3 Actions Would Make This Company a Huge Value

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

I guess you could label me as a perfectionist, I'm always looking at companies earnings reports and trying to imagine ways that they could be even better. When Oracle (NYSE: ORCL) reported earnings a few weeks ago, there were three actions I could see that would make this company a huge value. Let me walk you through what I saw in the company's earnings release, and detail what I believe the company must do to earn the respect that CEO Larry Ellison so desperately seeks.

Helping Businesses Grow:

Oracle is essentially in the business of helping companies use their data better. Whether you call it cloud computing, database management, or software solutions, in essence Oracle is in the business of growing businesses. The company faces significant competition for both hardware and software solutions from huge multinational conglomerates that are at least as well-financed as the company. When you can claim Microsoft (NASDAQ: MSFT) and IBM (NYSE: IBM) as two of your primary competitors, you know you're already playing in the big leagues. All three of these companies are making a push to become more involved in cloud computing, which is seen as the wave of the future. Each of these companies is expected to grow at between 9% and 12% over the next several years as well. Oracle seems to be the odd man out, as people focus on IBM's emergence as a solutions leader, and question whether we will see a new growth phase for Microsoft driven by Windows 8. Oracle doesn't get as much press as its competition, and there is no one who would like to change that more than CEO Larry Ellison. Let's take a look at the company's current quarter and see how things have been going.

Reported Earnings:

Oracle reported revenues down 2%, but non-GAAP earnings-per-share were up 11%. Foreign-currency related adjustments negatively affected EPS, and without this earnings would have increased 17%. The company is split into three different product segments, and the core of Oracle performed well. The company's Software Licenses & Cloud Software division reported revenue up 6%, and without foreign-currency impact, revenue would have increased 10%. The other software related division, Product License Updates & Support showed revenue up 3%. This unit would have also seen better revenue growth of 8% without foreign-currency adjustments. The problem child of the group is their Hardware Systems division. Hardware isn't Oracle's strong suit and this unit reported revenue down 24%, and 21% without foreign currency impact. The only good news out of the Hardware Systems division is, the fact that this unit only represents about 12% of overall revenue. 

3 Actions to Increase Shareholder Value:

First, Oracle needs to realize that it is a software company. While the Sun Microsystems acquisition might have seemed logical at the time, the hardware business is simply not where the company's core competency resides. To be blunt, the company needs to realize that the Hardware Systems division needs to go. Whether the division is sold to the highest bidder, or spun-off to shareholders, this piece does not fit with Oracle's future in cloud computing and continuing to provide software solutions.

Second, the company is carrying long-term debt that simply makes no sense based on the company's cash flow and cash position. In the most recent quarter, Oracle's $13.5 billion in notes payable cost the company $188 million in interest. At the same time, the company has over $31 billion in cash and investments on its balance sheet. While it's true that about $25 billion of this sits in foreign subsidiaries, the company's free cash flow each quarter is certainly not all being generated overseas. Oracle's interest income was just $57 million, so the company's long-term debt is essentially costing the company about $131 million each quarter. It's rare that a company could generate $131 million in earnings each quarter by a balance sheet maneuver, but that is the opportunity staring Oracle right in the face.

Third, the company's free cash flow is not being used to shareholders best advantage. In the most recent quarter, Oracle generated $5.5 billion in free cash flow. The company used just $292 million of this to pay dividends, and repurchased over $3 billion worth of shares. While the share repurchases certainly improve earnings, the company hasn't exactly been blowing the doors off their earnings projections. Given that their dividend free cash flow payout ratio was just 5.31%, it certainly seems the company could return more cash directly to shareholders pockets. By comparison, both Microsoft and IBM have a free cash flow payout ratio of between 21% and 22%. If Oracle followed its competitions lead and paid about 20% of its free cash flow in dividends, this would raise the annual dividend significantly. In fact, such an increase would give an indicated annual dividend of $0.91 per-share, as opposed to the $0.24 that the company currently pays. At current prices, the company's new dividend yield would move to nearly 3%. If the stock sells for just under $31 with a less than 1% yield, imagine what the stock would do if the yield tripled.

Conclusion:

There's no question that Oracle could be a good opportunity even without these three moves. The stock currently sells for less than 12 times projected earnings, and analysts expect roughly 12% growth. CEO Larry Ellison has built a reputation as fiercely competitive. His significant stake in Oracle stock would certainly be improved by a higher level of income, and improved balance sheet, and a better expected growth rate. Though it's not always the case, in Oracle's situation what is good for the CEO is also good for shareholders. While none of these moves is as exciting as an acquisition or a new product launch, if Larry Ellison wants to get people talking about his company these three steps would certainly do the trick.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines, Microsoft, 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.If you have questions about this post or the Fool’s blog network, click here for information.

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