Upgrading Microsoft to Accumulate

Microsoft (MSFT ): Upgrades to 4 STARS (accumulate) from 3 STARS (hold)

Analyst: Jonathan Rudy

The comapny's tentative deal with the Justice Dept. apparently requires no changes in the design of Windows software and leaves Microsoft's market power intact. S&P is not surprised that the settlement was reached, but is surprised by the lenient terms for Microsoft. Without any restrictions on Windows XP, Microsoft is extremely well positioned in the new product cycle going forward. However, the positive news is tempered by the potential legal action by 18 states and the company's premium valuation. Based on a discount cash flow model, the fair value for Microsoft is $70-$75.

UAL Corp. (UAL ): Reiterates 1 STAR (sell)

Analyst: James Corridore

The parent of United Airlines posted a Q3 operating loss of $10.05 vs. a $1.29 loss. The Street's mean estimate was for a $10.09 loss Revenues were down 16% as load factor, yields and passenger revenue miles all well below break-even. UAL is using $15 million in cash per day, but has $2.7 billion in cash due to a new debt offering. UAL also has $4 billion in unencumbered aircraft. The company expects a Q4 loss substantially greater than Q3, and will continue to have high cash burn rates. While UAL is working to cut costs, it also has tough labor contracts to deal with. Given the horrific losses and the uncertain timetable for recovery, S&P says sell.

Reader's Digest (RDA ): Upgrades to 3 STARS (hold) from 1 STAR (sell)

Analyst: William Donald

The publishing company posted a September-quarter loss of $0.01 vs. year-ago EPS of $0.21, which beat consensus by $0.04 despite $0.05 in direct costs of the bombing attacks. Revenues declined 8% excluding foreign exchange translations. EBITDA was hurt by softness in most U.S. core businesses, especially books and home entertainment. International sales also were slower. But Reader's Digest sees $0.75-$0.80 December-quarter EPS and is increasingly optimistic about the second half of fiscal 2002 (June) as it addresses revenue opportunities and expense cuts on all fronts. S&P is keeping the $1.26 fiscal 2002 estimate as is and believe Reader's Digest share price has bottomed.

Digi International (DGII ): Reiterates 3 STARS (hold)

Analyst: Megan Graham Hackett

The company announced Wednesday a plan to buy Net Silicon, a leader in embedded Ethernet solutions, in a deal valued at $50 million..The deal is seen accretive to Digi's fiscal 2003 EPS. The combination offers a more complete line of connectivity solutions, with Net Silicon contributing key software and silicon technology to Digi's box and board products. The exchange ratio was set at .65 Digi share for each Net Silicon share, but shareholdera can have stock, cash or both. Digi's cash outlays are not to exceed $15 million. S&P views the deal as fairly priced, valuing Net Silicon at 1.2 times sales, while enhancing Digi's competitive position.

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