Microsoft’s Expedia Deal in Peril?

With analysts concerned that the events of Sept. 11 will delay the recovery of the PC market, investor attention
has also been turning to Microsoft Corp. .

Goldman Sachs & Co. reduced estimates on the Redmond, Wash.-based software giant and 20 other software companies on Sept. 17,
“recognizing that the tragedy of Sept. 11 would have negative consequences for the economy, for software sales, and PC demand,”
according to GS analyst Rick Sherlund. But the reduction did not take into account potential exposure to Microsoft’s plan to sell its controlling interest in the Expedia
online travel site to USA Networks, announced in July.

A 10 cent per share gain was packed onto Microsoft’s December quarter earnings as a result of the deal, but the travel industry has
been hit hard since Sept. 11, and Expedia’s share
price has dropped from about $45 to about $22.

“This would imply the gain to Microsoft from the sale of their shares in Expedia will be less, probably by a few cents per share
(the computation is complex and there are undisclosed and uncertain factors),” Sherlund said Friday. “We presume this deal is being
renegotiated now that the share price is outside the collar range, and the gain will likely be less. If there is any renegotiation,
it would likely push the closing date out to the March quarter. This all assumes a successful completion of the merger, in the
absence of any information to the contrary.”

The 10 cent per share gain is a non-operating item, and normally analysts would exclude it from earnings, but Sherlund said
investors have included it given that last years results included a similar gain and there is a desire to be consistent.

There is also a fear that sluggishness in the computer sector will negatively affect Microsoft’s launch of its Windows XP operating system. On Sept. 17,
GS shaved $150 million off its estimates for the December quarter, under the expectation that the XP launch would cushion the
company’s quarter somewhat.

“Our December quarter revenue estimate is $7.25 billion, up 23 percent sequentially,” Sherlund said. “This includes an estimated
$300 million from the launch of Xbox, the sequential increase is 18 percent without this, which compares with 14 percent last year.
If the Windows XP launch were not as successful in adding revenues sequentially and PC demand is simply worse than expected, an
assumption of a similar 14 percent sequential increase as we experienced last year would imply about $250 million of revenue
exposure in the December quarter.”

Also, Sherlund said sources inside the industry have told GS that Microsoft is aggressively cutting costs, though he noted, “this is
not clear and we cannot calibrate this until we see results for the September quarter.”

On Sept. 17, Sherlund cut his forecast for Microsoft’s September quarter revenues by $250 million (4 percent), from $6.1 billion to
$5.8 billion, and its EPS estimate from 40 cents per share to 38 cents per share. The cut was relatively small, because Microsoft’s
business is not as back-end loaded as that of most of the software sector, so they should experience less of an impact for the
quarter. Sherlund said the bigger question is how much of an impact Sept. 11’s events have on PC demand in the December quarter and
through the first half of calendar 2002.

“Our earlier estimate reduction was directional in nature and we will need to get a better view of the September quarter and expense
levels before addressing estimates further, but the likelihood is high that we are not done cutting estimates.”

Meanwhile, U.S. District Judge Colleen Kollar-Kotelly, who is the newly appointed federal judge overseeing the ongoing antitrust case, has ordered settlement talks to continue through Nov. 2. If no settlement can be reached, Kollar-Kotelly said she will then hold hearings, likely to begin in March, on what sanctions should apply against Microsoft.

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