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Smooth Operator

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

Of course, the results of Microsoft’s business segments would become abundantly clear if its biggest antitrust fear came true. In the widely anticipated worst-case scenario, the company would be broken up along the lines of its various product segments. Yet analysts say that might not be so awful, simply because they could add back the pieces for purposes of valuation. And the sum of the disparate parts may even be greater than the whole if separation unlocks any value now hidden.

Few observers expect Judge Thomas Penfield Jackson to go so far as to break up the company. Some expect the court instead to require Microsoft to make the source code for its operating system available to outside software developers. The spokeswoman would not comment on that observation but did say that Microsoft was open to a settlement if it could continue to add new features into its operating system. But so far, she says, the government has refused to accept that possibility.

At any rate, a decision in the antitrust case isn’t expected to be made until year’s end, at the earliest. Any judgment that imposes stiff penalties on Microsoft will no doubt be appealed to the highest courts–a process that could take an additional two years or more.

One thing seems clear: Greg Maffei may well be a CEO somewhere by the time the antitrust battle is over.

The Dark Side of Deferral

Does Microsoft Understate Its Growth?

Microsoft’s argument that it isn’t a monopoly would only be helped by the impression that its revenue growth is slowing. But a big part of the slowdown may simply reflect a change in the way the company recognizes revenue.

A growing portion of Microsoft’s revenue isn’t recognized when payment is received, but is deferred instead. As of last March 31, the company had almost $4.2 billion in “unearned” revenue as a liability on its balance sheet, compared with $2.9 billion on June 30, 1998. Without such deferrals, Microsoft’s revenue growth would have remained above 30 percent in fiscal 1998.

Granted, the practice of deferring revenue in this fashion is required under generally accepted accounting principles to the extent that software contracts call for the manufacturer to supply product support and unspecified upgrades at no additional charge. And Microsoft insists that it hasn’t changed its revenue-recognition practices. Instead, it says the growing amount of its deferred revenue reflects the fact that its sales are increasingly contingent on product support and upgrades.

The company explains that it defers approximately 10 percent to 25 percent of its revenue from selling Windows to PC makers and other original equipment manufacturers, its main sales channel; that it expects to recognize this revenue over roughly three years; and that it will defer the same amount of Office 97 revenue, recognizing it over an 18-month period.

With the total amount of deferred revenue on its balance sheet now equal to roughly 80 cents a share (on an undiluted basis), or almost two quarters’ worth of current earnings, analysts now pay as much attention to this liability as to earnings. And they draw comfort from seeing the amount of the liability grow. “We believe the company’s core earnings power is higher than printed and is held back, in part, by the company’s aggressive revenue-deferral efforts,” noted Mary Meeker, an analyst for Morgan Stanley Dean Witter, in a recent report.


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