Softie Battles Back

With the Nasdaq booking its first “four-in-a-row” of positive
closes in more than seven months, tech investors breathed a sigh of relief that
maybe, just maybe, the tech gloom might be starting to lift. The 14% Nasdaq
bounce this week was a start, but the average is still off 20% year-to-date and
62% off its March 2000 peak. After so many letdowns since last year, any rally
remains suspect. What caught my eye this week, though, was the continued
strength in Microsoft which is up 43% year-to-date.

While the one-year anniversary of the March 2000 peak has passed, thinking
about Microsoft reminded me that another monumental anniversary passed on April
3. I draw attention to it because I think it played a very significant role in
the Nasdaq meltdown that occurred over the last year. It is, of course, the day
Judge Penfield Jackson ruled against Microsoft and ordered the break-up of the
software giant. Whether you are a fan of Microsoft or if you side with the
government’s view of Microsoft as a brutally competitive monopoly, you can’t
help but notice the correlation between Microsoft’s court loss and the
subsequent collapse in tech stocks.

The old saying of “as goes
General Motors so goes the country” used to mean that GM was such an integral
part of the U.S. economy that GM’s future as a business was paramount for
prosperity in the country. I think that today Microsoft is in a similar role to
GM’s. Historians will debate the assault on Microsoft for decades, but critics
of the government action wonder why the government would go after one of the
most successful companies of all time. Think of it; they sought to break apart
the biggest market-cap company at the peak of a technology-led economic boom.
Unemployment was at 30-year lows, productivity had soared, and inflation was
under control. So why target the lead dog that helped get us to that point?
Well, politics played a role as did lobbying by Microsoft rivals.

The government claimed consumers
were being hurt by Microsoft’s anti-competitive behavior and that innovation was
being stifled. This is the part that I can’t figure out. In a monopoly, the
monopolist has control over the supply of a product and can raise prices and
gouge consumers. Software prices fall year after year, and with regard to
Microsoft’s browser question, it was given away for free. The fact the case is
arguing about actions taken by Microsoft in the early to mid-nineties also makes
the case seem even more irrelevant.

But what happened to Microsoft on
April 3 of last year briefly changed the rules for tech investing, and I think
it helped give a little extra shove to the downside. The way the market reacted
to Microsoft seemed to suddenly say that any tech powerhouse that had 70%, 80%
or 90% market share might be vulnerable to antitrust action. That meant that
suddenly arguments could be made that Intel, Cisco, or Qualcomm might ultimately
face the same fate as Microsoft. Did this help cause the tech collapse? The
market was extremely overdone to the upside and due for a drop, but I really
think the Microsoft ruling dramatically increased the negative sentiment and fear levels in tech. In sympathy with Microsoft, the Nasdaq fell more than 7% the day of the ruling, and I don’t think that was any coincidence.

So the new rules suggested that any
up-and-coming potential giant could possibly meet the same fate if, and that is
a big if, they succeeded. So what purpose is there in risking capital to own
“the next Microsoft” if eventually trust-busting attorneys would lie
in wait at the end of the road. This is a simple explanation, and the facts of
the Microsoft trial did point toward a very aggressive company, but I think the
Microsoft ruling really spooked technology into a more painful decline than
would have happened if there had been a settlement. Technology companies often
follow a similar pattern where hundreds of competitors in a market get narrowed down to a few niche leaders that are
then followed by the emergence a single tech winner.

The dominance of one leader occurs
as the result of increasing rates of return on a product. Increasing rates of
return occur because technologies ultimately gravitate toward an industry
standard and a lower cost of ownership to the user. This occurs when one player
begins to dominate the market for a particular product, and that product then
becomes the standard. Prices continue to fall (because replicating a copy of
Windows is essentially free), and everyone benefits. (Except for Microsoft
competitors like Sun or Oracle.)

In the case against
Microsoft, the Government said it would not allow an increasing returns winner
to dominate, and they attempted to prove that Microsoft used unfair monopoly
powers to stifle competition and, in turn, stop innovation. The case had
far-reaching implications for technology investors because it turned the risk/reward scenario upside down. It also clearly showed that tech companies could
lobby the government for help in battling competitors. It’s no coincidence that
one of Bill Clinton’s first $100,000 speeches took place at an Oracle employee
gathering, since Oracle was one of the head cheerleaders for the government
action against Microsoft.

But a funny thing has
happened on the road to the Court of Appeals. Actions and statements by Judge
Jackson suggest an unfair bias against Microsoft by the judge, who compared Bill
Gates to Napoleon and said repeatedly that he thought Microsoft execs acted
childishly. Add to that the fact that the Bush Administration will likely be
much less active in terms of antitrust activity, and you can make a pretty good
case for having the case settled or overturned. The latest buzz on the case
seems to be leaning in Microsoft’s favor, and by the looks of Microsoft’s chart,
things are looking up for the Redmond-based giant.

After trading as low
as 40.25 on Dec. 21, Microsoft rallied back through February before building a
two-month base. The stock refused to collapse with the rest of tech and hovered
around its 50-day moving average as it built the base. Microsoft recaptured it
50-day on Apr. 10 on heavier-than-average volume and then built on that gain on
Apr. 11, also on heavy volume. Thursday action saw a gain of 2.14 to 62.18 to
put Microsoft right at its closely watched 200-day moving average. Next week will be key for Microsoft since it has
not been able to move back above its 200-day in more than a year. A high volume increase and close above the 200-day might be the sign the institutions need before they give a green light to Microsoft.

How ironic that the
demonized software king has been quietly emerging as a potential leader that
could bring some positives to an otherwise decimated Nasdaq. What is also
helping Microsoft is the fact that it is now showing up on value managers’
screens as well as those of growth managers. With a current PE of 34, it is
relatively cheap, and with its recent action and 43% year-to-date gain, Bill
Gates’ company might be worth keeping on the radar. A favorable court ruling
would just be icing on the cake for the resurgence of this once hard-charging tech monster.

a great weekend,


Kaltbaum on TradingMarketsWorld!
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