Oracle in the Swamp
As I think almost every Oracle (NASDAQ:ORCL) investor is aware by now, the company was sued this past week by a whistleblower named Svetlana Blackburn who alleged that she had been bullied by her manager(s) who wanted her to report inflated cloud revenue results. Her manager had allegedly wanted her to alter records and back-up data so that revenue in mixed contracts would be labeled as cloud rather than on-premise sales.
Blackburn alleged that when she refused to comply with the request to falsify records, she was terminated. Oracle management, needless to say, has denied that there had been any attempt to coerce Ms. Blackburn and that she was terminated because of poor performance. Oracle has said that they intend to file a counter claim against Ms. Blackburn. One report indicated that a month before her termination, she had been given an excellent performance review.
In addition to the Blackburn suit, Oracle is involved in multiple additional lawsuits. These lawsuits primarily stem from issues with regard to Oracle's claims about the "patentability" of the open source Java language that was acquired when Oracle bought Sun. Another claim is that of breach of contract, which is alleged by HP and refers to a particular hardware product on which Oracle dropped support despite a contractual commitment to continue support.
When I write these articles, I try very hard to stick with facts that are in the public domain. Obviously, my opinions are my own - but I like to try to base those opinions on a foundation of third-party facts. Sometimes, I can use earnings call transcripts; many times, I use opinions of industry analysts or I take a very deep dive into financial reports. But I like to insure that I present the best information that I can find.
In writing about Oracle lawsuits, that really isn't possible. And yet, at the very least, the Blackburn allegations are likely more serious than they may seem on their face. At the very least, current holders of Oracle shares may wish to come to their own conclusions as to whether or not the allegations produce sufficient additional risk to prevent a positive investment conclusion. Those who might be considering investing in Oracle in advance of their year-end financial report scheduled for June might wish to consider the risk/reward parameters of committing to a new investment in Oracle shares.
It would be terribly presumptuous on my part to do much to try to handicap the Blackburn matter. Oracle has denied the allegation and its formal response to Ms. Blackburn's allegations isn't expected before August, still a couple of months away. Ms. Blackburn also filed a complaint with the California Department of Labor back in November of 2015 that is still under review. I'm not a lawyer by training, I have no specialist knowledge of either Sarbanes-Oxley or Dodd-Frank, the statutes that are relevant in the Blackburn allegation and no one at this point can guess whose version of the facts is correct.
Whatever I write is nothing more than speculation, although speculation based on covering Oracle and investing in it on and off for many years now. Many personal friends of mine have worked at Oracle but none are doing so at the moment. Even if they were, none of them would have specific knowledge of what might have gone on at Oracle Finance.
While companies are not people, companies can have cultures. What's at stake in all of these matters, regardless of their ultimate disposition, is what impact they might have on Oracle's culture and how changes in that culture could potentially lead to conduct that slows the company's growth and leads to weaker than current valuation metrics. There's little doubt that Oracle or at least its senior executives have one of the more macho and competitive cultures in corporate America. Larry Ellison, Chairman of the Board and CTO of the company, competes in just about every way he can and against everyone that he can. Mark Hurd, co-president of Oracle, enjoys or is credited with a similar macho personality. It is part of who they are.
At this point, there's no public information available that will either substantiate or refute Ms. Blackburn's claims. We have no idea at this point if there's any documentation to substantiate Ms. Blackburn's claims. We have no idea at this point if the contest will be of she said vs. he said or based on documents and recordings. We do not know at this point much more about Ms. Blackburn's claims other than they include back pay, some level of punitive damages and other unspecified remedies. We know that in fact Ms. Blackburn had been with Oracle for little over a year and that she was not a high-ranking employee given her pay and an Oracle organization chart.
Federal prosecutors have been known to be remarkably zealous in terms of prosecutions under Sarbanes Oxley. The most notorious prosecution involved that of a fisherman who was charged with shredding evidence because he destroyed six dozen red grouper fish. Fortunately, on appeal, the conviction of the fisherman was overturned although the vote to do so was only 5 to 4.
