Oracle Grows Where Others Can’t, Stock Heading to $40

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

On Monday I made a case for why I thought the stock of database giant Oracle (NYSE: ORCL) should be bought ahead of the company’s Q2 fiscal 2013 earnings announcement. Aside from the fact that Oracle has been a consistent market performer, the stock has remained grossly discounted relative to peers.

Instead, analysts have shown more favoritism to the company’s rivals - namely (NYSE: CRM) and SAP (NYSE: SAP). However, after the database giant reported fiscal second quarter profits and revenue that exceeded even the most bullish estimates, this may no longer be the case.

The Quarter That Was

It’s time for Wall Street to wake up and realize that it has gotten this story wrong. For the period ended Nov. 30, Oracle enjoyed strong growth in its Internet-based software, which competes head-on with in that all important Software as a Service (SaaS) business. But it gets better: Oracle expects to generate more than $1 billion in revenue this year.

Impressively, the company reported an 18% year-over-year increase in net income, reaching $2.6 billion, or 53 cents per share. Oracle said profits actually arrived at 64 cents per share when excluding charges related to acquisitions and other costs - enough to beat analysts’ estimates of 61 cents per share.

Likewise, revenue grew 3% to $9.1 billion, exceeding Street estimates by $900 million. However, the most remarkable aspect of the report was the 17% surge year-over-year in the company’s software licenses and subscriptions business. This was good enough to exceed management’s most bullish projections three months ago.

On the other hand, the company is still struggling to grow its hardware business, which includes servers. This is an area in which Oracle has had much difficulty since its $7.3 billion acquisition of Sun Microsystems a couple of years ago. During the quarter, hardware revenue plunged 16% year-over-year. But does it really matter?

Management does not appear concerned and has even said that the hardware erosion is by design. Larry Ellison, Oracle’s CEO, said the decline of the hardware business has been in an effort to help the company become more efficient by removing the reliance upon less-profitable equipment. But he did assure investors that hardware revenue will start increasing towards the end of the fiscal calendar.

Moving Forward

Looking ahead, Oracle expects adjusted earnings for the quarter ending in February to arrive in the range of 64 cents to 68 cents per share. The company also expects revenue to come in between $9.1 to $9.5 billion, which would be good enough for a year-over-year increase of 1 to 5%. Although these are not “out of this world” projections, the company does have a history of under-promising to over-deliver.

What’s more, with the company spending its cash on acquisitions, picking up names such as RightNow and Taleo to help grow its cloud offerings, investors can expect better profit margins in the coming quarters. Also, Oracle is now in a much better position to fend off threats from, which has gone on a shopping spree of its own.

Investors should also be encouraged by Oracle’s ability to grow its software and subscription business to the extent of 17%, particularly since that business contributes one quarter of the company’s revenue. This means that Oracle is indeed stealing market share from Microsoft, SAP and

This also means that although might now have a decent lead in the SaaS market, it is certain to be short-lived. Because, unlike Oracle, has shown an inability to develop internally through its own R&D. Consequently, it has spent close to $1 billion buying up niche cloud/social media names such as BuddyMedia, on which it spent almost $700 million. This comes shortly after acquiring Radian6. So when is the profit going to come?

With Oracle’s strong software showing, the company will be able to generate additional revenue from license and subscription renewals. In other words, Oracle can rely on recurring revenue that comes at lower costs to the company – thus helping improve its profit margins.

It remains to be seen how Oracle’s performance might impact the overall competition, especially SAP.  Despite SAP’s strong operation and consistent performance, the company’s business has been highly regarded as “running behind Oracle.” Will this spur more consolidation or will SAP be pressured to leverage its $3.5 billion acquisition of SuccessFactors?

Bottom Line

Oracle’s strong quarter serves as a perfect example of how some analysts continue to misunderstand what this company is about. Not only is Oracle strategically positioned to realize every growth opportunity that big data and the cloud can bring, but the company is safe.

Oracle’s strong cash position, deep market penetration and innovative strategies make the stock one of the bright spots in today's recovering market. Value investors who are thirsty for growth and a decent yield should give Oracle a long look at current levels.

rsaintvilus has no positions in the stocks mentioned above. The Motley Fool owns shares of Oracle and has the following options: long JAN 2013 $50.00 puts on Motley Fool newsletter services recommend 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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