Can Oracle Make Its Own Luck?

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

Shares of Oracle (NYSE: ORCL) fell nearly 9% after earnings as total revenue grew a meagre 1% year-over-year amid concerns about its hardware business. In 2008, Oracle’s CEO, Lawrence Ellison, remarked cloud computing to be a “nonsensical “concept with absolutely no strategy on maneuvering the company in that direction. Five years hence, cloud computing has become an indispensable tool for huge companies seeking a sophisticated IT support system.

As a result, competitors have rapidly eaten into Oracle’s market share and hampered its growth in the software business. After a weak performance in the third quarter, new software licenses did not do well in the fourth quarter as well. The cloud business failed to perform in line with investors’ expectations keeping in mind that May is a crucial revenue-generating month for the company. CFO Safra Catz blamed the low growth in new software licenses to weak sales in regions like Brazil in South America and a number of countries in APAC as well.

Failed to meet expectations

GAAP EPS for the quarter came in at $0.80 including the effect of currency movement as compared to $0.69 in the same quarter last year. However, reduced number of shares in the quarter owing to share repurchases contributed approximately 6% to this significant jump. Total operating expenses fell 6% year-over-year helping the overall margin to improve by 100 basis points.

Besides operating margin, free cash flow also benefited from a reduction in operating and capital expenditure. Oracle generated $13.6 billion in FCF over the last four quarters. Oracle has an impressive track record with regard to FCF that has managed an average of 20% growth over the last few years.

Why was the stock punished?

Oracle’s performance in the fourth quarter was satisfactory, but still, it got a good beating because of a couple of reasons. Firstly, the time of April-May is the most lucrative period for the company in the year and it has delivered outstanding growth during this period earlier. Hence, analysts and investors were looking at growth in the higher end of its guidance given in the previous quarter. For instance, management had estimated new software subscriptions to grow in the range of 1%- 11% and it achieved a growth of just 2%, which wasn't enough to impress investors.

Competitors are taking Oracle’s share of the pie

Additionally, investors in Oracle have recently become conscious of its growing competition. As this article points out, Oracle’s revenue growth is quite petty when compared to high growth achieved by its major rivals. Workday’s revenue grew 61% year-over-year to $91.6 million with major contribution from subscriptions for its cloud applications.

Oracle claimed in its earnings call that its cloud business was growing at a faster pace than Workday’s that is a relatively smaller player in terms of resources and customer base. However, it is a fact that Workday has shown phenomenal growth in subscriptions for its cloud business. Besides strong business fundamentals, it has a maintained healthy operating margins and adequate cash on its balance sheet.

One of Oracle’s arch-rivals, SAP (NYSE: SAP) has been experimenting with various cloud strategies and trying to incorporate a business suite to the cloud of late. In its recent results, it announced a growth of 25% in software and cloud subscription revenue. Its revolutionary HANA platform has been driving excellent growth in the past few quarters. In the first quarter, HANA tripled its revenue as compared to same period last year that testified its potential to make it big in the industry. Oracle’s weaker than expected results negatively affected SAP’s share price as investors grew apprehensive of the industry's prospects.

Partnering with Salesforce.com

Oracle’s CEO Larry Ellison announced an alliance with Salesforce.com (NYSE: CRM) on the earnings call in order to strengthen its foothold in the cloud computing sphere and said that it would be a partner in company’s latest 12c technology. The company was in news recently for its acquisition of ExactTarget, which provides marketing solutions in form of SaaS, for a whopping $2.5 billion. There has been no monetary ascertainment of the value this deal will bring to Salesforce, but it will sure provide adequate leverage to the company in providing marketing solutions in form of SaaS.

From different angles

Oracle is currently working on new business propositions, including the cloud, that are going to rattle its CEO’s previous line of thought. The issue with the company is that there is no simple input-output relationship, making it difficult to analyze the stock with defined methods or metrics. I have outlined a few points that investors need to look out for:

  • A major part of Oracle’s earnings call was focused on software which camouflaged the poor performance of its hardware business. Its hardware system product revenue declined 23% year-over-year. The future still looks bleak with regard to hardware revenue, which, as per management, is expected to grow anywhere between negative 6% and 2% in the next quarter
  • As mentioned on the earnings call, Oracle has partnered with industry leaders Microsoft and Salesforce.com in order to reshape its cloud computing applications. This combined effort should have positive implications for Oracle’s cloud business besides the presence of its much talked 12c technology.
  • The decline in share price after the earnings call has made it a reasonable buy when compared to its peers. At a forward P/E of around 9, Oracle is quite cheap than rivals like Salesforce.com

Is it the time to buy?

While the wheels are turning at Oracle, management has given out big gifts like doubled dividend and massive buyback to its shareholders for remaining patient and optimistic. The time is ripe to invest in the company because it has massive opportunities in the future and is reasonably cheap.

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Mihir Mehta has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of 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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