In 2014, a California jury awarded Catherine Zulfer, a forming accounting executive at Playboy Enterprise, $6 million when it fired her for refusing to improperly set aside company funds for executive bonuses. In a case from Florida, a computer equipment company QSGI and its CEO and CFO were convicted of a SOX violation because they misrepresented to external auditors and the investing public the state of QSGI's internal controls over financial matters.
While I certainly do not have any special information about the complaint of Ms. Blackburn, given the overall track record of federal prosecutors in terms of going after what they believe to be violators of the SOX law, and given the desire of prosecutors to create publicity for their organization, it is almost a foregone conclusion that if there is the slightest bit of evidence that someone, somewhere at some time did the least questionable thing, it will almost certainly be prosecuted. I will forbear any further discussions of how US Attorneys run their fiefdoms. There has been more than enough publicity about the abuse of prosecutorial discretion here in the Southern District of NY.
The other lawsuits that Oracle is fighting are not likely to move the needle in terms of their potential to move the company's share valuation. Oracle is being sued by Hewlett-Packard Enterprise (NYSE:HPE) for a breach of contract concerning its decision to stop supporting HP's Titanium server in the wake of Oracle buying Sun and attempting to use Sun hardware to power its appliances after having used HP for several years. The most recent news is that a judge has reaffirmed the verdict and that Oracle will have to pay HPE $4 billion.
On the other hand, Oracle has been busy suing HPE, Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and many others regarding patent infringement claims that are based on Oracle's contention that Java, the operating system it acquired as part of the Sun transaction, is proprietary intellectual property that needs to be licensed before it can be used. The initial jury verdict rendered on May 26, 2016, has gone has gone against Oracle. The finding has been that Google made fair use of Oracle's Java code in building the Android operating system. A hearing on the Oracle-HPE suit is expected shortly.
Software companies are frequently sued by their customers for breach of contract. And software companies do sue each other all the time regarding IP disputes. But Oracle would appear to have put itself in the litigation swamp by its conduct in recent years that was perhaps engendered by a seeming aggressive and triumphalist management style
All of the IP cases and all of the breach of contract cases mean very little to Oracle. It has plenty of cash - $50 billion on the balance sheet in its most recent quarterly report. It is true that Oracle has $40 billion in debt and that much of its cash is outside the US, but it certainly has the resources to pay fines or judgments or any other financial sanctions. None of the IP cases or the breach of contract suit is likely to have any appreciable impact on Oracle's business conduct in the future.
The potential of the Blackburn case to Harm ORCL is a different matter entirely. The positive investment case for Oracle rests pretty squarely on the belief that its transition to building cloud-based revenue sources is proceeding quickly. Oracle has forecast enormous growth in its cloud revenue base and a substantial improvement in cloud profitability. If this prosecution raises doubt about just where Oracle is actually getting revenues, it will serve to undercut the principal element in the positive case for this company.
Even if the lawsuit is ultimately resolved before trial or even if it is dismissed, it seems a reasonable guess that Oracle will adopt far more stringent corporate policies designed to insure its compliance with the law. If the result of that is accounting managers move from an aggressive stance on labeling the revenue from mixed deals that are cloud based to a more conservative stance, that alone might change the future growth of reported cloud revenues.
There would be all kinds of potential ramifications if Oracle and its management are charged by Federal regulators with SOX violations. Monetary penalties are the least of the concerns. There can be cease and desist orders, the senior executives can be barred from running public companies in the future and depending on whether or not the practice, if there was a practice, is found to be pervasive the matter could be referred to the appropriate US Attorney for prosecution. These seem pretty remote potentials to me - but then again, perhaps less remote than might be thought by many readers.
Do companies have personalities?
Corporations have been held to be artificial people for a long time now and much of American jurisprudence has been spent deliberating the rights and obligations of these artificial people. There's much to be said for and against the concept although these days, in many instances, many politicians ride roughshod over the rights of artificial people. The artificial people can't fight back. Oracle may be an artificial person but it will aggressively defend this matter.
