On December 20, 2012, Oracle Corporation (ORCL) announced that it has entered into an agreement to acquire Eloqua, Inc. (ELOQ) for $23.50 per share, or approximately $871 million, net of Eloqua's cash. The acquisition, which comes approximately at 10 times Eloqua's TTM revenue, looks expensive by that measure. However, if you dig a little deeper into the numbers and consider the overall value Oracle might extract out of it, it may not be as expensive as it seems.
Before we get into the details and Oracle's possible logic behind the purchase, let's get introduced to the company and what it does. Eloqua is a leading provider of on-demand Revenue Performance Management, or RPM, software solutions that are designed to enable businesses to accelerate revenue growth and improve revenue predictability by automating, monitoring and measuring their complex marketing and sales initiatives. Eloqua completed its IPO in August 2012, when it raised $88m.
Based upon the securities registration statement filed by Eloqua, "Forrester Research, Inc. predicts that spending on interactive marketing in the United States will increase from $34.5 billion in 2011, or 16% of overall U.S. marketing expenditures, to $76.6 billion in 2016, or 26% of overall U.S. marketing expenditures. Within this category, spending on email, mobile and social media marketing is projected to grow from $4.8 billion in 2011 to $15.7 billion in 2016, representing a compound annual growth rate, or CAGR, of 27%. Business spending on automating, analyzing and optimizing marketing and sales functions is also projected to increase. International Data Corporation, or IDC, predicts that the marketing automation market will grow from $3.7 billion in 2011 to $5.5 billion in 2016, while the CRM analytics market, which includes marketing and sales analytics, is projected to grow from $2.2 billion in 2010 to $3.4 billion in 2015."
Eloqua has traditionally competed with Marketo, Hubspot, Aprimo, Unica and Pardot. Eloqua has a bit of first mover's advantage after having been founded in 1999. Marketo and Pardot had revenue of $33m and $7.4m in 2011 and Hubspot expects revenue of $52m in 2012. TTM revenue for Eloqua is $90m.
Let's now look at the possible logic behind Oracle's Eloqua acquisition.
Competitive Positioning: Although Oracle has owned the IP assets of Market2Lead, a provider of demand generation and marketing automation software, since 2010, apparently it is not enough. You see, the marketing automation software field has witnessed some consolidations lately. Unica was acquired by The Big Blue (IBM), Aprimo was acquired by Teradata Corporation (TDC) and Pardot was acquired by ExactTarget (ET). So one obvious reason why Oracle is acquiring Eloqua is to strengthen its competitive positioning vis-à-vis these and other cloud competitors such as SAP AG (SAP), Salesforce.com (CRM) and Microsoft (MSFT). With things heating up in this space, we would not be surprised if Marketo gets acquired by some company like Salesforce before the ink dries on Oracle's Eloqua acquisition.
M&A as growth Engine: Eloqua is closing in on a $100m annual revenue run rate, which is expected to grow at double digits during the next few years. Oracle, which has spent over $50 billion on more than 80 deals since the mid 90s, is one of the better acquirers in the tech industry. Oracle's cloud-computing software is on track for $1 billion in revenue and "will become much bigger over time," as per its co-President Mark Hurd, who was the CEO of Hewlett-Packard (HPQ) before joining Oracle. In an interview on Bloomberg Television's "Bloomberg West" after Oracle's estimate-beating FY2013 Q2 results, Hurd said "strong M&A" and the addition of 3,000 salespeople over the past year and a half helped lift software sales, and boosted new license sales in Europe. Obviously acquisitions such as Eloqua bode well for continuing this momentum.
It makes perfect financial sense: The third and in our opinion the most important reason for the acquisition is purely financial. Eloqua, which has yet to show positive net income, is operating in a very high growth field. Any buyer would obviously keep the growth synergies in mind when making a bid for it, however what makes the move by Oracle brilliant is that the potential cost synergies alone should make the acquisition work very well.
Let's start with Eloqua's numbers to understand why the acquisition makes sense for Oracle. Here are the numbers from Eloqua's income statements.
