- Oracle's ability to adapt to the decline of the on-premises software business and the rise of cloud/SaaS remains in question.
- Oracle Fusion has been a strong performer, but legacy businesses haven't been nearly as strong and enterprise CIOs seem to no longer view Oracle as a critical supplier/partner.
- Oracle shares do look a little undervalued on a DCF basis, but the valuation seems more fair on a relative basis given the low revenue growth outlook.
Reading the sell-side research on Oracle (NYSE:ORCL), I’m struck by how frequently the analysts benchmark Oracle’s valuation multiples (whether it’s P/E, EV/FCF, EV/revenue, et al.) against the peer/industry group in an attempt to make the “Oracle is undervalued” case, but neglect to benchmark the company’s revenue growth rate. While margins and free cash flow certainly do matter, revenue growth is a significant near-term driver for valuation multiples, and Oracle’s growth rate is much more in the CA Inc. (CA)/IBM (IBM) neighborhood than the Microsoft (MSFT)/Adobe (ADBE) neighborhood of older tech stocks.
Given the weak growth rate, the recent trends in Oracle’s position in sell-side CIO surveys, and the company’s ongoing challenges with the on-premises-to-cloud transition, I can’t work up much enthusiasm for the stock. While many old-tech companies have faced challenges in their attempts to renew themselves and remain competitive (Microsoft had its issues, IBM is still in the middle of them…), I just don’t see enough of a discount here to take on the incremental execution risk.
Oracle Seems To Be Sliding Down The Charts
Say what you will about sell-side research, but it can provide some useful data points and benchmarks from time to time. I particularly find it interesting to read the various CIO spending surveys that many analysts conduct on an annual basis. I’m concerned about two different issues that I’ve seen emerge in these surveys over the last couple of years – less spending in areas where Oracle is strong and less overall esteem/prestige for Oracle.
As far as spending priorities go, it’s not any great surprise that security and cloud dominate CIO priorities across almost all sell-side CIO surveys. While increased public cloud spending is a good thing for Microsoft (and Amazon (AMZN)), Oracle’s presence in IaaS is too small today to really get much benefit from this trend. Oracle is certainly looking to build up its offerings, hiring developers from both Microsoft and Amazon and trying to build a faster, more reliable platform, but they’re a long way from becoming a serious threat. At the same time, CIOs indicate that they’re spending incrementally less on the sorts of software where Oracle remains a strong player (ERP, CRM, HCM, etc.).
I’m also concerned about the declining significance of Oracle in the overall “stack” of CIO priorities. Different analysts phrase this question differently, so the results are not necessarily apples-to-apples, but where Oracle was once a top-three or at least top-five vendor in terms of who CIOs saw as the most important providers in the space, they’ve slid down successively over the last three or four years to the lower half of the top 10, while rivals like Microsoft and SAP (SAP) have maintained a strong presence near the top and Amazon has shot upwards.
While I’m concerned about this phenomenon, I’m not exactly surprised. Companies are increasingly moving to cloud solutions and Oracle’s embrace of the cloud was slow to start and has been choppy all along the way. Moreover, Oracle’s business practices haven’t always gone over well with its customers and now that there’s an option to “start fresh” with cloud offerings from rivals like Salesforce.com (CRM), Microsoft, Workday (WDAY) and others, many companies are choosing that route. I’ll grant that customer perception is always a tricky and subjective thing to measure (and almost any sufficiently large company is going to have critics/detractors), but the revenue results do lend some credence to the idea.
An Evolving Strategy With Some Good Core Strengths
Oracle is by no means doomed. Relational databases are still very important to many enterprises, and Oracle still enjoys very strong share (over 40%) in this market. Amazon has jumped up into the top five in recent years on the back of AWS, but in many cases that looks to be from new customers that weren’t in Oracle’s core target market anyway.
Oracle also does have some strong offerings on the cloud/SaaS side. Oracle Fusion is a legitimately strong business, with Fusion ERP, Fusion HCM, and Fusion CX generally doing well for the company. NetSuite has done less well since Oracle’s acquisition, but the company has been working hard to get this business on a better growth track. Elsewhere, Data as a Service is still a business with solid long-term prospects, even as major customers like Facebook (FB) revise their approach to customer tracking/targeting, and Oracle’s industry-specific SaaS verticals (like Fin Services Cloud and Healthcare Cloud) have been growing well from a small base.
Oracle also still has a strong core middleware business, though it is facing some of the same challenges as IBM in a shift toward cloud offerings.
The key for Oracle is simple to name and hard to deliver – figure out how to grow the cloud-based businesses at a rate fast enough to not only offset the erosion of the traditional on-premises business, but to keep the business growing overall. On-premises is still over 50% of the business at Oracle, and while the enterprise market isn’t (and likely never will be) fully cloud-based (and certainly not public cloud-based), the reality is that Oracle’s revenue growth has been consistently weak on a constant-currency basis, with only a handful of mid-single-digit (or better) constant currency revenue growth quarters since 2014/2015.
On one hand, it looks as though the company is exiting a period of ongoing negative revisions to cloud growth that led to some meaningful estimate resets, though the margin transition period seems to be over. And again, Oracle Fusion is a strong business today and the company’s next-gen IaaS plans have potential. On the other hand, the numbers are what they are and the strong growth in businesses like Fusion ERP (up 60%) and Fusion HCM (up 72%) weren’t really enough to offset the pressures elsewhere. What’s more, the decision to collapse down the reporting, combining cloud services and on-premises support into one line and cloud licenses and on-premises licenses into another hurts visibility into the business. While the challenge of properly recognizing/categorizing business that originated as on-premises and transitioned to cloud is real, I believe Oracle could have compensated for that without taking such a dramatic step.
It’s been quite a while since Oracle was a strong organic revenue growth story on any sort of consistent basis, and I don’t really see that changing. Perhaps the next-gen IaaS strategy will really take off, or the company will see better results in the on-premises-to-cloud transition, but I’m expecting long-term revenue growth to stay in the low single-digits. Margins and FCF generation could improve a bit from here, but likely not too dramatically, and I think FCF growth will be in the low-to-mid single-digit range.
On a DCF basis, Oracle looks a little undervalued and worth some consideration, with an expected annualized return just shy of the double-digits. Software and tech stocks don’t really trade on DCF, though, and it can be a long and frustrating wait to see those stories play out (more like waiting for Godot in some cases). What typically drives near-term valuation is revenue growth and margins, and Oracle just doesn’t score so well here. Relative to other lackluster near-term growth stories like SAP, CA, and IBM, Oracle’s forward multiples look pretty fair and I think around 4.3x forward revenue is a fair price to pay.
I’d note, though, that the software sector is currently trading above long-term norms, which would argue that a fair multiple today is closer to 4.75x or 5x, supporting a fair value in the $48 to $51 range.
The Bottom Line
If you think today’s overall tech multiples are reasonable and sustainable, Oracle may have enough upside to be worth considering. Likewise, if you think Oracle can defy expectations and reaccelerate revenue growth into the mid-single-digits or higher. If you expect reversion to the mean, though, and don’t really expect a much stronger growth outlook, I’d say Oracle shares are pretty much fairly priced today.
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