Attempting to Buy the Cloud

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

Oracle Corp (NYSE: ORCL) announced its first quarter results for the year 2013.  Revenues fell by 2.3% YoY to $8.21 billion, thus missing the lower end of its guidance by 0.3%. Safra Catz, Oracle’s co-President, was quick to identify that the decline in revenues was because of the strong dollar during the past six months. In constant currency terms, revenues are up 3%.

Drilling deeper, software revenues increased by 3.7% YoY to $5.74 billion due to a 6.3% increase in new software licenses and a 2.7% increase in update and product support. However, hardware sales slumped 19.5% YoY to $1.36 billion due to a 24.3% decline in hardware system and 12% decline in hardware support revenue. The slump in hardware was enough to completely offset the rise in software, causing Oracle to miss its estimates. Net income climbed 5.7% from $2.47 billion, or $0.48 per share, last year to $2.61 billion, or $0.53 per share, although this increase was due to $193 million in stock compensation.

Despite starting its fiscal year with a whimper, Oracle has high expectations for the future. Its Cloud revenue was $222 million and it added some high profile new clients to its customer base that included Accenture, Adobe, Barnes & Noble, Cisco, Colgate-Palmolive and Proctor & Gamble. It is expecting its non-GAAP earnings to rise considerably to $0.59 - $0.63 per share in the next quarter while analysts expect it to touch $0.59 per share.  Cloud-related revenue is expected to increase by 5%-15%.  This growth will have to offset the loss of hardware sales, which will continue to decline (by a projected 8%-18% in the following quarter), but since it is down to just 14% of total revenue this offset should occur easily.  Last year, 66% of total revenues came from software while 20% came from hardware systems. This year, the software accounts for 70%.

Clearly seeing its future in cloud-based systems, Oracle acquired a number of businesses in 2012. In February, it acquired Taleo Corp, a Cloud-based talent management firm, for $1.9 billion. Then, in March, it bought ClearTrial, a Cloud-based clinical trial operation firm. Two months later, it acquired Virtue, another Cloud-based social marketing firm that offers marketing tools on a SaaS basis. In June, it bought Collective Intellect, a Cloud-based social intelligence business that monitors social networking sites such as Facebook (NASDAQ: FB) and Twitter to provide consumer information. In July, it purchased Xsigo Systems, a network visualization services provider, and all the assets of Skire, a Cloud-based and on-premise capital management company. In its most recent purchase, on 17th September, Oracle bought SelectMinds, another Cloud-based talent and alumni management application developer. 

Growth through acquisition is always risky due to the logistics of integrating new organizations into the parent.  Buying half a dozen smaller companies en masse like this points to fear that they are behind their competition, which they are.  The SelectMinds acquisition is interesting, as it leverages social media as a recruitment tool, and the company boasts one of Oracle’s main competitors, IBM (NYSE: IBM), as one of their clients.

Cloud systems is a $109 billion industry, and it is getting increasingly competitive as bigger firms such as Microsoft (NASDAQ: MSFT) and IBM are also expanding quickly into this market. All the firms seem to be following the same strategy here: Buy out the smaller, experienced firms and successful startups. In June, Microsoft acquired Yammer, developer of a Cloud-based enterprise social network for $1.2 billion, Microsoft’s biggest acquisition in the market. Two months later, IBM trumped Microsoft by acquiring Kenexa Corp for $1.3 billion, another Cloud-based HR firm. The three purchases, Oracle’s Taleo and SelectMinds, Microsoft’s Yammer and IBM’s Kenexa, are strikingly similar, as the organizations see increasing opportunities to integrate social media into their architectures.

Since the beginning of the year, Oracle, partly due to its flurry of acquisitions, is up 25.9%, which is followed by Microsoft, up 19.3%, and IBM, up 11.8%.  However, with a massive ROE of 78.7%, IBM is far ahead of its rivals (Microsoft with 25.6% and Oracle with 23.5%) in the fiscal year 2011. ROA of all three firms was almost identical, around 13% to 14%.  

The acquisitions of Cloud-based companies will continue in the futur,e at least for Oracle and Microsoft who have more than $31 billion and $63 billion in cash and short term investments.  Microsoft is adding strategically with an eye on building a suite of services that directly integrate into their retail and enterprise ecosystem.  Oracle is building Cloud infrastructure, which looks like a Big Data strategy.

Oracle at this point looks adrift, trying to figure out where to go next; and while grabbing companies that specialize in data is a natural fit for them, I’m leery of a $150 billion company not building a lot of these startups themselves without an expressed goal.  Trading at a multiple of 15.5 with a minimal yield and a ton of cash, why buy them over Microsoft, which is trading similarly but with a better yield, less downside risk and a fresh image and product lines? 

Compare and Contrast

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PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook, International Business Machines, Microsoft, and Oracle and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook. 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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