Money managers would place their bets on a Microsoft applications company if a court-ordered breakup of Microsoft Corp. actually happens.
"With the applications company, which has to do with the Internet, there is potential to take market share from others or to create a new product that would dominate. A good possibility is a videoconferencing product that could dominate its market," said Brian Bruce, director of global assets at PanAgora Asset Management, Boston.
Microsoft, Redmond, Wash., already has the dominant market position in the operating system market, said Mr. Bruce, whose firm owns 2.64 million shares of Microsoft.
But there's a long legal road -- estimated at between one and two years -- to go before Judge Thomas Penfield Jackson's June 7 ruling could be implemented.
In fact, some observers doubt whether the ruling will remain intact. And Justice Department officials already are saying they would welcome an out-of-court settlement.
John Dale, senior vice president and portfolio manager at Peregrine Capital Management, a Minneapolis-based unit of Wells Fargo & Co. with 3.5 million shares of Microsoft stock, said the ruling is unlikely to stand. Microsoft officials should not kowtow to the government, Mr. Dale said.
"We don't want them to jump through government hoops. We don't want them to lose people," Mr. Dale said. "We want them to fight this thing with everything they've got."
Rob Joseph, vice president at State Street Research & Management Co., Boston, expects Microsoft to win most points on appeal. He said legal sources believe there's only a 5% chance of the case going directly to the U.S. Supreme Court, as government lawyers have requested. And he thinks the proposed remedy is too severe.
The stronger entity
Still, if the ruling is upheld and the company is split in two, managers believe the applications company -- which would include Microsoft's Office and Internet products -- would be the stronger entity.
"If you've got the operating system business totally boxed in, which is what the judge (favors), it just doesn't sound like a very dynamic business," said George Gilbert, senior vice president and co-portfolio manager of the Northern Technology Fund at The Northern Trust Co., Chicago. Northern Trust held 30 million shares of Microsoft stock as of March 31, according to Thomson Financial Securities Data.
Tony Ursillo, an equity analyst specializing in technology at Loomis, Sayles & Co., Boston, which owned 1.6 million shares of Microsoft as of March 31, said the applications company would offer greater potential.
"Microsoft has strong server products such as its Messenger software, but it's only run on Windows 2000. They don't offer it to Unix or Linux operating systems," Mr. Ursillo said.
"If the applications company was independent, it would have a strong incentive to offer (the products) to other operating systems. Now Microsoft gives away a lot of products. If the applications were in a separate entity, that would change and increase opportunities," he added.
But there's a dark side to the applications business, some managers believe. While software applications offer more growth potential, Microsoft faces greater competition in that area.
"As things become more and more net-based, Microsoft's strength in that market is not as great" as it is in the personal computer market, said Mark Williams, director of research, Invista Capital Management Inc., Des Moines, Iowa. The firm, a unit of the Principal Financial Group, had slightly more than 5 million shares of Microsoft stock at the end of May.
Indeed, some managers shed some Microsoft shares prior to the court ruling because of threats to the company's existing lines of business.
Wendy Barker, portfolio manager of the $1.6 billion TCW Galileo Growth Fund in Los Angeles, said she reduced her Microsoft holdings -- one of her top three positions -- by half in December. Ms. Barker declined to say how much the fund owns now. TCW Group as a whole had 4.3 million shares as of March 31, according to Thomson.
Ms. Barker said Microsoft is under attack in both the software and operating sides of its historically strong base of business.
Given away on the web
For example, she said, "a lot of traditional desktop software is now being given away on the Internet" such as e-mail and word processing programs. Such programs "are not as sophisticated as those in Microsoft Office, but . . . the Internet model is increasingly going to be the trend," she said.
Microsoft also is "under attack" on the operating system side of its business by the increasingly popular Linux operating system, Ms. Barker said.
Jim Chen, portfolio manager at Roger Engemann & Associates, Pasadena, Calif., said his firm reduced its holdings in Microsoft starting late last year. Mr. Chen didn't know how much had been sold, but Thomson data show the firm reduced holdings by nearly 30% in the first quarter, holding 5.4 million shares as of March 31.
The company's prospects still are "heavily tied toward the growth of PCs, anyway you slice and dice. They talk a lot about their Internet initiative. But their core revenues derived from the PC market are just too large, and it's going to take a while to transition," he said.
The question remains whether Microsoft is a buy or a sell.
Northern Trust's Mr. Gilbert believes a divided Microsoft would be worth less than the whole. He said the value of a split Microsoft would be roughly $55 to $65 a share, or perhaps a bit higher. (The stock closed at 68 13/16 on June 8, down 1 11/16 from the previous day's close.)
Mr. Gilbert cited four reasons the value of the two companies would be lower:
* Microsoft already would have split the company in two if management thought it would make sense financially.
* The operating systems' company would be highly regulated, giving it less flexibility in making technological innovations.
* Overhead costs would be duplicated.
* Each company's growth rate would be more volatile than that of the single entity, increasing risk for investors.
Citing similar factors, Goldman, Sachs & Co., New York, estimated that Microsoft would lose 10% of its share price in a breakup.
However, David Soetebier, senior technology analyst at Banc of America, San Francisco, is upbeat about Microsoft's prospects.
"The customers will still buy, even if the company is split up," he said. "They'll go to two places instead of one if they have to, because it's too expensive to start retraining people on a new system. Besides, consumers buy what they know."
Others think the stock remains attractive. Peregrine's Mr. Dale said Microsoft's price-to-earnings ratio is justified at the current level. "It's very attractively priced right now as a single entity," he said.
And Loomis, Sayles' Mr. Ursillo said he thinks $100 a share is a more realistic price for the company, whether it remains intact or is broken up.
Some might do some bargain-hunting if the price continues to fall.
Herb Dyer, executive director of The State Teachers Retirement System of Ohio, Columbus, said the system may boost its holdings. In recent weeks, it has been adding to the 10.2 million-share stake it owned as of May 31.
"We will continue to hold it and would add to it if the prices goes down to $60 a share," he said.