Thursday, March 30, 2006

Microsoft and EU

CNN carried an artile on the continuing fight between Microsoft and the European Union. Wall Street Journal is also carrying articles on the hawkish stance taken by European Union officials against Microsoft. While the merits and demerits of the case are not clear to a lay person, it is fairly certain that the EU is going to impose 2.4 million dollar fine on Microsoft. What does this mean for the stock and overall trade relations between US and Europe?

While the EU has its own motives for fining Microsoft, Microsoft hasnt helped its own cause by its confrontational attitude after paying a 540 million dollar fine. Microsoft could have easily released two versions of windows and charged different prices for the version with better features. It is also not helping Microsoft that many of the companies complaining are U.S companies. It undermines the U.S government from lobbying for Microsoft.

The fine is already priced into the Microsoft stock. The investors are expecting some type of settlement that will not require Microsoft to pay the daily fine after some time. If Microsoft has to pay fine on a daily basis, it will cost it 876 million dollars a year. This will reduce Microsoft's cash flow by approximately 6% a year.

The estimate is that Microsoft derives roughly 20% of its revenue from Europe. Out of this, the countries in the European Union probably contribute some where aroud 15% of the revenues. If we equate profits with revenues, 15% of the profits would be contributed by the European Union countries. If the government siphons off 6% of the profits, it is pretty much charging 40% of the after tax profit again. As I mentioned earlier, the EU's intentions are far from noble is putting this tax on Microsoft. The investors are not expecting this to be resolved quickly in some manner without Microsoft having to pay the penalty for every day of the year.

As the world stands today, Europe is dependent on the U.S far more than the U.S is dependent on Europe. U.S is the largest market for the fine french wines, the German automobiles and every European country with the exception of Netherlands runs a huge trade surplus with the U.S. A full blooded trade war will cost Europe more than it would cost the U.S. Since many of the companies complaining against Microsoft are based in U.S., it is likely that the Microsoft case will not get the full backing of the U.S government. Apple, another U.S company is being asked to open its ITunes so every music player can work like an IPod. In any case, the investors are betting on the issue to be resolved with minor financial loss to Microsoft. This is evident in the options market where most people are betting Microsoft to be around the $27.5 neighborhood for the next nine-twelve months.

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