Oracle - Same Story: Lack Of Revenue Growth Remains The Issue

Sep.19.13 | About: Oracle Corporation (ORCL)

Shares of Oracle (NYSE:ORCL) are trading with modest losses of 2% in after-hours trading on Wednesday. The enterprise provider reported first quarter results which were in line with estimates, yet the second quarter outlook was a bit soft.

I remain on the sidelines as revenue growth remains a challenge, while some competitors are significantly outgrowing the company in promising cloud markets.

First Quarter Results

Oracle generated fourth quarter revenues of $8.37 billion, up 2% on the year before. Revenues fell short of consensus estimates of $8.48 billion. The strengthening US dollar had a negative impact on reported revenues, as is in constant currencies, revenues were up by 4%.

Non-GAAP earnings rose by 6% to $2.8 billion, as non-GAAP earnings per share are were up by 12% to $0.59 per share, coming in line with consensus estimates.

GAAP earnings rose by 8% to $2.19 billion, driving a 14% increase in GAAP earnings per share towards $0.47 per share. In constant currencies, GAAP earnings per share were up by 17%.

As is typically the case with Oracle's results lately, sales growth was driven by modest growth in software which was largely offset by falling hardware and service revenues.

CEO Larry Ellison commented on promising developments, "Next week at Oracle Open World, we will announce the In-Memory Option for the Oracle database. Virtually every existing application that runs on top of the Oracle database will run dramatically faster by simply turning on the new InMemory feature."

Looking Into The Results

Oracle reported a 6% increase in software revenues to $6.08 billion, as those activities now make up 73% of total revenues. Even as revenues were up by 8% in constant currencies, the reported 7% growth is new software licenses and cloud subscriptions falls way short of spectacular growth rates reported by competitors. Both total hardware and service revenues fell 6% in constant currencies.

Total operating expenses rose by 5% in constant currencies. Oracle had pretty tight cost control with exception of sales and marketing efforts which were up by 12% to $1.71 billion. Yet these investments have not really paid off yet.

Operating margins fell by 90 basis points to 34.3% of total revenues as sales and marketing efforts rose by 115 basis points to 20.4% of total sales.

As operating income was roughly flat, net earnings were driven by lower effective tax rates, which boosted the net result by a reported 8% to $2.19 billion. Earnings per share growth was a bit higher as the company retired little over 5% of its shares compared to a year ago.

Outlook

Oracle gave a little inspiring outlook for the current second quarter. Growth in the important software license and cloud subscription revenues are expected to range from negative four to plus six percent.

Total revenue growth is seen between 1 and 4% in constant dollars, and between -1% and plus 2% in US dollars. This implies that second quarter revenues could come in around $9.15 billion at the midpoint of the guidance, falling short of consensus estimates of $9.4 billion.

Non-GAAP earnings are seen between $0.64 and $0.69 per share, while GAAP earnings are seen between $0.50 and $0.55 per share. Analysts were looking for non-GAAP earnings of $0.69 per share.

Last year, the company reported earnings of $0.53 per share which included a $145 million one-time benefit. Adjusting for this, last year's earnings came in at $0.51 per share.

Valuation

Oracle ended the first quarter of its fiscal year of 2014 with $39.0 billion in cash, equivalents and marketable securities. Oracle holds $24.1 billion in total debt, for a net cash position of around $15 billion. Oracle generated annual revenues of $37.2 billion for its fiscal 2013 on which it net earned $10.9 billion.

Trading around $34 per share, the market values Oracle at $160 billion. This values operating assets at $145 billion, the equivalent of 3.9 times annual revenues and 13 times annual earnings.The company pays a quarterly dividend of $0.12 per share, for an annual dividend yield of 1.4%.

Some Historical Perspective

Shares of Oracle peaked around $100 per share around the turn of the century amidst the internet bubble. Shares fell to lows of $10 in 2002 and have steadily risen to levels in their mid-thirties by 2011. Shares have traded in a $30-$36 trading range so far this year, trading with flat gains for the entire year.

Between the fiscal year of 2010 and 2013, Oracle has increased its annual revenues by a cumulative 39% to $37.2 billion. Annual earnings rose by 78% to $10.9 billion. Earnings per share grew even faster after the company retired roughly 5% of its shares outstanding.

Investment Thesis

Oracle continues to struggle. The company has focused it attention away from hardware and services, which resulted in revenue declines, towards software. While constant currencies sales growth of 8% looks solid, these are very low rates compared to some of Oracle's competitors, notably Salesforce.com (NYSE:CRM) and Workday (NYSE:WDAY). Growth from sales and internet-based subscriptions rose by 4% to $1.7 billion. While growth was low, it actually beat consensus estimates of $1.63 billion.

These companies, with heir cloud-based software, are undermining Oracle's integrated software packages, which it traditionally combined with own hardware to be sold at premium prices. Yet it is striking to see that Oracle's prominent CEO Larry Ellison missed the conference call, even though the company is seeing some rough times. He joined the Oracle Team USA sailing team in an effort to hold onto the America's Cup.

So while current results still look good, Oracle seems to miss out on the cloud computing trend as the IT industry shifts from hardware and related services to software and cloud. Normal companies like the SaaS offerings offered by cloud-providers which can be accounted for as operating expenses, instead of heavy upfront investments.

Another crucial part of this equation is that Oracle's sales representatives might get lower commissions as SaaS contracts revenues are recognized over the lifetime of the contract instead of upfront. This means that some representatives will undoubtedly see commission cuts and defect to faster growing SaaS providers.

So as Oracle is incredibly profitable at the moment, it is generating tons of free cash flows and distributing this to its shareholders. That being said, the company trades at 13 times earnings after backing out the solid cash position. As we have seen with Hewlett-Packard (NYSE:HPQ) in recent years, current earnings metrics look appealing, but that says little if the underlying business is eroding fast.

While Oracle has cloud-operations, they grow at suboptimal rates, lagging competition, while they make up just 20% of total revenues. Note that total software revenues make up the majority of sales.

Oracle's share price returns recently are largely driven by cash flows to shareholders in this low interest rate environment. The company repurchased $11 billion worth of shares over the past year, which implies a 7% return to shareholders. This is being complemented by a roughly 1.5% dividend yield.

Back at the end of June, I last took a look at Oracle's prospects. I concluded that lack of growth poses a threat to the current valuation of around $31 per share at the time.

I concluded that the lack of meaningful revenue growth was Oracle's biggest issue then. The fact that Oracle is paying out all of its earnings at the moment through repurchases and dividends implies the company has no better use for its cash to invest. As such, it is hard to think of Oracle as a growth stock at the moment, and shares should no longer be valued as such.

Trading around 13 times earnings, while paying out a total "yield" of roughly 8% seems fair at the moment. While there is upside if revenue growth accelerates, the competitive position is a bit shaky providing downside potential as well.

I remain on the sidelines, as I am not 100% confident in Oracle's ability to transform again, especially not if executives prefer sailing races to earnings calls.

Disclosure: I am short 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.