Of course, to answer my question, corporations are inanimate and so they can't have personalities. But it is apparently OK for them to cultures. The difference between a personality and a culture is pure semantics. In the case of Oracle, its culture and its personality are functions of its leadership team that has been unchanged now since Mark Hurd joined Oracle as co-president in 2010.
I want to state here that I have no personal knowledge of these people. I once met the former CFO of Oracle, Jeff Henley one-on-one for a couple of hours, and that is the sum of my personal interactions with the management of this company. Over the years, however, I have known many people who worked at the firm and there have been plenty of articles in the press describing the environment at Oracle. I far prefer facts to gossip and some readers may label these following paragraphs as gossip. But if I am going to try to evaluate what might have happened with regards to Ms. Blackburn's specific allegations and no facts are available, this is about the only way I can try to offer suggestions based on anything other than pure guesses.
If I'm going to try, at least in a qualitative fashion, to assess risk related to Ms. Blackburn's allegations, it will have to be based on generally well known facts that will never be precisely documented. It is better than nothing but it is hardly meant to be dispositive.
Oracle's culture has been described in some articles as "bruising." An ex-Oracle executive describes the company's people as driven yet pompous and territorial. Oracle has been notorious in the IT world for gouging its customers and for doing audits that rival the Domesday Book in terms of the results that are expected. IRS audits are said to be kinder and gentler.
Even though one of the three top leaders of Oracle is a woman, the culture is extraordinarily macho and the testosterone flows without check or inhibition. Co-President Mark Hurd "resigned" from his leadership role at HP because a scandal that included marital infidelity and perhaps worse - expense account cheating. At this point, Larry Ellison has had four wives and innumerable affairs. Some of the stories are more than a little tawdry and I wonder how many of them are true or are urban legends. At least, so far, his wives number two less than those of Henry VIII and none of them have met sticky ends.
Although rumors have been suppressed lately, in 2009, former co-president Charles Phillips was forced to resign his position at Oracle when the girlfriend of Mr. Phillips plastered billboards of the couple from happier times all over New York and other cities.
That Larry Ellison is one of the more competitive men on this planet is probably self evident to most careful Oracle observers by now. This is a man who despite his net worth or perhaps because of his success - and success he has had - can't stand to lose and can't stand to be bested in any endeavor. In the wake of a high profile legal controversy with a former "Oracle" sailor, it was revealed that Oracle pays the crews that race for the America's Cup $300,000/year. An interesting adjunct to the controversy is that another team Oracle grinder, Matt Mitchell has sued the team for $68,000 in legal fees that he said he accumulated while fighting allegations that he helped alter an Oracle racing boat in preliminary competition.
Back closer to home, Oracle has a box on the lower right corner of the front page of every Thursday's WSJ. These days the box proclaims that Oracle has more live cloud HCM installations than archrival Workday (NYSE:WDAY). For the record, the claim seems highly unlikely - unless the definition of cloud installations is exceptionally elastic. A few years ago, Safra Catz told a conference call audience that a couple of years ago Oracle's strategy was to strangle WDAY in its cradle. I guess Workday climbed out of that cradle and escaped.
Another quote from an article by Fortune says that Hurd would make some $40 million in his first year alone, working for a man who didn't care a fig what envelopes Hurd might have pushed - so long as he made his numbers.
The Fortune article about the "redemption" of Mark Hurd said that although Hurd didn't always care for the niceties of making employees feel good, he always got results. A brief walk down memory lane or conversations with ex-HPE employees might challenge the accuracy of that statement. Talking of things about which I do have first-hand knowledge, Mark Hurd and his colleagues ruined HPE's software business and destroyed a significant amount of shareholder value in the process.
A few years ago I was on tour with the CEO of BMC Software who was a direct competitor with one of HP's software companies that Mr. Hurd had bought called Mercury Interactive. Bob Beauchamp, the CEO of BMC, told me that the best thing that had happened to his company recently (this was a couple of years after HP bought Mercury Interactive, a company that had been giving BMC fits), was Mark Hurd's ascendancy at HP. He told me that competing against Mercury was so much easier after HP had bought it.
