Should You Avoid Oracle?

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Oracle (NASDAQ:ORCL) is the world’s largest enterprise software company. The company is fundamentally stable and is a dominant player in the database applications space. The world’s No. 3 software maker develops, distributes and services middleware and application software that helps organizations grow their businesses. However, the recent quarterly results suggest a gloomy picture for the company, and it seems to me investors should avoid this company for now.

Q3 Results – A bad miss

Oracle recently declared their third quarter 2012 earnings on March 21. Total revenue for the period stood at $8.97 billion compared to the $9.06 billion for the same period during the previous year. Oracle’s hardware business is not faring well and declined by 23%. Revenues from this business dropped to $671 million from $869 million in the year ago quarter. Net earnings marginally rose to $2.5 billion or 52 cents a share, which was much below market expectations. As a result, the stock plunged by nearly 10% on the day of the results. However, it is interesting to note that the stock enjoyed an 11% jump in 2013 prior to the result announcement. This clearly suggests that the stock did not perform as expected despite having a comparatively better price to equity ratio of 15.

Reasons behind the poor results

The reason behind the decline in revenues was attributed to poor sales execution by salespersons recently hired by the company. Oracle says that it significantly expanded its sales force around the world and they seemed less motivated to close deals in the third quarter.

But is this the actual reason?

If we analyze more deeply, Oracle has been struggling to retain its customers who are increasingly shifting away from legacy enterprise software to cheaper web based software. The world is moving to an open source system with most of the offerings happening through the cloud, enabling access from anywhere, and thus incurring less storage costs.

Oracle, however, is still stuck in a legacy world and has not moved on as fast as its competitors. Some numbers clearly suggest this. For example, Oracle posted a 2% drop in Internet based software subscriptions to $2.3 billion in the fiscal third quarter. The decline in demand of Oracle’s on-premises software coupled with its inability to take on the cloud seems to be the more appropriate reason behind the unexpected quarterly results.

However, Oracle did launch its cloud last summer. Acquisition of cloud companies like Taleo, a recruitment software business, and RightNow Technologies, a customer relationship firm, have strengthened its cloud offerings. According to the CEO of Oracle, Mr. Larry Ellison, the cloud subscription business is “enjoying a very high growth rate” and will make up around 10% of the expected $10 billion revenue from the software license and subscription fees in fiscal 2013.

Some recent developments

Recently, Oracle announced two new acquisitions with Acme Packet (NASDAQ: APKT) and Tekelec. The proposed buyout of Acme will give access to an Acme product that will enable the enterprise clients to handle over 200,000 simultaneous calls. This shows that the company is trying to focus on the carrier space. After buying Sun Microsystems in 2010, Oracle was a dominant player in the telecom database infrastructure, and it is continuing to increase its dominance with the recent acquisitions. Oracle is diversifying its business and betting on industries where customized applications are still required, hence the justification of the acquisitions.

The peer market

Oracle is facing a tough competition in cloud or Internet based software from the likes of IBM (NYSE: IBM), which reported better-than-expected fourth quarter results. The company managed to increase its net annual profit by 5% in 2012 by reducing its operating costs. Revenues from new sources like cloud computing and smarter planet systems increased by 25%, which shows that IBM is better positioned at moving on to the next generation of computing.

Rivals like SAP (NYSE: SAP) and have launched their cloud services before Oracle and have a first mover advantage in this regard. From the perspective of valuation, Oracle seems to be undervalued compared to SAP. SAP’s December 2013 forward price to equity ratio is very high at 22.77 compared to Oracle’s ratio of 12.26. Oracle has a lot of cash in hand compared to SAP when it comes to making acquisitions in the next few years. This may seem to prove that Oracle is a better buy than SAP.

Future performance and my take

Oracle has been looking forward to an impressive performance in the May quarter. It has projected a 10% rise in new software licenses and Internet based subscriptions due to the completion of some of the deals at the end of the fiscal year. However, business sentiment around the world is down, and government and corporate spending has been lower in an uncertain global environment. Moreover, Oracle is facing internal problems like inefficient sales execution. It is in urgent need of restoring investor confidence and balancing its growth plans. After the bad miss of Wall Street estimates in Q3, the company will take some time to recover, and hence I would recommend against buying the stock as of now.

Shas Dey has no position in any stocks mentioned. The Motley Fool recommends Acme Packet. The Motley Fool owns shares of International Business Machines. and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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