2011 | TTM | |
Revenue | 71348 | 90106 |
Cost of revenue | 23048 | 25808 |
Gross profit | 48300 | 64298 |
Research and development | 11679 | 13050 |
Marketing & Sales | 29481 | 37063 |
G&A | 12208 | 18795 |
Total SG&A | 41689 | 55858 |
Total operating expenses | 53368 | 72408 |
Operating income | -5068 | -8110 |
Other income/ expense | -707 | -560 |
Income before taxes | -5775 | -8670 |
Provision for income taxes | -378 | -300 |
Net income | -6153 | -8970 |
Accretion of redeemable Preferred Stocks | -89659 | -84271 |
Net income/ loss available to common shareholders | -95812 | -93241 |
Basic - EPS | -0.25 | -2.71 |
Diluted - EPS | -0.25 | -2.71 |
Basic - WA Shares Outstanding | 24275 | 34461 |
Diluted - WA Shares Outstanding | 24275 | 34461 |
Source: Morningstar and SEC filings (in thousand Dollars except per share numbers)
As you can see, 2011 and TTM net income are both negative. The revenue has been rising and so are the sales, marketing, general and administration expenses. Some part of the increased expenses can be explained by the fact that the company went public this year and obviously had to invest in accounting, finance, legal, compliance and IR departments. Secondly, you may notice the big accounting charges ($89.66m during 2011 and $84.27m during the TTM) caused by the accretion of the dividends for the preferred convertible stocks. Now this is what was making matters worse. That is, until Eloqua's IPO. You see, after the close of Eloqua's IPO earlier this year, all the classes of its convertible preferred stocks were converted to common stocks based upon their carried amounts and therefore the dividends ceased to accrue.
On one hand, the publicly listed stocks facilitate a nice payday for Eloqua's early private investors and on the other hand, the absence of accruing dividends results in a faster path-to-profitability for Eloqua. This is where Oracle comes into the picture. Despite being one of the biggest acquirers in the tech industry, Oracle has consistently grown its revenue, income and free cash flow while reducing its expenses all this while. With its well oiled M&A machinery, Oracle can squeeze much more juice out of an acquired company, than any other company out there. In fact, as we shall see shortly, it does not have to sweat a lot to get juice out of Eloqua.
Obviously we are not aware of the exact details of the deal; we shall still attempt to come up with a simple pro forma statement for Eloqua post-acquisition, with some reasonable assumptions.
Numbers & Facts known: Before we make assumptions about the future, here are numbers/facts we already know.
- The purchase price is $871m, which is 9.7 times of TTM revenue. In addition, the outstanding stock options, RSUs etc will also have to be paid off.
- Eloqua's revenue has grown at 24% and 41% in FY2010 and FY2011.
- As per the sell-side analysts, Eloqua's revenue growth for FY2012 (its fiscal year ends in December) is estimated to be 31.6%. TTM revenue already shows a growth of 26.3% over 2011 so 31% does not look that farfetched.
- Here are the various line items as a percentage of revenue for Eloqua during the last 3 years and for Oracle in the FY2012.
ELOQ | ORCL | ||||
2009 | 2010 | 2011 | TTM | 2012 | |
Revenue Growth Rate | 24.0% | 40.5% | 26.3% | ||
Cost of Revenue as % of Sales | 21% | 20% | 32% | 29% | 21% |
Gross Margin | 79% | 80% | 68% | 71% | 79% |
R&D as % of Sales | 0% | 0% | 16% | 14% | 14% |
Total SG&A as % of Sales | 58% | 62% | 22% | ||
Operating Margin | 79% | 80% | -7% | -9% | 37% |
Effective Tax Rate | 26% | ||||
Capex as % of Sales | -3.5% | -3.6% | -4.1% | -3.9% | -1.7% |
Source: Morningstar and SEC filings
Assumptions: Following table shows the assumptions we are making for Eloqua operations (as part of Oracle Corporation), followed by the logic behind these assumptions.
