Oracle (ORCL) is one of the largest software companies in the world. With a market cap of $155B, sales near $37B, and net income last year over $10B, Oracle is definitely a force not to be forgotten in the tech world. Only Microsoft (MSFT) and IBM (IBM) are larger according to the Software Top 100.
Traditionally Oracle is famous for its relational database. Almost anyone who works in IT in large corporations will have run across Oracle as a major database vendor. By 2011 the company had over 48% market share in the relational database market. Other major competitors are IBM and Microsoft, with about 20 and 17% market share respectively. There are some newer types of database technologies such as HANA from SAP AG (SAP) which have seen impressive growth over the past two years. HANA is an in memory appliance which is purportedly much quicker than traditional RDBMS. However SAP's market share still remains below 5%, and it will take time before it becomes a serious player in the industry. At least in the coming few years, Oracle still is assured to maintain its dominant position in the market.
Investors should also realize that Oracle has become much more than a database company over the past decade. In a similar style to IBM, the company has embarked on a shopping spree and used its cash to buy lots of companies and expand its reach. Since 1994 the company has made more than 80 acquisitions, most of which happened since 2005. The mega deals have included: Sun Microsystems in 2010, BEA Systems in 2008, Siebel in 2006, and PeopleSoft in 2005. These deals strengthened the company's position in enterprise servers, storage, middleware, CRM, SCM, and HRMS.
Here I've outlined 6 reasons that I think Oracle is a solid value pick for your portfolio:
- Impressive and Consistent Growth - Oracle has continued to grow consistently over the past 10 years. The company has increased sales and earnings every single year (Yes, even in 2009). Sales and earnings have quadrupled since 2003. Sales from $9.5B to $37B, and earnings per share from 0.43 to 1.96. That is a CAGR of 16%.
- Competitive Moat Remains Strong - Oracle has built a strong position in the enterprise IT market over the past decades. One thing I really like about its core business in databases, is that it is such a critical component that businesses will always pay top dollar for it. I know personally having worked in several large organizations as an IT professional, databases is one area that companies do not go cheaply on. Companies I have worked in have looked to cut costs by introducing open source software in their middleware layers, document management systems, and portal software. For databases there are also alternatives, but this was the last area that they would touch because keeping enterprise data secure is a top priority.
Quality and reputation win over price in this case, and this bodes well for Oracle maintaining its competitive advantages in its core business. Indeed, the company still maintains an operating margin of 35% which is well above the industry average in the low 20s. The company's enterprise software and cloud licensing continues to grow, with revenues growing 5% in the most recent quarter. Hardware sales (mostly from the SUN acquisition) continue to struggle, down over 20%. It should be noted however that this is a small part of the overall business, only 17% of revenue in 2011. With trailing 12 month gross, operating, and net margins all a few hundred basis points better than the 5 year averages, it would seem that the competitive advantages of the company are at least as strong if not better than a few years ago.
- Analysts are positive on the Stock - Not surprisingly Oracle is very well covered with 35 analysts providing estimates. By in large they are bullish on the company, with 12 month price targets averaging $36/share and 5 year expected EPS growth about 12% per annum.
- Strong Balance Sheet - The balance sheet remains quite strong. Despite numerous acquisitions, Oracle maintains a debt/equity ratio of 0.33 and a current ratio of 2.74. There is $31B in cash and less than $15B in debt. With FCF at nearly $12B per year the company would seem well positioned for further expansion.
- Value Investing Gurus Like The Company - Earlier this year Seth Klarman's Baupost Group bought a $425m worth of Oracle stock making it the fund's second largest holding. Klarman is an extremely well respected value investor, whose hedge fund has averaged about 20% returns since 2002. Besides Klarman, Oracle has also shown up on the magic formula screens from Joel Greenblatt in the past year. This strategy highlights good companies trading at cheap prices, by looking at their ROIC compared to the price paid, using EBIT/EV. With an EBIT/EV of 9.5% and ROIC at over 200%, Oracle looks attractive by these measures.
- Attractive Valuation - The company has a forward P/E of only 11, which is below the 5 year lowest P/E of 13.5. The PEG ratio is also just under 1, and the EV/EBITDA is quite reasonable at 8. The EV/EBITDA is lower than both direct competitors IBM (8.97) and SAP (13). Only Microsoft has a lower value at 6. Looking at discounted cash flows, the company is at least fairly valued, and as much as 45% undervalued if you use growth assumptions based on the historical 10 years, as is done in this GuruFocus fair value calculator.
Personally, I would use a lower discount rate (6%), and lower growth assumptions, somewhere in the 5-10% range which then gives an intrinsic value between $42-60/share. With the sheer size of Oracle I do not think the company will be able to sustain growth rates nearly as high as in the past 10 years. However, even you take a very conservative assumption that the company only grows at 5%, you can still make a case for a valuation that is greater than $40/share, especially with $6.5/share in cash on the balance sheet. This gives a margin of safety at minimum of 25%, and potentially much higher. I am therefore quite confident in the valuation of Oracle today.
Oracle is a steady growing software company that has a long established brand and a solid reputation. The company is attractively valued, retains a strong competitive moat, and is well poised to continue doing well over the coming years. I recommend the company as a fine choice to add to your portfolio today.
Disclosure: I am long MSFT.