Oracle (NASDAQ:ORCL) and SAP (NYSE:SAP) have been fierce competitors for some time. The two enterprise software companies are similarly structured and have stock prices that fluctuate in lockstep with each other. In the last six months, however, we have seen a very rare trend: SAP is strongly outperforming Oracle. During this time, SAP shares are up 22.9 percent while Oracle shares are only up 9.3 percent. Over the last 5 years, Oracle has outperformed SAP by 16.7 percent, so this trend reversal is very odd when considering Oracle is more than twice the size of SAP in terms of revenue, has 12.8 times as much cash, and the general trend in enterprise software has recently been leadership through acquisition. In this article, I further explain why Oracle is a better buy.
From a valuation standpoint, it appears that Oracle is very undervalued in comparison to SAP. SAP's 5-year projected earnings growth is 12.3 percent, which is only slightly higher than Oracle's 12 percent. However, SAP's December 2013 forward P/E ratio is very high at 22.77 when compared to Oracle's forward P/E ratio of 12.26. Neither an earnings growth percentage difference of 0.3 percent nor any competitive advantage that SAP has can account for such a large difference in P/E ratio.
In addition, Oracle is in a much better position to make acquisitions than is SAP. With many businesses looking to switch to cloud systems within the next 10 years, the two companies may need to completely revolutionize their delivery models in order to stay relevant. This will require Oracle and SAP to buy new systems companies not only to expand their product offerings, but also to bring on top talent to help overhaul their existing product lines. As previously mentioned, Oracle has a lot more cash, in relative and absolute terms, and is in a much better position to hold its position in the market going forward.
One reason why Oracle may be so much cheaper is investor fear that its stock price will take a significant hit if it acquires a larger systems company. Typical acquisition targets for Oracle and SAP don't come cheap. For example, Workday (NYSE:WDAY), a cloud-based enterprise application company, has a market cap of over $9 billion with only $270 million expected revenue for 2013, giving it a forward price-to-REVENUE ratio over 33. Although this is a legitimate concern, I believe Oracle can make any necessary acquisitions with its existing non-operating cash and its future earnings will not be significantly altered by acquiring a company that is not profitable.
In conclusion, I put a Buy recommendation on Oracle and a Hold recommendation on SAP. Because many large companies have plenty of cash to make systems investments and systems can be a source of competitive advantage, I believe Oracle and SAP will continue to outperform the market and provide nice returns for shareholders. Because of a huge difference in valuation and its large stockpile of cash, Oracle is definitely the better buy right now. I currently have a 1-year target price of $41 on Oracle (currently trading at $35.01) and a 1-year target price of $82 on SAP (currently trading at $79.70).
Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.