A few years ago, Mark Hurd noticed that the headline stories on Google did not present his tenure at HP in a flattering light. He hired a former investigative journalist Glenn Bunting to fix the problem. Hurd reportedly got Oracle to pay for "fixing up" Google search results and chatter about the circumstances of Hurd's departure from HP have finally receded. Hurd has said he simply wanted to set the record straight and to defend his family.
I think it is pretty easy to draw an inference that the people who run Oracle will do just about anything necessary to "win" and they are often not deterred by niceties. I suppose other people might draw other conclusions and feel that Oracle is just run the same way as normal software companies. And yes, normal software companies and their executives are as prone to bad conduct as anyone else. No one runs software companies without a helping of sharp knees and elbows. And yes, there are plenty of software companies with philandering senior managers. The software business has always had a macho culture. As to philandering executives in the software space - I have seen some of that up close.
Oracle does indeed have a culture or a personality and it has been one in which conduct at or beyond normal limits has been countenanced - at least in my opinion.
How hyper-competitive people with flexible ethics can wind up doing very silly things
OK - plenty of gossip and innuendo. So Oracle isn't run by members of the Sunday School Choir. Has Oracle ever done anything like the mis-deeds being alleged by Ms. Blackburn?
Well, I certainly think it has and I would hear it in conference call after call - but I can never prove such a thing. Back in the late 1990s as the internet bubble emerged, a company in Texas developed an elaborate supply chain management system. I2-technologies was a shooting star at the time and managed to do something to annoy Oracle.
In those years, Oracle was primarily a database company but was trying mightily to build out its application stack. I2 was achieving prodigious growth rates and it would cross the billion-dollar revenue mark in 2000 before imploding.
Oracle never really had a competitive supply chain planning product in those years. I2 competed with Manugistics and also with SAP (NYSE:SAP). It ultimately came to sue SAP - the IT world is chocked full of lawsuits. But that didn't stop Larry Ellison from reporting substantial SCM revenues on call after call. He often tried to make the case that Oracle would have larger Supply Chain Planning revenues larger than I-2 in some finite time span. In those years, Oracle reported the revenues for its application stack separately. There was really no conceivable way that the claims of Oracle in terms of its SCP size could possibly be true. But claims were made time and time again.
But of course the devil is in the details and in the definitions. Oracle's in those years had completive products in both financials and in Enterprise Resource Planning. ERP is not the same as SCP - but it sounds close and after all both solutions plan for the use of resources. What more could anyone want? Of course this was long before the days of Sarbanes-Oxley and certainly one could make the case that SCP and ERP are second cousins a couple of times removed.
Personally, I don't think it mattered very much. The numbers that Oracle would report in the SCP bucket really weren't credible. Investors were only interested in the gross revenues of apps and not in their constituent parts. But Larry Ellison cannot stand losing and cannot stand being shown up - and thus the desire to represent "his" SCP as larger and stronger than it really was.
A few years later, a category that we still know as CRM (Customer Relationship Management) emerged. Oracle actually was one of the industry founders and the company did launch its products in 1998. But Oracle didn't provide the nascent effort with adequate resources and a company called Siebel Systems almost immediately became the category leader.
By that time, SCP was out of favor and Oracle had stopped talking about it on conference calls. And so it had both the latitude and the desire to talk about how it was gaining share against Siebel call after call after call. Was that the truth? I doubt it. In 1999 Siebel was named the fastest-growing company in the US by Fortune. Of course Siebel went through hard times during the tech recession of 2001-2003 but it was acknowledged for all of those years as the category leader.
None of that really stopped Oracle's management from their strategy of pronouncements to the effect that they were winning against Siebel. Nothing stopped them from saying how successful they were competing against Siebel until they paid almost $6 billion to buy the company in 2005. I will leave the reader to determine whether or not Oracle was gaining or losing in the CRM field in those years.
There are other examples of this behavior - BEA Systems and "Fusion" middleware come most readily to mind. But Oracle simply has to be the category leader and gaining market share in whatever segment in which it competes - and somehow the numbers will be massaged to prove the point.
