Seeking Alpha
Long/short equity, deep value, value, special situations
Profile| Send Message|
( followers)  

We've followed Oracle Corporation (NYSE:ORCL) off and on for the last 13 years and we have seen its shares transition from a go-go growth-oriented tech company into a more value-oriented business enterprise software company. We're not ready to recommend an unconditional long position in the company, but we maintain that investors should accumulate a position in the company during market pullbacks and company specific pullbacks. We like that its adjusted consensus EPS estimate for FY 2014 is $2.79 and that gives ORCL a forward PE of 12.4X. However, we are disappointed in Oracle's soft revenue performance from its hardware division. Oracle enjoyed a solid 8% constant currency revenue growth from its software license updates and product support solutions; however, its new software licenses revenue growth stalled, its services revenues declined by 7% and its hardware revenues dropped by 15%.

(click to enlarge)
Source: Oracle's Q3 2013 Earnings Report

Oracle Hardware

We're still stunned Oracle's CEO Larry Ellison said Sun Microsystems was one of the most strategic and profitable acquisitions Oracle ever made. Based on the sales figures and gross margins of Oracle's hardware business, we have to disagree with Ellison's evaluation of the Sun Microsystems deal. But we think that Oracle's former Vice President of North American Sales and Consulting Keith Block said it best when he said, "We bought a dog. Mark wants us to sell the dog. ... Nobody wants to sell Sun. ... nobody talks about Sun. ... not even the Sun customers. It's dead, dead, dead. It baaaallllloooooooows. Pig with lipstick. ... at best." We think Mr. Block's refreshingly candid evaluation of Sun probably explains why Oracle's Hardware system product revenues declined by 23% on a reported basis (22% constant currency) in Q3 2013 and for YTD 2013.

Oracle's hardware system support revenues also declined year-over-year on a constant currency basis (5% in Q3 2013 and for YTD 2013). Although Oracle's hardware related operating expenses declined at a faster rate in relation to its revenue declines, it was not enough to prevent a decline in its hardware related operating income for Q3 2013 (3.7%) and YTD 2013 (10.5%). This followed up the poor performance in FY 2012 for the hardware product suite in which its revenues declined by 9.25% and its operating income declined by 19%. Fortunately for Oracle, its hardware revenue proportion has been declining ever since it purchased Sun in FY 2011 and its solidly stable software performance has offset the soft performance of its hardware segment which enables ORCL's consolidated revenues to hold steady.

(click to enlarge)

Source: Oracle's Last 12 Quarterly Reports

Oracle Services

Oracle Services has seen mixed results. Oracle Services' revenues received a boost in FY 2010 and FY 2011 from the inclusion of service related revenues attributed to the Sun Microsystems acquisition. Oracle Services' revenues increased by 1% in FY 2012 on a reported basis and on a constant currency basis as the incremental revenue increase coupled with declines in its service related expenses enabled it to generate a 20% increase in operating income and a 3% increase in its operating margin. Oracle Services has seen headwinds to its performance in YTD 2013, as its revenues have declined by 3% on a constant currency basis while its operating expenses have only decreased by 2% on a constant currency basis and that pushed its operating income down by 9%.

Oracle Software

Oracle Software generates the lion’s share of Oracle Corporation’s revenue and profits. Oracle Software enjoyed 8% constant currency revenue growth in YTD 2013 due to an 8% increase in new software licenses and cloud software support. Cloud related revenue for Q2 2013 was $238M, up 3.5% from $230M in Q2 2013 but down by 1% year-over-year. On a geographic basis for Q3 2013, Oracle Software’s revenue increased by 8% in the Americas, APAC was up 9% and EMEA was up 7%. With the ongoing implementation of ObamaCare, as well as new compliance and regulatory guidelines life sciences companies must face, we are expecting increased demand from corporate clients concerning Oracle Health Sciences offerings. We reached out to the well-known Oracle Health Sciences partner BioPharm Systems Inc and we were told that pharmaceutical, biotechnology and medical device companies, in addition to contract research organizations (CROs) and academic institutions (AROs), have been implementing Oracle’s clinical and pharmacovigilance systems at an increasing rate that has not been seen in recent years. For companies that want access to Oracle Health Sciences offerings but lack the technical and financial resources, BioPharm Systems offers clients the ability to host their Oracle Health Sciences and other related systems in the cloud for an affordable and predictable monthly maintenance fee. We think that cloud offerings, via partners or the Oracle Health Sciences Cloud, would also be a positive catalyst for Oracle’s healthcare offerings.

(click to enlarge)

Source: Morningstar Direct and Our Estimates

Corporate Cash Management

Oracle accelerated the payment of its quarterly dividend payments for FY 2013 into December. Instead of investors receiving $.06/share in January, April and July, investors received $.18/share in December in order to avoid facing higher dividend tax rates as the dividend tax cut was only extended for individuals making $400K/year and couples making $450K/year and filing a joint return. Oracle still generated gargantuan free cash flows for YTD 2013 of $7.6B, which was higher below the $6.4B achieved in YTD 2012. We are aware that this because this was primarily because of reduced spending on acquisitions. Oracle closed its acquisition of Acme Packet in March for $1.7B. Oracle repurchased $6.7B in shares during the first nine months of the year and has $33.4B in cash and marketable securities (mostly domiciled outside the US) versus $19.75B in outstanding debt.

(click to enlarge)

Source: Morningstar Direct

Conclusion

In conclusion, we like Oracle. We like that it has been able to generate strong EPS through incremental organic growth, share repurchases, acquiring smaller up-and-coming tech firms and creating synergies between the companies. While we don't expect ORCL's multiple to expand much over the next twelve months, we believe that Oracle is a great company to buy on the dips and we expect its share price to at least track its expected long-term EPS growth of 9%. Although Oracle made a mistake with regards to buying Sun Microsystems, we believe that Oracle's acquisition strategy will enable it to supplement its incremental organic growth from its software offerings and serve as an additional engine of growth.

(click to enlarge)

Source: Morningstar Direct and Our Estimates

Source: Oracle: Solid Software Sales Growth Offset By Hardware Headwinds

Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.