A Window into Microsoft...

06/17/2005 12:00 am EST

Focus:

Mark Mowrey

Senior Analyst, Al Frank Asset Management

Although the team at the Al Frank funds is best known for their focus on value situations that are often away from Wall Street's radar screen, Mark Mowrey turns to Microsoft as his latest "Stock of the Week." Here, he looks at its growing role in new technologies.

"The core of our faith in the long-term story at Microsoft (MSFT NASDAQ) is the fact that despite gads of critics, hordes of competitors, and even not-so-occasional product-related issues, the firm continues to soldier on, leading the great majority of tech companies in flexibility, innovation, and earnings growth. We'd even argue that its latest products nod to their competition in both design and functionality, suggesting they're now more willing to learn from others even as it innovates from the inside. That subtle shift, we believe, means Microsoft will likely continue to grow in not-so-obvious ways, despite increased inroads into its operating system (OS) turf.

"Though OS and Office productivity software sales made up the majority of revenue in the fiscal third quarter, other divisions saw much faster top-line growth. Its server systems is where the company keeps its Exchange products, from which we expect big things in terms of next-generation corporate messaging, including the eventual integration of Voice-over-Internet Protocol technologies into the desktop. Microsoft is also focusing on combined electronic messaging and telephony in a mobile context with its Windows Mobile OS. We think that the company will be a long-term winner in mobile as its products should allow itinerant workers to most efficiently access corporate data and communications systems.

"The area of greatest interest in the near-term is the Home and Entertainment division, the maker of the Xbox gaming console and Microsoft TV. It has unveiled the next generation Xbox 360. In addition to gaming features, the new device will incorporate music and video streaming capabilities, photo storage and wireless connectivity. The firm's best-of-breed online gaming service, Xbox Live, was a key contributor to top-line momentum, and remains a fine example of how Microsoft can exceed competitive offerings by great leaps. Microsoft's work in TV is also gaining credibility, as both Verizon and BellSouth have agreed to try Microsoft TV in their fledgling video initiatives, while cable provider Comcast is expected to roll out Microsoft TV to all customers in MSFT's home state of Washington.

"Microsoft's next major OS upgrade, called Longhorn, has been long-delayed, and won't be available until later next year. Windows XP has been around since late 2001. Since Microsoft's OS upgrades are a core driver of the PC upgrade cycle, we would have applauded an earlier change. The new system has been delayed, most likely, because of continued criticism of its security initiatives, nearly all of which have been corrective as opposed to proactive. Even without the OS upgrade, we believe Microsoft has shown there is impressive growth to be had from communications and connectivity, home entertainment, and mobility markets. Now yielding 1.3%, the shares offer significant upside, in our view, based on that growth potential."

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