Oracle and SaaS - What's Going On There?

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

It's always a smart move to pay close attention to corporate actions such as mergers and acquisitions (M&A). That's because giant tech companies sometimes go through various transition periods in the course of which they perform a major shift in their core business. Take International Business Machines (NYSE: IBM), for example.

Only a decade ago, "Big Blue" used to sell laptops and hardware. Through a chain of prolonged and complicated M&A transactions, the company has totally changed its business to become the number one IT business in the world. Turnarounds, like that of IBM, always leave some trail in the sand. A vigilant investor could  pick up on that by monitoring the trail that IBM has left during its M&A journey. I believe that Oracle (NYSE: ORCL) is now on the same type of journey, to compete head-to-head with SAP (NYSE: SAP)

Oracle and SaaS - Not interested 

Oracle didn't believe in the concept of software as a service (SaaS). On various occasions, the company's chairman stated that customers are simply not interested in SaaS, and that Oracle won't go down that road. He gave two main reasons to justify his argument. First, SaaS is very database intensive. Normally, people do not want all their data resident on an on-demand product. Second, it seems that customers want to 'own' software. When it comes to software, they want to make a decision on ownership. They don't want others to make it for them.

Oracle and SaaS - Very much interested 

But words are very cheap. It's actions that really matter. Oracle has been very rigorous in pursuing target companies that would give it an edge in the Saas field. All you have to do is to take a careful look at Oracle's M&A recent record. In the year 2011 alone, Oracle bought out Endeca, Art Technology, and RightNow for $1.1 billion, $1 billion, and $1.5 billion, respectively. That's a total amount of $3.6 billion funneled into SaaS in 2011 alone. But it didn't stop there.

Oracle kept on buying SaaS companies in 2012. The company bought Vitrue, Eloqua, and Taleo for $0.3 billion, $0.8 billion, and $1.9 billion, respectively. Here went another cool $3 billion for SaaS acquisitions. Let's bring that into perspective. Oracle's free cash flow from operations totaled $11.2 billion in 2011 and $13.7 billion in 2012. This means that Oracle forked out 32% of its cash from operations in 2011, and 22% of its cash from operations in 2012, on this SaaS acquisition spree. I believe that Oracle's actions send out a very clear signal, regardless of what the company says or doesn't say. Oracle wants to become the world leader in SaaS

Oracle and SAP are two of the most successful business software companies in the world. In particular, Oracle has long been known as a category killer that ruthlessly runs smaller competitors out of business. It either kills them, or buys them out altogether. We have seen enough examples of that.

Oracle isn't alone

SAP and IBM have both been fierce rivals of Oracle in the SaaS arena. SAP, known in the industry as a consistent over-payer, bought Business Objects in 2007 for an astronomical sum of $6.8 billion, Sybase in 2010 for $5.8 billion, SuccessFactors in 2011 for $3.4 billion, and Ariba in 2012 for $4.3 billion. All in all, SAP has forked out a staggering amount of $20.3 billion on SaaS acquisitions over the past five years. That's an average of about $4 billion year on M&A alone. And IBM has had its share of acquisitions too, though on a much smaller scale than that of Oracle and SAP. In 2011, it bought DemandTec for $0.44 billion. And in 2012, it paid $1.4 billion to purchase Kenexa Technologies.

As a result of IBM's transition to software, gross profit increased from 46.9% in 2011 to 48.1% last year. Net profit margins also improved last year, from 14.8% to 15.9%. This improvement in margins gave a strong boost to IBM's cash flow generation. It now consistently generates more than $15 billion a year in free cash flow. This strong cash flow will leave IBM with lots of powder on its hands to seek further acquisitions in the SaaS sector. 

My Foolish takeaway 

Always pay attention to the trail of M&A actions that companies leave behind. It's an indisputable fact that something is indeed going on, and that some transition is underway. In Oracle's case, it's a story of a company which consistently denied having anything to do with SaaS, to a company that now wants to become the world leader in that very field. 

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Shmulik Karpf 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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