Oracle: A Strong 'Buy' Candidate For 2012

Mar.14.12 | About: Oracle Corporation (ORCL)

Cloud computing is everywhere now and growing bigger by the day as more companies turn to cloud computing as a way to reduce costs (no buying or maintaining large banks of physical memory required). In this budding industry, there are a few key players leading the charge. Companies like Dropbox and Box.net have sprung up like daffodils in Spring and gained enough of a following to challenge the more establish companies that offer cloud computing, like Amazon (NASDAQ:AMZN), and completely leave slow movers in their dust. It has gotten so bad that Amazon is even offering free storage for music files as a way of enticing customers to use its service.

The heavy competition is even worse for the software-as-a-service (SAAS) companies that relied on enterprise sales, selling the software that companies need to connect across borders, both literal (as in a multinational corporation that needs to share documents) and figuratively (as in helping people with different technical abilities or possibly even languages collaborate). They don't have the specialty needed to launch such a service, especially not the quality of service its enterprise clients would expect. So, to explain it simply, rather than spend billions in development, they are spending millions to acquire companies that have that technology.

Oracle (NYSE:ORCL) is one SaaS company that isn't taking the rise of the machines (read "cloud computing companies") lightly. The company has been strategically buying up web-services companies for over six years now. It started by purchasing complementary products that were more horizontally positioned, helping Oracle expand its product offerings and their features. After that, the company switched gears and started focusing on acquiring companies situated more vertically.

The idea is to eventually offer its customers a rage of cloud solutions that include the same customer service, sales force automation, human resources, talent management, social networking, databases and Java that the company is known for. To this end, the company has already made a series of strategic acquisitions, including the October 2011 acquisitions of RightNow Technologies and data management company Endeca and its more recent deal to acquire cloud-based talent management software provider Taleo (NASDAQ:TLEO).

Oracle's cloud computing service, called Oracle Cloud, is in beta testing now. It launched five months ago and is unique amongst other cloud services because it doesn't use a multi-tenant infrastructure. In other words, one user's date isn't co-mingled with another user's data. The feature could limit Oracle Cloud's scalability but it could also appeal to customers who want to keep their data separate. The only question is whether it is enough.

Right now, Oracle isn't positioned badly - It recently traded at around $30 a share and it carries a mean one-year target estimate of just over $33 a share, so that is about 10% upside predicted over the next year, plus its 24 cents dividend (0.80% yield). The company is also priced fairly low relative to its future earnings, with a forward price-to-earnings ratio of 11.77.

I think the company is fairly priced and is good as a long position but keep in mind that Oracle is not alone in its aggressive pursuit of a cloud computing foothold. Many of its rivals are employing a similar strategy.

Rival SAP recently acquired Taleo competitor SuccessFactors (NYSE:SFSF) for $3.4 billion in early December. The move was a solid one. According to Sven Denecken, SAP's VP of cloud strategy, there is only a 14 percent overlap in which companies use both SuccessFactors and SAP software. SAP is seeking to integrate the two offerings. This way users of its on-premise software can benefit from SuccessFactors' cloud-based software and avoid having important HR data tied to any one device.

More recently, in early March, SAP announced a partnership with Samsung. Under the deal, SAP will provide its mobile device management system Sybase Afaria for Android-powdered Samsung devices. The system is expected to help boost the penetration of Samsung tablets and smartphones. Also in early March, SAP announced the introduction of the SAP Business One OnDemand, a new cloud computing offering that builds on its SAP Business One application while addressing the needs of smaller enterprises - namely small up-front investments, transparent costs and deep functionality. The way the system is structured, it can complement its SAP Business One application for mid-market companies. SAP is launching a new cloud computing service for consumers as well. It's called SAP Travel OnDemand and is designed to help sales and service people keep track of and manage expenses.

SAP is showing weak operating cash flow right now, but the company has solid revenue growth, return on equity and attractive valuation, to say nothing of its stock price performance. Its revenue grew by 5.2% over the same quarter last year and its return on equity also increased. Plus, in both cases, SAP outpaced its industry's average. The company's stock performance also outpaced the market, rising 17.57% over the last year, compared with 8.09% for the market over the same period. SAP recently traded at $68.99 a share and is priced at 19.60 times its forward earnings.

I like SAP but I think it is too early to tell whether its gamble will pay off. I'm not seeing any signs that it has such a unique or strong offering, so I imagine that most of its competitive basis will be on value, at least early on. Given its weak operating cash flow, my bet is the stock will go down before it starts to go back up, but probably not enough for a short position. Right now, I recommend SAP as a hold.

Competitors International Business Machines (NYSE:IBM) and Microsoft (NASDAQ:MSFT) are also attractive with good prospects and valuation. IBM is introducing some great products that make work more social like its IBM Connections. The idea is to incorporate social networking, open source and crowdsourcing into the marketplace the same way that Facebook enables people to share media as well as their opinions, related or otherwise. Given that the demand for social software like IBM Connections is expected to increase to $6 billion by 2016 - an average increase of 60% a year from 2010 - the opportunity is huge for an early mover with the resources IBM has. Plus, IBM is priced well. It recently traded at $200.62 a share, pays a $43.00 dividend (1.50% yield) and is price at just 12.20% times its forward earnings. I like IBM and I think that the idea of "social working" is brilliant. Facebook falls a little short on dividing work and play, Google Plus (NASDAQ:GOOG) tries but it can be hard to follow and LinkedIn (NYSE:LNKD) sort of misses that, so I think IBM Connections definitely has its place.

Microsoft is similarly well-priced. The company recently traded at $31.99 a share, pays an 80 cents dividend (2.50% yield) and is priced at just 10.66 times its forward earnings. It also has strong prospects. Microsoft offers a range of products for consumers and businesses alike that focus on collaboration and the cloud, like its Windows Live SkyDrive. Many of these products are already integrated in Microsoft products, like its Windows operating system or its Office suite of products, so uptake should be high. The question is will it be high enough to make a profit. My guess is not yet.

I like cloud computing and I am sure that this is where the future lies, but I do not think every company will be a winner in this industry. I like Oracle the best out of this group, largely for its focus on acquisition rather than development.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.