2013E | 2014E | 2015E | 2016E | 2017E | 2018E | 2019E | |
Revenue Growth Rate | 20.00% | 15.00% | 13.00% | 10.00% | 9.00% | 8.00% | 7.00% |
Cost of Revenue as % of Sales | 26.0% | 24.0% | 21.0% | 21.0% | 21.0% | 21.0% | 21.0% |
R&D as % of Sales | 14% | 13% | 12% | 12% | 12% | 12% | 12% |
Total SG&A as % of Sales | 49% | 35% | 22% | 22% | 22% | 22% | 22% |
Effective Tax Rate | 35% | 30% | 26% | 26% | 26% | 26% | 26% |
Capex as % of Sales | 3.1% | 2.4% | 1.7% | 1.7% | 1.7% | 1.7% | 1.7% |
Source: Morningstar and SEC filings
Revenue Growth: The revenue growth rate assumptions for Eloqua during the next 7 years are the following: 20%, 16%, 13%, 10%, 9%, 8% and 7%. Do we think these are aggressive growth assumptions for Eloqua? On the contrary, we believe these are conservative assumptions. Check the following:
- Eloqua's actual revenue growth rates in the last three years are 24%, 41% and 31%E and as you can see from the Forrester Research quote earlier, it's going to be a high growth space.
- Oracle, which 10 years ago, had 100 times bigger revenue than Eloqua's current revenue, has grown its revenue, income and free cash flow at double-digits CAGR since then.
- The sell-side analysts expect Oracle, which now has revenue ~ 400 times of Eloqua's revenue, to grow its EPS by 13% in the next five years.
Expenses: In general, we're going to assume that the expenses in Eloqua operations are going to be reduced gradually to finally be in line with Oracle's in the third year of operation and they remain constant afterwards. This is due to the economies of scale, purchasing power, marketing muscle, operational efficiencies, leadership and other expertise Oracle brings to the table. Specifics of the individual line items are discussed below.
Cost of Revenue: The cost of revenue as a percentage of the revenue, for Eloqua and Oracle are 29% and 21% respectively. For Eloqua, these are made up of capitalized software hosting costs and depreciation expenses associated with computer equipment such as servers, rent, IT costs, and depreciation and amortization to cost of revenue based on headcount. Oracle, which does all this for a living, can bring great savings in each one of these expenses.
We are assuming the cost of revenue to be 26% in FY 2013, 24% in FY 2014 and finally matching Oracle's 21% in FY 2015.
R&D Expenses: The R&D costs as a percentage of the revenue, for Eloqua and Oracle, are 14% and 12% respectively. Historically, Oracle's R&D spending has been around 12%-13% in the last 10 years. Again we are assuming that Eloqua's R&D expenses would drop by a couple of points to catch up with Oracle's, in the third year of operation.
SG&A Expenses: Selling, general and admin expenses as a percentage of the revenue, for Oracle and Eloqua stand at 22% and 62% respectively. This is typically where the most cost savings are realized. Oracle despite those $50 billion worth of deals since 2005 has been able to contract its SG&A expenses by 371bp. That's simply incredible. We don't see any reason why Eloqua's SG&A won't fall in line with Oracle's. We're assuming SG&A expenses for the 1st, 2nd and 3rd years of operation are 49%, 35% and 22% i.e. it takes 3 years for SG&A expenses to match Oracle's.
Effective Tax Rate: Eloqua is unprofitable right now, so its tax rate is meaningless. Oracle on the other hand, has been able to reduce its effective tax rate from 29% in FY2005 to 23% in FY2012. We are assuming an effective tax rate of 35%, 30% and finally 26% (3% higher than Oracle's mainly because Oracle is much more diversified in various tax jurisdictions) in the 1st, 2nd and third years of operation.
Capital Expenditure: The capex as a percentage of revenue for Eloqua and Oracle are 3.9% and 1.7% respectively. Oracle has been able to keep its capex almost flat during its acquisition spree. In FY2005, it spent 1.6% of revenue on capital expenditure and in FY2012, it spent 1.7%. We are therefore assuming Eloqua's capex for next 3 years to be 3.1%, 2.4% and finally 1.7% of revenue.
