Oracle Widens Moat With Public Cloud Service
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Oracle (NASDAQ: ORCL) recently launched its much anticipated public cloud computing service called Oracle Cloud. The service will offer a suite of Oracle products and applications that will be delivered to its clients via remote access over the Internet. It will be everything an enterprise needs.
The portfolio of applications include web, mobile, analytics services, enterprise resource planning, human capital solutions, talent management and other key applications. Each client will pay a monthly subscription fee to access these services. The client can access the applications instantly and updates will be automatic.
The savings from using cloud are substantial over time as it lowers the cost of using the company’s data. There will be no more licensing fees that the enterprise will have to pay. There will be no more servers that consume a lot of floor areas. As the enterprise scales up, the cost savings will be higher.
Oracle’s Impregnable Moat
The company’s built-in moat is its core strength in enterprise software. It has basically bought out more than 50 companies since 2005. It has spent more than $40 billion in acquisitions. This basically extended their product offerings and portfolio, as well as contributed to the high switching costs of the Oracle model. The notable deals include PeopleSoft, StorageTek, BEA and Sun. Moving forward, it plans to develop in-house corporate applications for the cloud and acquire software companies. I believe that Oracle will snap up smaller software names and build applications.
The announcement of its cloud offering cemented its position as the leader in the applications space. The cloud arranges all of Oracle’s applications under one ecosystem. If you’re a client and you heard that Oracle will be offering all of its products for a fixed monthly fee, what are the chances that you will be switching the service to competitors such as Microsoft (NASDAQ: MSFT) and IBM (NYSE: IBM)? The chances are slim. If you’re the chief technology officer, it will cost you your job if you decided to switch to competitors just because they are offering lower prices for its cloud computing services.
The move also addresses the concerns about open-source software and software-as-a-service offerings (SAAS) that will have impact on its profitability. It will also reduce its reliance on hardware from the acquisition of Sun Microsystems a couple of years ago. Over the long run, the company will continue to add new cloud-based product offerings. In fact, it has announced its intentions to include accounting, supply chain management and enterprise resource planning moving forward. There are also speculations that it could also increase the demand of Oracle software and services on tablet computers and mobile devices.
Is Oracle a little too late in the game?
There are concerns that Oracle may be too late in the cloud computing space. CEO Larry Ellison said that it took them 7 years before finally making it to the cloud. The leading competitors like Salesforce.com (CRM) and Workday have already strengthened their competitive positions through the years.
However, the cloud computing industry is still at a nascent stage. According to research firm Forrester Research, the global cloud computing market will grow from $40.7 billion in 2011 to $241 billion in 2020. This is more than 5 times growth for the next 10 years. There is no saturation at this point in time. The report also mentioned that the infrastructure as a service market will only peak in 2014. After its peak, the segment will experience commoditization of its products resulting in margin pressure and lower average selling prices. On the other hand, the SAAS market will come to saturation only in 2016. It will continue to grow to a $92.8 billion industry from the current $21 billion market. It is also expected that new technology will come after saturation of the incumbent products.
This means that technology will constantly be changing. This bodes well for a giant such as Oracle. This will also give the company the chance to tap into the significant opportunity in this space. It has the capacity to acquire companies that have strong potential, as well as develop in-house products to address the demand of the products. It currently has net cash of almost $15 billion and annual operating cash flow of $14 billion year. This is more than enough to acquire smaller names in this sector.
Its software segment has an average revenue growth of 15% over the last 5 years. However, it has significantly declined from its peak revenue growth of 26%. The reason is that it has allowed its competitors to eat up its market share in the sectors it operates. CEO Larry Ellison has acquired smaller competitors to address the issue of increased competition. While this may seem a defensive move, it appears that the past acquisitions have worked out well. It also yielded incremental revenues for the company. Moving forward, this will change as its revenues from applications will contribute significantly given the launch of its public cloud offering.
Oracle’s Market Valuations: Not Valued as a Growth Play
The stock is currently trading at 11 times 2012 earnings. It also carries a dividend yield of 0.90%. If you look at earnings growth of 12% for the next 5 years, the stock seems cheap. In fact, its price to earnings over growth ratio is at 0.95 times, implying that the market is not valuing the stock as a growth play. It could be due to the overall concerns on the technology sector as a whole. The current macroeconomic environment suggests that short term corporate IT spending will still be slower than expected.
In contrast, other technology stocks are valued higher. SAP AG (NYSE: SAP) trades at 15 times earnings and has a dividend yield of 1.65%. IBM is valued at 14 times earnings and carries a dividend yield of 1.74%. Also Microsoft trades at 14 times earnings and has a dividend yield of 4%.
Oracle’s size and competition might hinder growth, but the fundamental demand driver for its core businesses remains intact. Given the high moat it possesses and strong growth prospects, the valuation is undemanding. It would only be a matter of time before investors will pick up shares of this undervalued technology giant.
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