Oracle's (NASDAQ:ORCL) acquisition of NetSuite (NYSE:N) looks expensive on paper. However, this acquisition might be one of the missing pieces in the long-term growth strategy of the company. Despite being a late comer to the cloud services, Oracle set a brave target of $10 billion in annual revenues from this segment. However, the company has been unable to achieve that target and the most recent cloud segment revenues were around $3 billion. This acquisition might look like an admission of failure from Oracle, and some people might say that the company knows it cannot achieve $10 billion in revenues by selling its own products. However, I do not agree with this notion and believe that this acquisition will in fact be a key component of its overall strategy in this area.
Oracle has a history of acquisitions and the company has always grown its business through acquisitions. It is the integration of these acquisitions that matters the most. In NetSuite's case, the company is not just buying a strong player in the cloud segment, but it is also growing its product offering to a business segment that it had not penetrated before. It is a strategic acquisition, which will allow Oracle to capture the mid-tier and small enterprises. A combination of Oracle and NetSuite's products will result in rapid growth in revenues. NetSuite revenues are already growing at a swift pace.
On the other hand, Oracle's revenues have stagnated. In fact, some of its server-based solutions are becoming less favored with the customers and other companies are gaining ground. Its competitors, SAP SE (NYSE:SAP) and Salesforce.com (NYSE:CRM), are growing their revenues at an impressive rate.
The deal looks expensive if we look at the multiples without the strategic importance of the acquisition. However, Oracle has a lot of cash on hand and the free cash flows are incredibly strong. This cash is used better by buying a rapidly growing business in a key business segment. Oracle has more than $56 billion in cash and short-term investments.
A large portion of Oracle's cash is overseas. This might be a reason that the company has been taking on large amounts of debt. It will have to pay a hefty tax bill if the company repatriates that cash. This explains why the company has been raising cash through debt in order to meet some of its cash expenditures.
NetSuite's trailing twelve months revenues are $846 million. This means that Oracle is paying a revenue multiple of about 11x and forward revenue multiple of 7.75x - NetSuite is expected to generate $1.2 billion in revenue during the next year. At the moment, NetSuite's EBITDA is negative which means that the EV/EBITDA multiple becomes irrelevant. NetSuite's strong revenue growth will bring some pace to the cloud segment revenues of Oracle. Furthermore, Oracle will get access to NetSuite clientele and the company will be able to offer its own products to these customers.
If we look at the cash uses of the company, one of the most significant cash outlay has been the share buyback plan. Acquisitions have been the other major outlay. In each of the last four years, Oracle has bought back shares worth between $8-11 billion. If the trend continues then the current year cash outlay will reach more than $20 billion. At the moment, the balance sheet shows a total cash balance of just above $20 billion. Oracle has about $36 billion in short-term investments, which is also a highly liquid asset. We also need to keep in mind the dividends paid by the company. Dividends and some debt repayments will take the total cash outlay to over $25 billion. Oracle can easily cover these outflows.
Oracle's annual free cash flows of over $12.5 billion and healthy cash balances mean that there is no concern regarding the rising debt levels of the company. The addition of debt is merely a strategic move and it should not affect the future growth strategy of the company. Cash sitting outside the USA can be used later for further M&A purposes if there is an opportunity to buy a business outside the country.
This acquisition will certainly not take Oracle to the targeted $10 billion in cloud segment sales. However, it can help bridge the gap to some extent. Companies like Salesforce.com are ahead of Oracle in this area and the addition of businesses like NetSuite is needed for the future growth. This acquisition allows the company to compete better in a market where there is still room for growth.
Oracle's share price has not done much during the last two years. However, the dividends plus the share repurchase has ensured that the investors get some cash generated by the company. This is a share to hold for the long term as there are opportunities for the company to grow and the financial position is incredibly strong.
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.