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Oracle (NYSE: ORCL) recently acquired portfolio-management software developer Instantis. Instantis will be integrated with Oracle's Primavera and Fusion, which are both project-management applications. This acquisition is seen as another piece in Oracle's strategy to defend against its customers defecting to cloud-based applications.
The Cloud Computing Threat
There are critics of Oracle's acquisitions strategy, but one thing is for certain: Oracle isn't standing still. Competitor IBM (NYSE: IBM) was at the top of the technology food chain decades ago, but it ignored the growth of the personal computer. Microsoft (NASDAQ: MSFT) capitalized on IBM's stumble, but it was partly asleep at the wheel when the Internet was in its infancy, and then "Mr. Softy" was slow to adapt to the new reality of mobile and tablet computing. Oracle, by contrast, is forward-looking, and it realizes that cloud computing is the future. The problem is that cloud computing is a threat to Oracle's business model, as it stands.
Oracle offers a wide variety of enterprise-level IT solutions to big businesses. This includes databases, middleware, applications, and some hardware. The vast bulk of Oracle's revenue comes from software licenses and product support, and these are also Oracle's most profitable businesses. The threat is that Oracle's customers could move to the cloud, away from Oracle's mostly on-premise solutions. To combat this threat, Oracle's strategy is twofold: 1) Make customer switching costs high, and 2) Move itself onto the cloud.
Oracle's Preemptive Defense
Rather than ignoring the growth of the PC like IBM, or the spawning of the internet like Microsoft, Oracle is actively engaging in preemptively defensive efforts to maintain its position at the top of its industry. The first element of Oracle's two-pronged strategy is to make customers' switching costs higher. Oracle does this by inserting termination penalties in its customer contracts, but just as importantly, by supplying a high quality of service. Keep in mind; the databases that Oracle hosts contain all of the key data that businesses need to function: a hiccup is unacceptable. Customers, which include Fortune 100 firms, are hesitant to risk switching, even if it switching could save a lot of money.
The second element of Oracle's defense is, in recognition of the inevitable, moving itself to the cloud, and the best way to do this is by acquiring companies that are already there. Oracle's own Primavera and Fusion products are cloud-based, and combined with the newly acquired Skire and Instantis, Oracle is positioning itself as a leader in cloud computing.
The previously mentioned IBM and Microsoft are both technically competitors to Oracle, but in reality, they're in different classes in the fields in which they compete. Oracle's real competition -- outside of the innocuous cloud itself -- are enterprise-solutions provider SAP (NYSE: SAP), and the more niche-centered, smaller businesses like Salesforce.com (NYSE: CRM) and Workday (WDAY).
SAP is the world leader in the enterprise resource-planning software industry. Its sales for the most recent fiscal year came in at $14.23 billion, and its net income was reported at $3.44 billion. Oracle's top and bottom lines crushed these figures, though, coming in at $37.12 billion and $9.98 billion, respectively -- that's because Oracle is a player in more fields than SAP. SAP offers a pure play on enterprise-level software, while Oracle also competes with firms like Salesforce.com.
Salesforce.com provides cloud-hosted customer-relationship-management software services. Workday basically does the same thing, but focuses on human capital management (HCM) services, including payroll, financial management, time tracking, and employee-expense management. Oracle has its fingers in all of these pies, and while that may seem to create an overly competitive environment for Oracle, the company's gross margins have remained high and have been rising for the past two years.
Oracle concludes its year on May 31 of each year, and for fiscal 2012, Oracle's gross profit came in at 78.8% -- that's up from 76.4% in fiscal 2011, and in 2013, Oracle's gross profit is expected to rise to 79.3% of sales. In fact, if Oracle is able to meet projections, its gross margins will be higher than at any other time in company history, and that's saying a lot for a firm whose lowest annual gross profit in the past ten years was 75.3% in 2003. In fact, Oracle's gross margins improved or stayed the same nine out of the past ten years -- this is not something you're likely to see when a company's market is overly competitive. The fact is that Oracle is just a cut above the competition.
Oracle is currently valued at 15 times trailing earnings. This means the stock is trading at a 9% discount to the industry average, and a 25% discount to its own five-year trailing P/E ratio. In forward terms, Oracle's P/E is just 9.9, which yields a PEG of less than 1. Oracle also pays a 0.8% dividend, which isn't bad for such a growth-oriented stock. The firm has more than $31 billion in cash and cash equivalents, and less than $15 billion in debt. It generates $12 billion in annual free-cash flow, making it an extremely healthy firm, from a purely financial perspective.
Oracle looks like a good long-term buy at $31 or less. Its wide economic moat and future-oriented focus make it a predictable cash generator for years to come. The recent acquisition of Instantis just solidified the general outlook and strategy of the firm. Will it cause Oracle's margins to improve? Negligibly. More importantly, it makes things tougher for Oracle's would-be competitors: IBM, Microsoft, SAP, Salesforce.com, and Workday. Even the cloud itself should be looking over its shoulder for Oracle.
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