Deal Financing: Oracle has $34 billion in cash & equivalents in its coffers as of Nov 30, 2012. Although the majority of it ($26 billion) is held overseas, it has plenty ($8 billion) in the U.S. Make no mistake, Oracle has an A+ S&P Issuer credit rating and can avail debt financing at very good rates. In fact, it secured $2.5 billion 5-year senior notes at 1.5% and $2.5 billion 10-year senior notes at 2.5% in October 2012. So if it wants, it can use debt financing for the deal, however we think it's going to make use of its cash in order to get better returns than what the cash is earning right now. Oracle's capital allocation policies are generally shareholder friendly and we don't see any reason why it will be different this time.
Therefore we are assuming that Oracle is using its cash to finance the deal.
Purchase Price Allocation: We also need to find out how the purchase price is going to be allocated to various items such as tangible assets, liabilities, identifiable intangible assets and goodwill. There is no formula for such allocations as it varies from deal to deal. We can however use Oracle's prior acquisitions as a guideline to come up with the reasonable estimates. The following table shows some of the deals, Oracle has made recently along with the percentage of purchase price it allocated to various items.
As you can see, on an average, Oracle has on spent 45% of purchase price on "Identifiable Intangible Assets" and 52% on the goodwill. From Eloqua's future income point of view, the item we're most interested in is IIA, as it can be amortized. In the deals below, IIAs were amortized over a period of 1 to 10 years.
Target | Date | Total Price | Cash | Options & RSUs | IIA (Amortized) | TA | Liabilities | Goodwill | Sum |
Taleo | 4/5/2012 | 2000 | 2000 | 10 | 1100 | 267 | 1200 | 2033 | |
54% | 13% | 59% | 100% | ||||||
RightNow | 1/25/2012 | 1500 | 1500 | 14 | 697 | 247 | 1100 | 1550 | |
45% | 16% | 71% | 100% | ||||||
Others | 2012 | 1600 | 1600 | 5 | 540 | 29 | 1100 | 1611 | |
34% | 2% | 68% | 100% | ||||||
ATG | 1/5/2011 | 1000 | 900 | 16 | 404 | 111 | 491 | 1006 | |
40% | 0% | 49% | 100% | ||||||
Phase Forward | 8/11/2012 | 736 | 735 | 1 | 370 | 37 | 329 | 736 | |
50% | 0% | 45% | 100% | ||||||
Sun Microsystems | 1/26/2010 | 7300 | 7200 | 99 | 3300 | 2615 | 1400 | 7315 | |
45% | 0% | 19% | 100% | ||||||
AVERAGE | 45% | 52% |
Source: Oracle's SEC filings (in million dollars)
As a result, we're going to allocate $348.4m, which is 45% of the acquisition price $871m, to "Identifiable Intangible Assets" and we're going to amortize it over 7 years, using the straight line method.
Pro Forma Statement: With the facts and assumptions laid out above, here is the pro forma statement for Eloqua operations for the next 7 years.
2011 | TTM | 2013E | 2014E | 2015E | 2016E | 2017E | 2018E | 2019E | |
Revenue | 71348 | 90106 | 108127 | 124346 | 140511 | 154562 | 168473 | 181951 | 194687 |
Cost of revenue | 23048 | 25808 | 28113 | 29843 | 29507 | 32458 | 35379 | 38210 | 40884 |
Gross profit | 48300 | 64298 | 80014 | 94503 | 111004 | 122104 | 133094 | 143741 | 153803 |
Research and development | 11679 | 13050 | 15138 | 16165 | 16861 | 18547 | 20217 | 21834 | 23362 |
Marketing & Sales | 29481 | 37063 | |||||||
G&A | 12208 | 18795 | |||||||
Total SG&A | 41689 | 55858 | 52982 | 43521 | 30912 | 34004 | 37064 | 40029 | 42831 |
Total operating expenses | 53368 | 72408 | 68120 | 59686 | 47774 | 52551 | 57281 | 61863 | 66194 |
Operating income | -5068 | -8110 | 11894 | 34817 | 63230 | 69553 | 75813 | 81878 | 87609 |
Other income (expense) | -707 | -560 | |||||||
Income before taxes | -5775 | -8670 | 11894 | 34817 | 63230 | 69553 | 75813 | 81878 | 87609 |
