ALEX MOTOLA
PORTFOLIO MANAGER
THORNBURG CORE GROWTH FUND

COMPANY: Microsoft

TICKER: MSFT (NYSE)
PRICE: $27.25 (as of 4 p.m. yesterday)
52-WEEK RANGE: $23.82-$28.38
MARKET CAPITALIZATION: $281.5 billion

Alex Motola is a managing director with Thornburg Investment Management and the portfolio manager of the Thornburg Core Growth Fund (THCGX). He spoke to David Dalley of The New York Sun about the software giant Microsoft.

Everyone knows Microsoft, but briefly, what does the company do?

They’re the world’s largest software company and they have a virtual monopoly on two huge businesses – operating systems and the Office suite of applications. They also have a couple other businesses. They do the Xbox game console, which is nice; they do paid search in competition with Google, and they control various other products: Windows Media Player, Digital Rights Management, and IPTV, for example.

Why do you like it?

They have one of the best balance sheets in the world, and they control two of the best monopolies. Keep in mind, too, that those are competitive monopolies, not regulatory monopolies. Those businesses generate a lot of cash, and Microsoft is extremely profitable. And yet the stock hasn’t done anything for five years, despite the fact that the business has been improving that whole time. So you’re buying a much cheaper company today than you were five years ago.

Why hasn’t the stock been stronger?

A few reasons. There’s a hangover from the Internet bubble, and there’s lackluster enthusiasm for large-cap growth stocks right now. But largecaps are an extremely attractive class, and Microsoft is a poster child for that sector.

What will drive growth going forward?

They’re getting ready to release a new operating system to replace XP called Windows Vista. In theory, the new system will be much more secure, more functional, and there’s good reason to think people will upgrade. They’re also getting ready to release a new product in their server business.

What do the fundamentals look like?

Like I said, Microsoft has one of the best balance sheets in the world. There aren’t too many companies with $44 billion in shareholder equity. That’s down from $50 billion because they’ve been buying back stock aggressively, which is great. Their liabilities are insignificant, and they have a huge amount of cash. Operating income for the December quarter was over $4.5 billion – that’s a 39% operating margin. The fundamentals are very strong.

Why is now the time to buy?

That’s the trick, and I don’t really know the answer. In terms of catalysts, when you look to the release of Vista, that will get people more interested in the Microsoft story. And the large-cap class is starting to get more attention from investors. They’re still growing at good rates – top-line growth was 9% in the last quarter. I don’t know the date when the stock will start to really rise – I think the longer your horizon, the more certainty you have that you’ll make money.

Where do you see the price ultimately heading?

It’s not inconceivable that they’ll trade at a 24 multiple, and they have before. Currently, it’s trading at around 19 on expected earnings, and I think that Wall Street projections could be a little conservative, so that number might even be a little large.

What are the risks?

With Microsoft I think you do have to be worried that they turn out not to be as successful in penetrating the Internet arena. They have MSN and Explorer, but they don’t have a strong presence with a lot of the back-end stuff on Web sites. It’s not clear that they’ll be the dominant player there, and that could be a challenge.

They’re mostly through the regulatory woods, certainly in the U.S. Competitively, it would be negative for the company if they never made much progress against Google, but even if they don’t, that doesn’t really affect their core franchises. Remember, most businesses have threats. If you’re not being threatened, you’re not in an interesting, competitive business.