Uh-Oh Oracle - Lack Of Revenue Growth Poses A Threat To The Valuation

| About: Oracle Corporation (ORCL)

Shares of Oracle (NASDAQ:ORCL) have seen a more than 10% correction over the past trading week. Last week, the enterprise software giant reported its fourth quarter results after the close on Thursday.

The slightly disappointing outlook and general weak sentiment are the major reasons behind the correction, as investors are fearful about the lack of revenue growth at the company.

Fourth Quarter Results

Oracle generated fourth quarter revenues of $10.9 billion, unchanged from the year before. Reported revenues fell short of consensus estimates by around $100 million.

Non-GAAP earnings fell by 1% to $4.1 billion, while non-GAAP earnings per share actually increased by 5% to $0.87 per share on the back of sizable share repurchases.

Luckily for investors the gap between GAAP and non-GAAP earnings narrowed, as GAAP net earnings rose by 10% to $3.8 billion. Again, GAAP earnings per share outpaced actual net earnings growth on the back of the smaller number of outstanding shares. GAAP earnings rose by 17% to $0.80 per share and were in line with consensus estimates.

CEO Larry Ellison made some upbeat comments about developments during the quarter:

"Exadata, Exalogic, Exalytics, SPARC SuperCluster and our other engineered systems grew at a rate of 45% in Q4 as we took considerable market share from our primary competitor - IBM P-Series - which declined 32% in their most recent quarter."

Looking Into The Results

Flat revenue growth was disappointing, but is partially explainable due to a strengthening dollar. In constant currencies revenues were up by 2%.

Software revenues continued to grow at a healthy 4%, coming in at $8.4 billion. The pain was felt in both hardware systems and service revenues which both fell by 9% to $1.4 billion and $1.1 billion, respectively.

Impressive was the cost reduction which the company achieved. Operating expenses fell by 6%, just below the $6.0 billion mark, despite a 5% increase in sales and marketing efforts.

As a result, operating income rose by 9% to exactly $5.0 billion, boosting net income by 10% to $3.8 billion. As the company retired more than 5% of its shares over the past year alone, earnings per share saw an extra boost.

Looking Into The Fiscal 2014

Oracle is cautious for the immediate outlook after a difficult quarter for ERP providers. Like many other competitors, Oracle's earnings failed to impress shareholders and investors.

Non-GAAP earnings for the first quarter of its fiscal 2014 are expected to come in between $0.56 and $0.59 per share, while GAAP earnings should come in between $0.42 and $0.45 per share. In comparison, last year Oracle earned $0.41 per share.

Excluding the positive earnings per share impact of the share repurchase program, earnings are expected to even fall on the year. On average, analysts are looking for non-GAAP earnings of $0.58 per share for the current first quarter.

The disappointing guidance is attributed to difficulties in closing deals on the back of the economic environment. Oracle stresses that it is not losing business to some of its competitors.

Softening The Pain For Shareholders

Oracle's earnings report, and especially its outlook, came in a little below expectations. As a result, the company's board of directors took the opportunity to use the strong balance sheet to increase payouts to its shareholders.

Oracle will double its quarterly dividend to $0.12 per share, for an annual dividend yield of 1.6%. The board furthermore increased its repurchase program authorization to $12 billion in addition to its current program.


Oracle ended its fiscal year of 2013 with $32.2 billion in cash, equivalents and marketable securities. The company has $18.5 billion in total borrowings and notes payables outstanding, for a net cash position of $13.7 billion.

Oracle generated full year revenues of $37.2 billion for the fiscal year of 2013, essentially unchanged from the year before. Net income advanced by 9% to $10.9 billion. The sizable share repurchase program resulted in a 15% increase in earnings per share, coming in at $2.26 per share.

Trading around $30 per share, the market values Oracle at around $141 billion. This values the company's operating assets at $127 billion. As such, the firm is valued at 3.4 times annual revenues and 11-12 times annual earnings.

