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June 01, 1998 01:00 AM

MICROSOFT SHOWS BATTLE SCARS: INVESTORS SAY COURT FIGHT TAKING ITS TOLL

Steve Hemmerick
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    Some money managers are questioning whether the Justice Department already has seriously wounded Microsoft Corp.

    In its lawsuit, the Justice Department accuses Microsoft of anti-competitive practices in a war with Netscape Corp. for dominance of the Internet browser market.

    Portfolio managers aren't using judgmental words like "anti-competitive." But some of them think Microsoft has used its "leverage" of a virtual monopoly in operating systems to dominate others, and they question whether the leverage might be gone or seriously weakened. If it is gone, the market value of Microsoft as a $200 billion company could be eroded, and the entire software industry could be changed.

    Microsoft was selling at 865/16 May 28, below its high of 991/8 April 22.

    Maynard "Brandy" Brandon, an equity analyst with Eaton Vance Management, Boston, said the software industry would find "a much more level playing field" with Microsoft's ability to "leverage themselves curbed."

    Mr. Brandon said he's "wrestling" over the issue of how much Microsoft has been affected by the suit and whether Microsoft stock is fairly priced.

    At the end of March, Eaton Vance had 153,400 shares of Microsoft, according to CDA/Spectrum institutional stock holdings survey.

    "I don't think it (Microsoft) can sustain those growth rates without having a major new market like the Internet," said David Dreman, chief investment officer for Dreman Value Management LLC, Red Bank, N.J. Through May 20, Microsoft has had annualized earnings for five years of 48.77%.

    And Mr. Dreman believes Microsoft, as a result of the Justice Department suit, might have lost its ability to dominate the Internet market. Microsoft is about to launch sales of Windows 98, its updated operating system. But Mr. Dreman doesn't see that as a huge growth area for Microsoft.

    Experts think Windows 98 is a mediocre update to Windows 95. Most users of Windows 95 already have a browser on their system.

    But Microsoft officials see Windows 98 as crucial in establishing their right in making a browser part of their operating system, and introducing new users to Microsoft's browser, Internet Explorer.

    Some computer companies already have announced they intend to change the opening screen of Microsoft's Windows operating system. That opening screen is considered important in Microsoft's link to the Internet.

    According to software experts, a dominant maker of browsers can, to a significant degree, control Internet traffic.

    They also expect the Internet to be a huge growth area as connection speeds to the Internet increase and new technology finds new uses for the Internet.

    It is that domination of the Internet through a browser that some portfolio managers think Microsoft needs.

    But Mr. Dreman thinks Microsoft might already have lost the war for Internet domination. Mr. Dreman describes Microsoft's current situation as "almost do or die here," a situation where Microsoft can't win.

    Mr. Brandon agrees, saying "a line in the sand clearly has been drawn," with "strong implications going forward."

    "Once the government starts these (anti-trust) cases, it doesn't stop," said Mr. Dreman. Even if Microsoft reaches a compromise with the government on the browser war, the government is going to "continue to look over Microsoft's shoulder," he predicted.

    When IBM Corp. found itself in a somewhat similar antitrust case, it never was the same company, said Mr. Dreman. A value manager, Mr. Dreman said he wouldn't buy Microsoft stock. At the end of March, Dreman Value didn't hold any Microsoft shares. In comparison, the firm held 10,000 shares at the end of 1997, according to CDA.

    Whether Microsoft has lost its leverage "is the critical question," said David Siphron, chief investment officer for Siphron Capital Management, Beverly Hills, Calif. Mr. Siphron said he is in the "middle of examining that very question." He said he wouldn't be able to comment on his conclusion for several days. According to CDA, his firm held 304,500 of Microsoft at the end of March.

    Walter Zagrobski, a senior vice president and portfolio manager with Appleton Partners Inc., Boston, takes a different view.

    If Microsoft loses its case with the Justice Department, "it would be a blow to the stock" -- at least "a little bit," he said.

    But, Mr. Zagrobski thinks the media blitz over the Justice Department suing Microsoft is heightening interest in Windows 98.

    Overall, Mr. Zagrobski think the Justice Department suit offers Microsoft "better upside from this whole thing than downside." At the end of March, Appleton Partners had 40,450 shares of Microsoft stock, according to CDA.

    William H. Gates, Microsoft's chairman, claims Microsoft isn't guilty of anti-competitive practices. He says Microsoft is only being punished for smart business practices and hard work.

    But Microsoft might have to convince pension funds, too.

    CALPERS TAKES A LOOK

    The activist California Public Employees' Retirement System, Sacramento, has the Microsoft issue scheduled for discussion at its next session in mid-June.

    Charles Valdes, chief investment officer for CalPERS, said of Microsoft: There "has to be some negotiation -- or the court has to look at it. There is a monopoly, I don't think that is fair."

    At the end of March, CalPERS had 13.9 million shares of Microsoft, according to CDA.

    Pension funds like CalPERS have Microsoft stock in their portfolios, particularly indexed portfolios. But California also has Silicon Valley to protect, a giant software development area near San Jose, Calif.

    According to money managers, stocks of several others companies would have prospered if Microsoft didn't have the leverage it does.

    One of the California-based stocks is Netscape, Mountain View, Calif., whose corporate officials have been complaining loudly about Microsoft.

    California is also one of the 20 states suing Microsoft. Dan Lungren, a candidate for California governor and California's current attorney general, filed the suit.

    Although CalPERS has some elected members, the majority of the board is appointed by the state's top elected officials, including the governor.

    "I think (this) might be more of an investment issue than a technology issue as to what happens to these companies if they get hung up in lawsuits for a long period of time and people hold off buying PCs until it is resolved," said Bill Imhof, a practicing director of the Alliance of Fiduciary Consultants, a financial consultant.

    He said there is pent-up demand for Windows 98, partly because of compliance issues with the European Monetary Union and the Year 2000 bug.

    Microsoft's current problems aren't creating an impact at BARRA Inc., Berkeley, Calif., a maker of analytical and risk management software, said Paul Green, vice president.

    But, he said, because Microsoft is an industry giant, BARRA has an easier time designing integrated software than it would if the software industry were fragmented.

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