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Smooth Operator

Behind every news-making Microsoft deal stands its soft-spoken, hard-bargaining CFO.

Indeed, Microsoft hopes they will eventually produce an entirely new business model for the company–one no longer dependent on one-time sales of licenses, but instead on rental contracts that produce an ongoing stream of revenue. Likening such a model to that of companies that offer cell phones or cable TV service, analyst Hensel says that Microsoft would eventually like “to get a cut every time” its software is used. And he says the company’s E-commerce business in particular lends itself to such a model.

“Our business model is clearly changing,” confirms Maffei. And as the CFO sees it, more and more of Microsoft’s business will eventually produce “an annuity-like revenue stream.”

How would that happen? Maffei explains that commercial software is starting to become “embedded in services” and “highly aligned” with communications capabilities–so much so that the business and the technology are inseparable. “Is AOL [America Online] a software company?” he asks. “Sure. Is Amazon.com a software company? Is Ebay? Software is a very important element of what they do. So I think you’ll see us continue to be looking for all sorts of partnerships.”

These deals will help produce a fee-based business model in both direct and indirect ways. Deals such as the one with AT&T will help develop the infrastructure for Internet services, thereby supporting other deals in which Microsoft either offers such services itself or provides the software for other service providers. In either type of arrangement, the company expects to get a cut of whatever advertising or transaction revenue the services generate. As for the software itself, “It’s a loss leader,” says Hensel.

And to the extent that such a model would produce a steadier revenue stream and less volatile earnings, Maffei says Microsoft’s stock multiple and price might begin rising again. (For the most part, the stock has been going sideways since last April.) What’s more, the new model might allay analysts’ and SEC concerns about Microsoft’s accounting. To create such a model, “Greg’s challenge is to put into place the right assets,” says WebTV’s Pimentel, who has no doubts Maffei is capable of doing that.

Long before the deal with AT&T, Microsoft began investing in a host of content-oriented Internet properties, including the MSNBC news site, Hotmail E-mail service, Expedia (travel services), and CarPoint (car shopping). Its more-recent forays have stressed the underlying technology that helps distribute such services, including stakes in several European cable TV companies as well as in AT&T and Nextel Communications Inc. All told, Thomas Hensel projects Microsoft’s Internet business to account for 10 to 15 percent of Microsoft’s revenue next year, and the Wall Street firm of Warburg Dillon Read estimates the business is currently worth about $50 billion.

Granted, “Microsoft has more money than time” to get all the necessary assets into place, according to Esther Schreiber, a former analyst for CS First Boston. But Maffei isn’t prepared to overpay for them. His poker- playing skills may have been reflected in the AT&T deal, observes another analyst, since it preceded a flurry of subsequent transactions, including a $600 million investment in Nextel and the $127.5 million acquisition of Swedish Internet software maker Sendit A B. (Talks are also reportedly under way for stakes in the cable TV operations of Cable & Wireless and Deutsche Telekom AG.) This analyst, who asked not to be identified, suggests that Maffei may have held off on some of these subsequent transactions until he had closed the AT&T deal, for fear of “showing his hand” to AT&T–which thus would have been able to negotiate a higher price.

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