pressure from shareholder advocates and institutional investors.

Interestingly enough, dividends and options expensing are relatively commonplace at older, more established corporations, while fast-growing technology players have in the past rejected both as either unimportant or an impediment to growth. Are the changes at Microsoft a signal that the company is no longer a cheetah but more of an elephant? Perhaps.

Obviously, the software giant is no Wal-Mart just yet—its profit margins are still massive (90 per cent in the case of Windows), and the cash flow it generates is staggering, while the dividend it pays (12 per cent of which goes to Mr. Gates) is hardly enough to eat into the amount of cash it has.

At the same time, however, Microsoft is having to do more and more just to keep its revenue and profit growing; like the Red Queen in Alice in Wonderland, it is having to run as fast as it can just to stay in the same place. Its Windows operating system faces increasing competition from Linux; its MSN on-line service faces stiff competition from AOL; its Xbox game console has cost billions and is still far short of leader Sony, and new ventures such as its much-hyped operating system for mobile phones have had little success. Windows and the Office software suite continue to be huge revenue generators, but they are both growing long in the tooth.

Not so cheap

Meanwhile, Microsoft's stock is far from cheap—although bullish analysts make the case that the software giant's shares are never cheap, and that based on historical multiples they are at the lower end of their traditional range. Still, the stock trades for close to 30 times earnings and more than 8.5 times its sales. The only large-cap tech stock with higher multiples is on-line auctioneer eBay, which has a P/E multiple of 93 and trades for 19 times sales—but its revenue has grown by more than 50 per cent for the past two years, while its profit has risen by more than 100 per cent. Microsoft's revenue and profit growth have slipped to the 10-per-cent range.

It's not easy being Microsoft, alright—and it isn't getting any easier.

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

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