Provision for income taxes | -378 | -300 | -4163 | -10445 | -16440 | -18084 | -19711 | -21288 | -22778 |
Net income | -6153 | -8970 | 7731 | 24372 | 46790 | 51469 | 56102 | 60590 | 64831 |
Accretion of redeemable Preferred Stocks | -89659 | -84271 | 0 | 0 | 0 | 0 | 0 | 0 | 0 |
Net income (loss) available to common shareholders) | -95812 | -93241 | 7731 | 24372 | 46790 | 51469 | 56102 | 60590 | 64831 |
Basic - EPS | -0.25 | -2.71 | |||||||
Diluted - EPS | -0.25 | -2.71 | |||||||
Basic - WA Shares Outstanding | 24275 | 34461 | |||||||
Diluted - WA Shares Outstanding | 24275 | 34461 | |||||||
Depreciation & amortization | 1872 | 2030 | 49771 | 49771 | 49771 | 49771 | 49771 | 49771 | 49771 |
Operating cash flow | 2737 | 2702 | |||||||
Capital expenditure | -2898 | -3535 | -3352 | -2984 | -2389 | -2628 | -2864 | -3093 | -3310 |
Free cash flow | -96838 | -94746 | 54151 | 71159 | 94173 | 98613 | 103009 | 107268 | 111293 |
FCF/Purchase Price | 6.2% | 8.2% | 10.8% | 11.3% | 11.8% | 12.3% | 12.8% |
In thousand dollars
RESULT:
- Eloqua which has been operating at a loss immediately starts showing positive income. To be fair, with the preferred dividends out of the picture, it was going to show positive income sooner or later; the Oracle deal speeds the things up a bit.
- The biggest difference caused by the change in control however is in the free cash flow generation. Amortization of the assets helps here a great deal.
- Most importantly, Oracle, by using its cash, which was earning a pittance earlier, is able to get returns of 6.2% in the first year itself, which actually keeps on increasing at a CAGR of 13%. This is why I said that Eloqua deal makes sense from the cost synergies point of view alone.
Other Benefits:
Growth in Eloqua Business: Even though we did not consider high growth synergies in our analysis, it is quite conceivable for Oracle to sustain and possibly increase Eloqua's high growth in the years to come. That would definitely be the icing on the acquisition cake.
Cross Selling Opportunity: You should also keep in mind that Eloqua has an impressive list of the customers; as shown below, based upon its SEC filings. Now, Oracle has no dearth of customers itself but imagine what kind of cross-selling opportunity it has with the additional accounts.
Technology/Manufacturing Affymetrix AMD Cisco Dell HP Lenovo Liebert National Instruments NETGEAR SACHEM Seagate Financial Services Deutsche Bank Digital Insurance Fidelity Investments Franklin Templeton Investments Platts Schroders Standard & Poor's Trust Company of America WisdomTree Wolters Kluwer | Software ArcSight Avid Cognos Endeca GXS Informatica Manhattan Associates McAfee NetApp Nuance Perkin Elmer Rosetta Stone Schooldude.com Siemens Software AG Solarwinds Sybase TrialPay VMware Winshuttle Entertainment Golden State Warriors Miami Heat Sacramento Kings Washington Capitals WGBH Telecommunications Comcast LifeSize Savvis Telstra Terremark | SaaS/Cloud Blackboard Brightcove Concur Cornerstone OnDemand Mindbody SuccessFactors Taleo Telligent Zoominfo Business Services ADP American Express Aon BAASS Business Solutions Booz Allen Hamilton Corporate Executive Board D&B Fujitsu Harvard Business School Publishing Iron Mountain NIIT (USA) Inc. TriNet |
Eloqua as the service provider brought these customers a small tap at their homes. Oracle as the service provider can be counted on bringing a hose pipe.
Now we know why Oracle has been a great business over the years.
Conclusion: As we saw above, Oracle does not have to rely on high growth in the Eloqua business in order to achieve good returns from the acquisition. It just has to do what it usually does best and things will be taken care of. We remain a long-term investor in Oracle.