As Oracle doubled its quarterly dividend to $0.12 per share for an annual dividend yield of 1.6%.

Some Historical Perspective

The correction on the back of the earnings report has wiped out the entire gains year to date for 2013, as shares have moved into negative territory.

Shares rose from lows of $15 in 2009 and have steadily advanced to highs of $35 in 2011, levels which the company has re-tested in March when shares fell back towards $30 per share following disappointing third quarter results.

Between its fiscal 2009 and 2013, Oracle has expanded its annual revenues by a cumulative 60% towards $37 billion. Net income doubled to $10.9 billion in the meantime. As revenue growth has stagnated over the past year, Oracle resorted to initiating and hiking dividends, and repurchasing its own shares at a high pace.

Investment Thesis

Obviously, investors are disappointed and concerned about some emerging trends. Revenue growth in Latin America and in some parts of Asia-Pacific, notably Australia, was clearly disappointing.

Adding to that is the difficult economic environment, which makes it difficult for the company to close deals and implicitly results in lower earnings in the first quarter compared to a year ago. This is despite all the promising cloud developments. Yet the consensus is that Oracle cannot entirely blame the poor results to the macro-environment, but execution is an issue as well.

Oracle generated cloud revenues at a run rate of about $1 billion per annum, as the company claims it is bigger than SAP (NYSE:SAP) and Workday (NYSE:WDAY) combined. The company also grew its business at impressive rates, adding 500 new SaaS customers including some large multinational client during the quarter.

Oracle almost solely relies on software sales which crossed the $10 billion revenue mark this year, growing at 6% in constant currencies. The mathematics imply that full year revenue growth could accelerate into 2014, as the drag from hardware sales should end. The hardware business, resulting from the $5.6 billion acquisition of Sun Microsystems back in 2010, has notoriously underperformed as it continued to report declining revenues.

Yet Ellison remains positive about the developments at the company including the Exa range products in the hardware atmosphere, with Oracle claiming to gain market share from IBM (NYSE:IBM). The company is eager to impress analysts with facts about its cloud-offerings including the fact that it has some 5,000 cloud customers, with a daily user base of 8 million, resulting in 16 billion transactions per day.

Yet the company is seeing a lot of competition in the field. Cloud growth is not resulting in total revenue growth as legacy businesses continues to decline. Still the company is confident that its offerings based on Oracle Database and Java, with an active and large community of developers, should boost its competitive position and restore long-term revenue growth. On its earnings call, Oracle already pre-announced a partnership with competitors including Salesforce.com (NYSE:CRM) to make its offerings compatible between multiple platforms.

Oracle's problem is simple, lack of meaningful revenue growth. Margin expansion and strong cash balances continue to boost earnings per share for now, but the company needs long-term revenue growth to boost the value of the franchise. To comfort investors in the meantime, Oracle has started to tap its massive cash balances by increasing payments to its shareholders.

During the quarter, Oracle repurchased roughly 85 million shares for $2.8 billion, repurchasing its shares at a rate of almost 8% per annum. On top of that comes the doubled dividend at $0.12 per share, implying that Oracle is actually returning cash faster than it earns at the moment. All this makes the current valuation appealing, at just 12 times earnings, and should provide support for shares.

Yet there are some clear warning signs. Just like Hewlett-Packard (NYSE:HPQ) has seen to a greater extent, other big technology names like Cisco Systems (NASDAQ:CSCO), and Intel (NASDAQ:INTC) have seen really poor share price performances in recent years, as the market view has changed. These businesses are no longer valued on growth, but are seen as "value" stock, often placing a discount on the valuation on the fear of paradigm shifts in their respective businesses.

The same might apply for Oracle, even as the company aims to be a leader in the cloud, among others. The company has to make transformational steps in the coming years, to secure future revenue growth, and investors are not 100% confident in its ability to execute on this plan.

I remain on the sidelines, balancing between the attractive current fundamental valuation and the fear of a long-term demise caused by lack of revenue growth.

Disclosure: I am long WDAY. 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.