Oracle: Nothing Wrong, But Is That Enough?

| About: Oracle Corporation (ORCL)
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In the recent results from the quarter ending in August, Oracle's (ORCL) performance didn't impress its shareholders through its performance. The company posted a 23.5% fall in revenue compared to its previous quarter. Its stock price reacted accordingly, showing negative movement and falling 1.84% on year-to-date basis.

The maintenance backup

Oracle calls its software license and update revenue - maintenance revenue. This segment provides nearly 52% to the company's total revenue. It grew 8% in the first quarter of fiscal year 2014 to $4.4 billion year over year.

There is a reason for the continuous growth in this segment. Whenever customers purchase any hardware of software licenses, they tend to purchase its support or maintenance contracts as well. This is because Oracle's products are considered significant investments, and these products support critical apps and processes. These maintenance contracts are generally three to four years long and provide the company with high margins.

Looking at the maintenance contract structure, we believe Oracle will continue experiencing similar levels of revenue from this segment in the coming quarters. This is irrelevant of any decline in its software or hardware sales. One more thing to note here is that if there are scenarios when Oracle products become uncompetitive, then there will still only be a gradual decline in the new license revenue. Henceforth, this reflects continual growth in this segment. Additionally, Oracle's service contracts for its products also have high renewal rates. This recurring stream of revenue will keep Oracle's stock attractive even in difficult economic times.

Growing competition in database market

Oracle has a larger revenue share when it comes to the database market. It has a revenue market share of 48.3%, followed by other giant leaders like Microsoft (MSFT), International Business Machines (IBM), HP (HPQ), and SAP AG (SAP).

The slowly growing market share of SAP through its HANA, an in-memory database launched in 2011, is raising concerns. HANA is a database management system that relies on main memory for computer data storage, used by companies like eBay (EBAY), P&G (PG), Lenovo (OTCPK:LNVGY), and many others. HANA has features like eliminated seek time, run at full speed, and maintain data even during power failure. In other words, this means decreased search time, supported with speed, and data protection. SAP has a market share of 1%-2% in this database market. It has over 2,000 customers for this database, mostly from outside SAP's core installed customer base, reflecting growth in its overall customer base. It signed about 200 new customers in the second quarter of this year.

SAP's internal customer relationship management system went live in the first quarter of this year. Additionally, the company is close to having its internal Enterprise Resource Planning, or ERP system, with over 50,000 users to go live on HANA this quarter. The growing number of users gives us confidence regarding SAP's revenue guidance of $880 million to $950 million from HANA this year, with further acceleration in user base expected in the remaining period of this year.

Comparative valuations

We have compared the companies competing with Oracle in its various segments in order to provide better understanding regarding its position in terms of valuation.

The industry ROE stands at 16.6%. Here, IBM is a clear winner with ROE of 82.88%, way ahead of Oracle and SAP, which posted 25.27% and 21.83% respectively. Being the industry leaders, these companies are expected to enjoy high margins and high revenues.

(Also Read our previous coverage on IBM: Right Move at the Right Time?)

In technology companies, a company's R&D spending determines the change in future revenue. Let's consider R&D to sales metric to understand the R&D to sales relation maintained by these companies for future productivity and output. Looking at the past historical figures, Oracle, SAP, and IBM have maintained their R&D intensity at 13.6%, 13.7%, and 6.03% respectively. Oracle has kept its R&D expenses at $4.5 billion levels over the past three years. It has experienced revenue around $37 billion levels in the same period. Based on this pattern, we can expect similar behavior from it in the coming quarters. Similarly, SAP has maintained its R&D expense of over $3 billion and posted revenue around $22 billion levels in the past three years. IBM has a totally different story. It is steadily increasing its R&D expense by $50 million to $100 million every year. Still, this strategy isn't providing any impact to its revenue. Instead, its revenue has fallen by $2 billion every year over the past three years.

Long term gains is the word

Going ahead, we do not expect any major changes in the valuation of Oracle since it doesn't have any major fundamentals that may provide a game-changing situation in this fiscal year, at least. Additionally, we do not see a major fall in the revenue, as it is highly supported by the maintenance segment.

Its tendency to provide investors cash through share repurchase and cash dividends every year is another positive element. Over the past three years, the company has increased dividend distribution by almost $200 million every year. This provides investors enough support to hold this stock and expect this cash-rich company to post better results in the coming future.

Disclosure: I 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.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.