Fast forward a few years. Speaking at Oracle OpenWorld in 2008, Mr. Ellison declared that the computer industry was more fashion-driven than women's fashion and that cloud computing was simply the latest fashion. He went on to declare, "that the interesting thing about computing is that we've redefined cloud computing to include everything that we already do… When is this idiocy going to stop," he said.
Needless to say under the circumstances, Oracle was very late to the cloud party and has lost an enormous amount of market share to a host of small rivals - Salesforce.com (NYSE:CRM), Workday and many, many other vendors who offer purpose built cloud solutions.
The company began to play a furious game of catch-up a few years ago and it became inevitable that the Oracle's financial statements would soon be altered such that the only product categories were cloud and on-premise. Everything else was gone. So now, Oracle reports cloud revenue and all other product revenues and cloud revenues are growing prodigiously. And because of that prodigious growth, those who wish to do so can make a positive case for Oracle shares.
If the focus of Oracle is on cloud, if the management team at Oracle can't stand to lose or to be shown up, and if Oracle's CEO has made some embarrassing statements when the cloud was just being born then it seems to this writer the desire to highlight the success of Oracle's cloud must be overwhelming. Has Oracle management obfuscated? I really do not know.
Did the senior management team at Oracle all play a Henry II (Henry II had a raging dispute with Thomas Becket, archbishop of Canterbury, and late in 1170 he was said to have said... who will rid me of this turbulent priest - four knights heard Henry and sailed across the channel and murdered Becket on Christmas Eve 1170) role in encouraging managers down the food chain to reflect the best possible results for Oracle? I do not have that answer.
Would it be shocking to find out that at the least, there was some kind of indication that senior management wanted to show the best possible growth in cloud revenues and that it wanted lower level managers to push the envelope? I would almost be surprised, under the circumstances if something like that didn't happen, certainly sounds plausible. And that is all that I can say on the subject. No smoking gun. Just a set of circumstances that would tempt a pre-disposed management team to push the envelope a bit too far.
"The Fundamental Things"
That's part of the lyric from the song "As Time Goes By." First composed in 1931, it is far more famous in the movie "Casablanca." I think, however, it is reasonable to look at the fundamental outlook for this company as well as the legal overhang.
The lawsuit overhang is there although impossible to quantify. It will not be resolved in the near term and depending on how it all goes it may have a minor effect on the share price or quite a serious impact on the company and the way it records revenue.
But Oracle will be releasing its year-end results on June 26. The song lyrics relate how fundamental things don't change as time goes by. My view that Oracle, the company, continues to struggle with the economics of its transition to the cloud is one I have held for quite some time now-years literally.
A couple of weeks ago, brokerage JMP Securities reported that Oracle might be doing a sales restructuring. The brokerage also has said that it believes Oracle "has made significant headcount reductions in its sales consulting ranks at the start of the company's new fiscal year." I have heard from another source that Oracle has laid off a bunch of pre-sales consultants. Oracle has revamped its sales force many times over the years. Sometimes the reorgs were the harbinger of bad times, but certainly not always.
My own negative view of the shares was encapsulated in an article I wrote recently for Seeking Alpha. I continue to wonder how Oracle can protect its core database franchise in the new cloud world where it has many formidable competitors who offer advanced DB functionality at ultra-low costs as part of their cloud offerings. I wonder how long it will be before the company's legacy maintenance revenues start to decline as users replace on-prem workloads with workloads in the cloud.
Recently, Aziz Hamzagoulian, the manager of the large-cap growth fund for Loomis Sayles was recently interviewed by Barron's. His article included other tickers besides Oracle to be sure. His screen, as indicated by the article, suggests that Oracle and the other companies mentioned, has a strong balance sheet and sustainable competitive advantages that produce cash flow growing at double the growth rate of the GDP. That is a pretty common view among some investors and commentators these days. It sounds great until looked at in detail.
Oracle's rising cash flow is totally a function of the stream of legacy maintenance revenues. If those revenues stop rising, or worse yet start to decline as applications migrate from on-prem to the cloud, Oracle's cash flow will stop rising and is likely to start falling.
