New Software Licenses Will Shoot Oracle Higher In 2013

| About: Oracle Corporation (ORCL)
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Oracle (NYSE:ORCL) reported its first quarter earnings after the closing bell Thursday. The company reported that fiscal first quarter earnings per share of $0.53, higher than the previous year's $0.48. Revenues came in at $8.21 billion, a decline of 2% compared to the same period last year.

According to the consensus estimates of Thomson Reuters, analysts expect $0.53 earnings per share on $8.42 billion. From these figures, Oracle's earnings came in line with expectations, but its revenues have fallen short of estimates. This is a big reversal from the previous quarter's earnings results. Excluding one-off items, Oracle reported $0.73 per share, up by 8.2% year-on-year. This was at the upper range of the company's guidance of $0.78 to $0.83 per share.

The weaker quarterly report seems understandable. First quarter has been usually seasonally weak for Oracle. I expect this trend to continue in the next fiscal second quarter, but believe that third and fourth quarter will most likely offset the weaknesses in the previous quarter. The slower than expected financial results is due to the significant drop on hardware sales. Moving forward, it expects that hardware sales to decline further as it strives to turn around its Sun computer division amid lower technology budgets from enterprises. Meanwhile, its acquisitions of RightNow Technologies and Taleo Corp delivered strong applications sales for the company but were not enough to offset the declining hardware sales.

These were big ticket acquisitions recently and aimed to increase the company's offerings in the cloud computing space. The acquisition of RightNow makes it a direct competitor of (NYSE:CRM) and helps beef up its software-as-a-service offerings. On the other hand, the Taleo acquisition would give Oracle tools that will help them manage human resources, recruit employees, and set compensation. This will result in a strong product portfolio for Oracle as it has the ability to cross-sell its products to its existing clients.

The acquisition binge will continue in the near-term as it plans to further boost its product portfolio. It generally favors companies that can be integrated within its existing or new product lines. The latest acquisition is SelectMinds, a cloud-based recruiting solutions provider. The deal will be completed in the second half of this year. This will be integrated with Taleo to enhance its human resource capabilities. Given the strong record of Oracle in the acquisition space, I believe that these acquisitions will increase shareholder's wealth in the long run.

Oracle's Future Is in the New Application Software Licenses

Oracle's New Application Software Licenses will have a significant impact on its business in the future. It has managed to grow this segment's revenues for the past years. It posted revenues of almost $2.7 billion in 2011. It has recently launched Fusion Apps, a portfolio of next generation suite of software applications. The portfolio appears diverse which includes services like financial management, human capital management, customer relationship management, supply chain management, governance, procurement, and project portfolio management. Since 2005, Oracle has been on the acquisition binge to include notable companies such as Peoplesoft, JD Edwards, and Siebel Systems.

The application software is expected to grow its revenues by $3.8 billion for the next 5 years. There are risks to these estimates. There is competition brewing in the ERP and CRM spaces from enterprise software giants like SAP (NYSE:SAP), IBM (NYSE:IBM), and However, it seems that analysts are excited over the company's prospects from its Fusion Apps.

In fact, Morgan Stanley said that it noted that the recent acquisitions have produced strong results and its Fusion Apps cycle will begin to ramp up in the coming months ahead.

Meanwhile, another research firm Oppenheimer said that its recent field checks suggest that the Fusion Applications products are starting to show improvement on a functionality and reputation standpoint. This is a great improvement from the previous checks it conducted. It concluded that this trend will continue and will generate improving software sales.

Growth Will Remain Intact

Oracle's financials have remained predictable over the long-term. There is a widely held view that companies with predictable and steady earnings will translate into strong capital gains for investors. In the case of Cisco, its revenues have grown by 14.39% over the past 10 year period. This translates to operating margins of 36% for the same period. Its free cash flow has also increased from $5 billion in 2002 to $24 billion in 2011, suggesting strong capital allocation skills for management.

The company is forecasted to earn $2.66 per share this year, up by 8% year-on-year. It is expected to grow by 11% for the next 5 years.

Technology giant IBM reported a 2.22% revenue growth for the last 10 years. Its operating margins have increased from 8% in 2002 to 19% in 2011. The strong margins are due to the company's decision to focus on enterprise software market compared to the traditional hardware business. This is the same path that Oracle plans to do. IBM is forecasted to grow its earnings by 10% for the next 5 years, in line with Oracle's growth.

On the other hand, Microsoft (NASDAQ:MSFT) has posted 10% revenue growth for the same period. But, growth has been slower for the last 5 years at 7%. Its operating margins have also decreased from 41% in 2003 to 29% in 2011 as it faces fierce competition in the software business. Microsoft is also moving into the enterprise software business but has relatively small exposure.


Oracle's valuations appear undemanding for a leader in the different niches it competes. It trades at 10 times earnings and 3.6 times book. This is significantly lower than its 5-year average earnings multiple of 20 times. It also carries a dividend yield of 0.7%. In terms of price-over-growth (PEG) ratio, it is valued at 1.2 times.

In contrast, SAP is valued at 16 times earnings and 5.2 times book value. SAP's PEG ratio is at 1.3 times. Also, Microsoft trades lower at 9 times earnings and 4 times book value. On a PEG ratio, it appears expensive at 5.8 times.

Oracle's undervaluation is due to the uncertainty surrounding its Sun Microsystems business. I believe the market has focused entirely on the difficulties of Oracle's hardware business. In 2013 and beyond, its new applications software licenses will constitute higher earnings contribution. This will offset the decline in hardware. At present, the market is not paying for Oracle's future growth.

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.