In January 2010, software developer Oracle Corp. (NYSE:ORCL) completed its acquisition of Sun Microsystems for approximately $7.3 billion. With the acquisition, Oracle entered the enterprise server and storage hardware businesses to compete with IBM (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ). However, revenues from the division have been steadily declining since the completion of this acquisition for Oracle. Prior to the acquisition, Sun Microsystems reported revenues of $12 billion and $9 billion in calendar years 2008 and 2009, from the sale and service of its hardware products. Post acquisition, Oracle reported related revenues of about $7 billion, $6 billion and $5 billion in CY2011, CY2012 and CY2013 respectively.
In this note, we look at various trends within the global server shipment industry and Oracle’s hardware business in detail. Our price estimate for Oracle stands at $44, indicating a premium of 16% over its current market price.
A Look At The Global Server Hardware Market
Hewlett Packard, IBM and Dell continue to remain leaders in the server market globally with double-digit market shares.The total market includes x86-based systems, which account for more than 90% of the market on a unit basis, as well as high performance Unix- and Mainframe based systems, which command very high price points but represent a very small part of the market on a unit basis. In this total market, HP overtook IBM in market share during Q1CY13 as sales in its Divisional, Departmental and Workgroup servers picked up. HP’s ProLiant brand continues to remain a strong driver for the company’s Enterprise division. According to Gartner, HP had a revenue market share of 27.6%, while IBM and Dell had market shares of 22.9% and 16.4% respectively as of September 30, 2013. 
However, smaller players such as Cisco (NASDAQ:CSCO) and Huawei have more recently seen strong growth in their server shipments, and subsequently, server revenues in recent times. Both Cisco and Huawei have focused their offerings around the blade server form-factor that has resonated well with their customers.  On a year-on-year basis, Cisco posted a 43% growth in revenues from shipping servers in its third quarter. Revenues for Cisco reached $600 million in Q3CY13 from $420 million in Q3CY12, crossing Oracle’s Q3CY13 revenues of about $500 million.  This resulted in a jump in market share for the company from 3.3% in Q3CY12 to 4.9% by September 30, 2013. Similarly, Huawei posted a year-on-year growth of over 200% in its server shipments in the third quarter to 69,573 units.
Various industry trends such as preference for blade servers over rack servers and decline in shipments of high-performance Unix-based servers, have contributed to a weak performance in the global server shipment market. Introduced by HP over a decade ago, blade servers increase the density computing resources, substituting vertically mounted x86 processor boards within a rack formerly dedicated to a one- or two-processor x86-based server on horizontally mounted board. In Enterprise computing, both rack and blade systems have local storage for operating purposes, though most data used in computing is stored in networked storage, most often in a Fiber Channel array. (Large data centers deployed by Google,Facebook and others tend to use custom architectures, however.) In any event, high-performance servers continue to lag the global server market, underpinning the weakness in the global IT environment.
Why Is Oracle Losing Market Share?
Oracle entered the fiercely competitive Enterprise hardware business as a secondary goal to its acquisition of Sun’s powerful software offering (including Java and the Solaris platform). It was imperative for Oracle to secure a firm foundation for the platform, given the large number of customers it shared with Sun, which was then foundering. It has since exited the x86 server business to focus on providing holistic engineered Unix solutions that club its software offerings with its high performance hardware. However, it required a complete overhaul of older legacy Sun platform. After the acquisition of Sun, Oracle shutdown the OpenSolaris project and returned Solaris to its proprietary roots as the most fully featured of the Unix-based operating systems. It reinvested in Sun’s proprietary RISC microprocessor (SPARC) platform to close the gap that had opened between it and HP’s Itanium-based HP-UX systems and IBM’s Power PC-based AIX systems, in an effort to regain its market position. With a refreshed, higher performance platform, Oracle in this way stepped up competition with the Unix platforms of IBM and HP, with notable prominent ads for its Enterprise offering in mainline publications.
However, weakness in the global Enterprise server market led to decline in RISC server shipments for all three vendors, as investment shifted away from these vertical high-priced offerings. According to Gartner, x86 server shipments registered weak growth of 2.1% while high-performance RISC/Itanium servers registered a 4.5% decline in shipments on a year-on-year basis.  Concurrently with this growth in x86 systems, Oracle exited this market to focus on the higher priced SPARC servers. While this shift resulted in a higher average pricing for Oracle’s servers, the number of shipments continued to drop for the company from this shift. This decrease in shipments contributed to the decline in revenues despite a higher average price per server.
Data Center Growth Should Drive High-End Server Demand
Despite this fall in revenues from the hardware division, Oracle has stuck to its strategy of replacing older legacy Sun hybrid (i.e.,both SPARC and x86) platforms with faster and high-margin upgraded SPARC servers and Oracle’s Engineered systems. In its Q2FY14 earnings call, Oracle reported double-digit growth in bookings for its Engineered systems’ division, with triple-digit growth in revenues from the high-end SPARC SuperCluster line of servers.  Strong demand for high-end servers arises from the growing need for faster provisioning of services. Globally, colocation hosting services are expected to cross $43 billion by 2018, from approximately $25.7 billion in 2013. 
Although a recovery in Oracle’s hardware business is not to be seen in the short term, Oracle stands to benefit richly from its shift from low-priced x86 servers to SPARC servers and Engineered systems as a result of the rise in data centers in the future.
- Gartner Says Worldwide Server Shipments Grew 1.9 Percent, While Revenue Decreased 2.1 Percent in the Third Quarter of 2013, Gartner Press Release, December 2013
- Oracle’s CEO Discusses F2Q 2014 Results – Earnings Call Transcript, Seeking Alpha, December 2013
- Global colocation market to exceed $43 billion in 2018, Internap, October 2013
Disclosure: No positions