Oracle's Cloud Strategy Sputters: The Stock Hangs By A Thread, But 1/3rd Of Oracle's Market Cap Is In Cash

Includes: ORCL
by: Brian Gilmartin, CFA


Post-earnings, Oracle's stock fell to long-term support.

The $4.9 billion buyback in the May quarter helped.

Oracle still has $67 bl in cash on the balance sheet.

Operationally, the Cloud transition looks to be struggling.

The valuation is reasonable, but the risk is now Oracle becoming a value trap.

Oracle (ORCL) reported their fiscal Q4 '18 financial results a few weeks ago and the reaction of the stock price was that it promptly dropped into the $43 - $44 area but fortunately hasn't gone lower.

Technically, the stock is still trading above a critical long-term area of support in the $42 - $43 area.

The stock is hanging by a thread.

As a Seeking Alpha contributor who prides myself on getting the numbers right, the earnings preview was not helpful since Oracle changed up the reporting of their three Cloud segments: PAAS, SAAS and IASS, and from what i can see probably only informed the sell-side analysts.

Looking at one sell-side research report on Oracle's May '18 quarter, here are some key highlights:

1) Total Oracle revenue (non-GAAP) rose just 3% y/y, the slowest rate of growth of the last 4 quarters.

2.) Total Cloud revenue (non-GAAP) rose 22% y/y in fiscal q4 '18, down from 51%, 44%, and 32% the last three consecutive quarters.

3.) Cloud licenses and service support (non-GAAP, and per Oracle's earnings release) rose 6% - 7% in constant currency.

4.) Operating margin rose 120 bp's y/y to 47.1%, probably helped by the 10% drop in SG&A in Q4 '18.

Analyst comments in the report noted the Cloud revenue "reconfiguration", the positive effect of currency and the stock repurchase of $4.9 billion in the quarter.

Oracle's cash position:

Oracle's market cap as of Tuesday, July 3rd's closing bell was roughly $178 billion, and $67 billion of that is sitting on the balance sheet in form of cash and securities.

Oracle spent $4.9 billion on share repurchases in fiscal Q4 '18, but continues to dilute shareholders with ISO's or incentive stock option exercise not a surprise after you look at the stock portion of the Netsuite purchase.

q4 '18 q3 '18 q2 '18 q1 '18
2021 EPS est $3.77 $3.62 n/a n/a
2020 EPS est $3.64 $3.65 $3.43 $3.36
2019 EPS est $3.36 $3.36 $3.17 $3.17
2021 est EPS gro rt 4% -1%
2020 est EPS gro rt 8% 9% 8% 6%
2019 est EPS gro rt 8% 9% 8% 8%
2021 P.E 12x 13x
2020 P.E 12x 13x 14x 15x
2019 P.E 13x 14x 15x 16x
2021 est rev's ($'s bl's) $43.7 $42.0
2020 est rev $42.5 $43.1 $43.3 $43.3
2019 est rev $41 $41.3 $41.1 $41.1
2021 est rev gro rt 3% -2%
2020 est rev gro rt 4% 4% 5% 5%
2019 est rev gro rt 2% 4% 4% 4%

Source: Forward estimates from Thomson Reuters IBES as of 7/4/18

Looking at the trends in the EPS and revenue estimates, readers can note that the EPS forward estimates are likely being supported by the potential share repurchases, but forward revenue estimates continue to slip.

Oracle Valuation:

Valuation metric as of May '18
3-yr avg exp EPS gro rt 7%
3-yr avg exp rev gro rt 3%
3-yr avg P.E 12x
Price/sales 4,6x
Price/book 3.95x
Price to tang book negative
Price/cash-flow 12x
Price / free-cash-flow (NYSE:FCF) 13x
Price/cash flow (ex cash) 7x
Price to free-cash-flow (ex cash) 8x
Balance sheet cash per share $16
FCF yield 7%
Cash (net of debt) per share $2.68
Div as % of FCF 23%
Dollar amount of L-T debt $56 bl (up from $30 bl in Feb '15)
Debt-to-capital 41%
Morningstar moat wide (but negative trend)
Morningstar fair value estimate $46

Source: internal valuation s/sheet and Morningstar data

Analysis / conclusion:

This review of Oracle's quarter is meant to be short and sweet since the stock price and estimate trends pretty much tell you everything about the stock.

No question Oracle's Cloud strategy is struggling and management may be looking at ways to pivot around it. Since I'm not a "technologist" so to speak, but instead simply watch numbers, Oracle's BYOL (bring you own license) initiative seems designed to keep the installed base (probably Oracle's greatest competitive strength) captive to Oracle.

There is a chance Oracle could become a dividend-grower to a greater extent than they have in the past, but Oracle's penchant for stock-driven acquisitions, like a Netsuite, only means continued dilution will remain high.

Oracle is in the same spot as IBM and Cisco - the legacy business has been disrupted and Oracle management is now shifting to the Cloud to realign the business model, and with Oracle's installed user base, or stand-alone users, it is becoming a tougher transition than the one Microsoft made to the Cloud. Microsoft's transition has been a resounding success, while Oracle's results the last 4 - 6 quarters show decelerating growth.

Oracle's $67 billion cash position is an unambiguous positive - could the software giant opt for an ASR (accelerated share repurchase) and spend a big chunk of this cash ?

Possibly, but management has been more inclined to make large cash-and-stock acquisitions and as the shares trade poorly, more cash than stock might have to be used.

Client's 1.9% position coming into the Oracle earnings release is now a 1.6% position without selling any shares. The balance sheet cash position is a good reason to sit on the shares but long-term debt has doubled in 3 years from $30 bl to $56 bl.

Oracle's Cloud strategy is nearing a do-or-die moment. A decision will be made on the stock in the next few weeks or months, and may not be updated here.

Client's will be out of the stock on a heavy volume trade below $42.

Disclosure: I am/we are long ORCL.

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.