A Long Oracle/Short SAP Strategy

Includes: ORCL, SAP
by: Yaser Anwar

Oracle (NASDAQ:ORCL) reported non-GAAP total revenues of $3.7 billion, 26% YoY, which was above street estimates. Results were driven by another quarter of solid applications license growth, up to +80% YoY and an unexpectedly strong contribution from database technology +15% YoY (see conference call transcript).

  • On an organic basis, Oracle reported applications growth of 47% YoY, after posting over 50% growth and over 30% growth in 3Q of 06, hence Oracle has turned a corner with their applications business .
  • Siebel license revenue of $32 million was a bit below analyst expectations and the overall applications license revenue of $228 million was below the Street's $231 million estimate.
  • However, Oracle continues to see very strong growth in their middleware products, +56% YoY, and database license revenues accelerated to 10% YoY growth, pushing the total database technology license line to $565 million +15% YoY.
  • ORCL also noted they would no longer be breaking out the contributions of database and middleware in this revenue line going forward. Support revenues crossed the $2 billion mark in the quarter, continuing their solid growth and beating street estimates, as Oracle consolidated results of iFlex into their results for the first time.
  • The inclusion of iFlex revenue stream, heavily weighted towards consulting, did have a negative effect on margins. Non-GAAP gross margins of 73.4% were down and management estimated iFlex to have been 1% point dilutive to operating margins in the quarter.
  • That being said, Oracle still managed to see an increase in non-GAAP operating margins in the quarter, to 36.0% versus 33.5% Street estimates. Stronger top line and higher margins allowed Oracle to report EPS of $0.18, which was ahead of consensus estimates ranging from $0.13 to $0.16.
  • Fundamentals appear to favor Oracle for the remainder of 2006, as SAP has to show accelerating growth in the second half of 06 to hit expectations, while Oracle has outperformed expectations in their toughest quarter.
  • At the same time, SAP (NYSE:SAP) still trades at a premium to Oracle on the PE multiple basis. I believe investors can short SAP and go long Oracle. This way investors can be hedged & profit from the spread trade if they believe ORCL will outperform more than SAP for the remaining 2006.

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