-- Microsoft Is Studying GE To Find Secrets of Success


Steve Ballmer, meet Jack Welch. Mr. Ballmer, the hard-charging chief executive of software maker Microsoft, has been taking some lessons lately from Mr. Welch, the old-style management icon and leader of hulking conglomerate General Electric. Mr. Ballmer says he is studying GE's financials to better understand how a big company can keep squeezing so much growth out of its operations -- and train good people to run them. An interesting picture, this: Microsoft, the former darling of the New Economy and supergrowth stock of the 1990s, turning to a maker of light bulbs and jet engines for business advice. It isn't just a financial tie: Mr. Ballmer has read Mr. Welch's book on management, and Mr. Welch has participated in Microsoft's CEO summits. "There's some irony there," says Tom Rath, a portfolio manager and analyst for Safeco Asset Management in Seattle. Microsoft sure could use the help. Its stock has lost more than half its value since the start of the year, thrusting a big chunk of its employee stock options under water. The precipitous share-price drop, exacerbated recently by earnings warnings from other technology companies and lackluster industrywide demand for personal computers, could also force Microsoft to pay up, for the first time in several years, for some complicated derivatives it has sold in connection with its stock-buyback program. Microsoft shares closed Thursday at $55.375, down six cents in 4 p.m. Nasdaq Stock Market trading. They hit a low for the year earlier this week. It is all happening as Microsoft, in perhaps its biggest business-model shift ever, is trying to reignite revenue growth with Internet-based products and services. But change, painfully, takes time -- and we aren't talking Internet time. Analysts are expecting Microsoft's quarterly revenue to increase a very Old Economy-like 5% or so when it reports its latest financial results later this month. Influential analyst Rick Sherlund, of Goldman Sachs, said in an interview this week he expects earnings to be "in line with low expectations." Some analysts say the stock still may not have reached its bottom, since Microsoft must post improved performance in coming quarters to gain credibility, and the near-term outlook remains sluggish. With its shares still under pressure from its antitrust troubles with the government -- Microsoft is appealing an unfavorable court ruling and recently won a procedural victory in the case -- some analysts say only an uptick in sales of major products like its Windows 2000 operating system and related server software can boost the stock. "It's a 'show-me' story right now," says Bill Epifanio, an analyst with J.P. Morgan who nonetheless thinks the shares are an attractive buy now. Safeco's Mr. Rath, too, says he is adding them to his portfolio. It is a vastly different story at GE, the Fairfield, Conn., behemoth that has its fingers in everything from television to plastics to finance. The company's revenue has been growing in double digits recently, "which is just phenomenal for a company GE's size," says Bill Fiala, an analyst who follows GE for Edward Jones in St. Louis. GE's stock is also up strongly for the year, meaning its forward price-to-earnings ratio is now actually far higher than Microsoft's -- about 40 compared with Microsoft's 29, Mr. Epifanio calculates. Microsoft shares are also now trading at a multiple that is almost as low as that of the forward price-to-earnings ratio of the S&P 500, he points out. And GE, of course, now has a market value that eclipses Microsoft's. So what is GE's secret? Mr. Ballmer clearly wants to know. At Microsoft's annual meeting for financial analysts at its Redmond, Wash., headquarters this past summer, the CEO acknowledged in a speech that he has "been spending a reasonable amount of time recently studying GE's results. Not that I want to be a maker of airplane engines," he added, "but any company that's got $70 billion-plus of revenue, that has a gross profit of 15% a year, you've got to study those guys. That's an amazing performance." In an interview last week, Mr. Ballmer said he was most impressed with GE's ability to "execute on all fronts," and get growth out of all its diverse businesses, not just one or two. That is a lesson for Microsoft, which is trying to expand beyond its core business of desktop software into wireless devices, interactive television and even computer games. Some noncore businesses are now growing faster than desktop software for Microsoft, "but they're a smaller percentage of our total," Mr. Ballmer notes. Sales have to ramp up, though, because "the PC market is not going to go back to 25% annual growth." Another GE trait Mr. Ballmer admires: Expertly recruiting, promoting and training good leaders. GE's management bench is notoriously deep, while Microsoft has struggled recently to hang onto longtime executives who have departed to enjoy their Microsoft-made wealth or dive into new start-ups. Retaining important employees may be more difficult, with Microsoft's shares in the basement; most employees count on the stock as a major component of their pay. Indeed, Microsoft's stock has been in such a tailspin that at least 20% of its outstanding employee stock options are worthless at today's stock price, according to disclosures in the company's latest annual report. The report also disclosed another ramification of the recent stock-price plunge: a potential change in a Microsoft derivative strategy. To help pay for employee stock options, Microsoft has for several years bought back shares of its own stock and employed a complicated hedging strategy to soften the impact. Since 1995, Microsoft has made more than $2 billion in fees from selling "put warrants" to investment banks, which give the banks the right to sell Microsoft shares back to the company at predetermined strike prices. Until now, with Microsoft's stock at lofty levels generally above the strike prices, the company has simply collected fees and watched most of those warrants expire worthless. But now, that is no longer the case: As of June 30, the company had 157 million such warrants outstanding at strike prices ranging from $70 to $78 a share. That means Microsoft may have to dip into its cash reserves to buy back stock over the next 2 1/2 years at those levels. That could cost the company $11.6 billion over the next 10 quarters, the company acknowledges. Still, that is money Microsoft could have spent anyway to buy back its stock, and "we've had numerous quarters where we've spent in excess of $1 billion" on buybacks, says Brent Callinicos, Microsoft's treasurer. He adds that those stock purchases aren't accounted for on the balance sheet and won't affect earnings or cash flow, since the company has a huge cash hoard of $23 billion. Over the long haul, of course, Microsoft's stock could go up, and the company won't have to buy back the stock at above-market prices. Meanwhile, it continues doling out hefty options grants to employees to keep them happy. In the company's just-filed proxy statement, for instance, Microsoft disclosed it gave options to buy stock to three top executives that could be valued at between $553 million and $643 million each in 10 years, if Microsoft's stock appreciates 10% a year until then. Mr. Ballmer brushes off any worries about retention. "Even if some people worry about whether we have the people to run our business, we just keep bringing in new ones," he says, citing a cadre of "hungry guys in the prime of their careers." But Mr. Ballmer isn't taking all of Mr. Welch's management ideas to heart. Asked about Mr. Welch's famous bottom-line orientation and aversion to competing in businesses where it can't be the top dog, Mr. Ballmer says Microsoft obviously "has to be smart about where we put our resources." But it often takes time to gain traction with a new product, the CEO points out, so "we don't have any hard and fast rule about having to start out as No. 1 or No. 2" in a given business. Mr. Ballmer isn't the only New Age guy paying heed to the old guard. Analysts note that Mr. Ballmer's archrival Scott McNealy, who heads Sun Microsystems, is also listening up. Mr. McNealy now sits on GE's board. Says Safeco's Mr. Rath: "These technology companies are entering a new stage in their corporate life cycle ... they're having to grapple with having tens of thousands of employees, and how to keep everyone motivated, and all those types of issues I guess Welch has dealt with for years." Write to Rebecca Buckman at rebecca.buckman@wsj.com ------------------------------------------------------------------------ Return to top of page | Format for printing Copyright 2000 Dow Jones & Company, Inc. All Rights Reserved. Copyright and reprint information.