Oracle's cash flow growth also is the product of very low levels of capex relative to the size of this company. But if the cloud initiative is successful, capex demands will escalate sharply. Amazon has to spend $10 billion a year just to grow its network and keep up with demand. Oracle will have the same capital requirements if it is successful.
Finally, and most important of all, Oracle does not have competitive advantages in the new cloud world. It has competitive disadvantages. Most of its cloud offerings are far less functional than solutions offered by newer vendors such as WDAY and CRM that have purpose built cloud-based code. At the end of the day, it ought to be far more natural and economic for users migrating to the cloud to buy their IT infrastructure from a single vendor if they can. Oracle has no real franchise remaining on the sale of database technology to migrating users. There are those who say that migrating database to cloud is difficult. On the other hand, almost all cloud vendors offer programs and software for users to move their data base information to their cloud providers in a seamless fashion.
For the first time in at least a generation the market for database solutions and other pieces of infrastructure is up for grabs. Oracle enters that fray with a hand tied behind its back.
In my opinion, the premise for Mr. Hamzaogullan is simply wrong. If my thesis plays out, he along with scores of other institutional money managers are going to have to rethink their positive bets on this company. Retail investors who are in Oracle for its dividend might be able to stay the course, but depending on the rate at which legacy maintenance revenues potentially decline, the resources to both run the business and pay the dividend could be under threat. Not the best case for producing positive alpha.
What results and what guidance will Oracle provide in the upcoming conference call? Of course I do not know. Perhaps a bit more cautious than triumphalist. Are the sales force layoffs and possible sales force reorg harbingers of a more negative outlook that will be made clear during the company's conference call? On the historic track record I would say no. But does that change because the company has the whistleblower lawsuit and a host of shareholder lawsuits it must deal with? I simply do not know. I think there are far better investments in the IT space without the overhead of the Blackburn suit.
Oracle is in the midst of litigating several lawsuits at this time. Most of the claims are garden variety software suits relating to both intellectual property and breach of contract issues. These are not of significance to investors and should be ignored.
The whistleblower lawsuit is a different matter. The claims of the plaintiff, Svetlana Blackburn, if proved, will have a significant impact on the way the company does its business and ultimately on the valuation of its shares. I certainly have no specific evidence that would allow me to handicap the lawsuit. I'm not a lawyer and all that we have heard so far is the allegations from Ms. Blackburn and Oracle's denial. I have no idea what documentation exists or how far-reaching the practice may have been.
But claims under the Sarbanes-Oxley statue are no laughing matter. Companies can easily run afoul of some overzealous prosecutor out to make a name for herself/himself. Claims by US Attorneys have gone as far afield as a suit concerning red mullet fish as an evidence repository. It took the Supreme Court to shoot that one down and it was only knocked off on a 5-4 vote.
There are a variety of consequences that I can envision. At the least, the lawsuit will be an overhang on the shares of some undetermined amount. If Ms. Blackburn's claims are upheld, the company is likely to have to restate results and to adopt different standards for the revenue recognition of mixed orders from users buying both cloud and on-premise solutions and/or upgrades. Anything that serves to reduce Oracle's reported cloud growth rate will undercut one of the principal positive cases that can be made for the shares.
Oracle management has been and remains super-aggressive in almost all phases of their business. The individuals running the company have abused their customers at times. In the past, management has made claims about its growth and revenues in what were then hot areas in the software space. Those claims could never be substantiated and were as the saying goes, "economical with the truth."
The combination of an aggressive management that hates to lose and which forecast that the cloud would be a bust has set up a situation in which some individuals may have taken chances that could make them culpable in the whistleblower case. It is likely to take a significant amount of time before it is possible to see the specifics of the claims and their defense. Until then there is no way at all to handicap the chances for any particular scenario.
Over the past year, Oracle shares have fallen about 10%. Since the last earnings call, the shares are up marginally. Over the same span, the IGV software index has appreciated by about 10%. I think there are many fundamental issues for investors in looking at Oracle shares. The addition of another potential negative simply goes to reaffirm my belief that an investment in Oracle shares will not produce positive alpha.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.