Does Its Recent Entry in Cloud Computing Makes this Tech Giant a Good Buy?

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

With the advent of cloud technology, more and more IT customers are shifting from in-house solutions to cloud based and open platforms. All the major companies in the technology sector have already increased their presence in the cloud domain. Oracle (NYSE: ORCL) and HP had been the laggards in this front, but now they too have started moving into the cloud domain.

Oracle’s last quarter results were below the consensus estimate. The drag was due to the drop in the demand for its hardware and renewals. To offset this the company has aggressively started venturing in the cloud platform with its recent acquisition of a cloud based company. During its recent earnings call-conference, President Mark Hurd said that Oracle has added 500 cloud computing customers. The stride in cloud computing will help the company increase its revenue in the coming quarters.

In addition to acquisition in cloud space, the company is also forging alliance with other major players in the industry. The company has recently announced its alliance with Microsoft. Oracle’s offerings will be available in Microsoft’s cloud infrastructure. This will help the company increase its software license sales in the coming quarter. Oracle has also announced its alliance with Saleforce.com. Their alliance will help both Oracle and Salesforce.com provide their offerings in tandem to the customers. These strategic alliances will help Oracle increase its software and hardware sales.

With the advent of cloud and mobile, we believe the demand for hardware and software licenses will decrease. The customers are going for cloud based applications and servers, thereby reducing the fixed cost associated with the installation of hardware and software at their work place. This frees a lot of cash for the customers, which they can use to expand their core business. We believe this trend will further gain momentum in the coming year. Seeing this trend, Oracle's move to explore the cloud business makes sense. We believe with strong software and hardware offerings it will be able to get good market share in cloud computing.

Peer analysis

Oracle’s trading at the lowest forward PE in its peer group despite it having the highest operating margins. Clearly, the market is not giving it much credit for the recent steps it has taken to enter into cloud computing space. Its immediate peer, SAP, which has a relatively strong position in cloud computing, is trading at a significantly higher PE multiple than Oracle. We believe this valuation gap will narrow over time. Lets take a look at its peer companies.

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>P/S ratio</strong></p> </th><th> <p><strong>Op. Margin</strong></p> </th><th> <p><strong>1 yr. Fwd. P/E</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>IBM</strong></p> </td> <td> <p>2.12</p> </td> <td> <p>21.05%</p> </td> <td> <p>10.65</p> </td> </tr> <tr> <td> <p><strong>Oracle</strong></p> </td> <td> <p>4.21</p> </td> <td> <p>38.55%</p> </td> <td> <p>9.51</p> </td> </tr> <tr> <td> <p><strong>SAP</strong></p> </td> <td> <p>4.17</p> </td> <td> <p>28.35%</p> </td> <td> <p>18.65</p> </td> </tr> </tbody> </table>

SAP AG (NYSE: SAP) has announced strong first quarter results. The company’s revenue increased by 7% compared to the same period in 2012. The company’s software and cloud subscription increased by 23% in the first quarter compared to 2012.

We believe the company’s new software, HANA, cloud subscription and mobile will drive the future growth. The company’s guidance for the full fiscal year remains strong.

The company recently announced the acquisition of hybris, which will help SAP deliver e-commerce platforms either on premise or through cloud deployment. We believe that at its current price and with its future growth strategy the company’s stock is worth buying.

IBM (NYSE: IBM) is another competitor of Oracle. The company posted weak first quarter results with revenue down by 5.1% year-over-year. This is because the sales of both software and hardware were disappointing and due to the divestment of its low margin business.

But the company showed tremendous growth in the cloud, Analytics and Smart Planet platform. The company is expected to continue to benefit from the investments and acquisitions in these areas. The company has also been divesting its low margin business, which will help it to focus on the high margin business.

The company is also re-balancing its resources which will help cut its operating expense. We believe this strategy will negatively impact its revenue in a few of the coming quarters, but in the long term it will help increase its revenue and margin by focusing and investing in high margin businesses.

Conclusion

Oracle has been regarded as a laggard in developing its cloud competency. This has adversely impacted the company’s revenue. Of late, the company has taken steps to enter into the cloud business and has been on an acquiring spree. We expect the alliance with Salesforce.com and Microsoft will help the company improve its software and cloud subscription revenue in the coming quarters. With the economy also showing signs of revival, the sales of its software and hardware should also increase in the upcoming quarters. At this price the stock is worth buying.

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Lalit Kumar has no position in any stocks mentioned. 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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