June 26, 2008

Oracle Excels Amid a Tough Outlook

The last time software maker Oracle reported quarterly results, investors got an unpleasant surprise. Sales fell short of expectations, Oracle's stock fell, and Wall Street questioned the company's ability to shrug off a slowdown in technology spending. The doubts proved to be short-lived.

Oracle's (ORCL) business snapped back in the most recent quarter, which ended May 31, typically its strongest of the year -- though a tempered forecast for the current period curbed investor enthusiasm. Fourth-quarter revenue rose 24% and profit soared 27%, beating analysts' expectations on both counts, Oracle reported June 25. And sales of new software licenses, an indicator of future sales, surged 27%, vs. Wall Street's expectation of 16% growth.

"Profit Machine"

Executives said Oracle's purchases of more than 40 software companies for more than $25 billion in the past three-and-a-half years helped it widen share in the market for business applications and let it sell customers an ever broader portfolio of products. The $8.5 billion acquisition of middleware vendor BEA Systems closed Apr. 30. "We don't think that our strategy is in any way running out of gas," co-President and Chief Financial Officer Safra Catz said on a conference call with investors.

But Catz warned investors that growth in the historically slow quarter that ends in August would pale in comparison to a year earlier. Oracle expects new license sales to rise 10% to 20%, compared with a 35% increase in the same period a year earlier, when the company landed several large deals, including with Ford (F) and Cisco Systems (CSCO). Oracle shares lost more than 3% in extended trading after the report was released. They had risen 32%, or 1.4%, to 22.55 in regular trading.

Despite Catz's cautionary note -- and the prospect that companies could cut technology spending ever further in the second half of the year amid a U.S. slowdown -- Oracle's stock is shaping up as one of the tech sector's better buys right now. The company collects nearly half its revenues from technical support, or "maintenance" fees, and consulting contracts for its software, which generates lots of cash that's either booked as profit or used to acquire more companies. That, in turn, feeds new license sales, which create future maintenance streams. "Oracle, given its size, is a profit machine," says UBS (UBS) analyst Heather Bellini, who has a buy rating on Oracle. "That's one reason we think Oracle's such an anchor stock. There's a lot more predictability around their revenues and their earnings growth" than for other technology companies, she says. "License revenue is the sexy part everyone focuses on, but the profitability lies in the maintenance stream."

Acquisitions Lead the Way

Net income for the quarter hit $2.04 billion, or 39% a share, vs. $1.6 billion a year ago. On a non-GAAP basis, Oracle earned 47% a share, beating Wall Street's expectation of 44% a share. Sales rose to $7.24 billion, exceeding analysts' expectations of $6.86 billion. New license sales of business applications, which companies use to manage inventory levels, bill customers, and plan manufacturing schedules, surged 36%, to $989 million, following a disappointing third-quarter performance [BusinessWeek.com, 3/27/08].

One big reason for Oracle's success is its ability to gain a bigger slice of companies' information technology budgets. "It's easy to buy software from Oracle," says Patrick Walravens, an analyst at JMP Securities (JMP) who rates Oracle a buy. Whereas customers in years past may have divided spending among Oracle and companies like PeopleSoft and Siebel Systems -- both of which Oracle has acquired -- "now you just write a check to Oracle." During the conference call, Oracle CEO Larry Ellison said the company plans a major announcement about its core database business in September.

Oracle, the dominant supplier of database software, has been using acquisitions to make inroads in the business applications market that's led by Germany's SAP (SAP). SAP held 22% of the $63 billion market in 2007, compared with 13% for Oracle, according to tech industry consulting company AMR Research.

Leaner 2009 for Business

A price hike could add to Oracle's momentum. In June, Oracle raised prices by 15% to 20% for its applications and database, its biggest increase in years, according to a June 18 report by Citigroup (C) software research director Brent Thill, who rates Oracle a buy. "Oracle has the power to raise prices based on dominant or No. 2 share in each of the categories they play in," wrote Thill.

The company is also expanding into new markets. On June 23, Oracle bought privately held Skywire Software, which makes applications for the insurance industry, and announced it had formed a new unit to sell software to the health-care industry. On May 13, Oracle said it acquired AdminServer, another developer of insurance industry software. Oracle has been able to make inroads into software for data-intensive industries including retail, banking, and public utilities, where customers already use its database software, says Stuart Williams, an analyst at market researcher Technology Business Research.

Though Oracle gets a bigger piece of budgets, companies could slice overall spending come August as they prepare for what may be a leaner 2009, says JMP's Walravens. Faced with a choice between layoffs and buying fewer computers and software packages, many companies may opt to dial back tech spending, he says.

Rival SAP has been feeling the pinch. SAP's average deal size in the U.S. has been falling as IT projects here become smaller in size and companies push more buying to decision-making boards, CEO Henning Kagermann said in a June 20 interview. "In a tough environment, you look at every dollar."

And Oracle will be vying for every one that doesn't get cut.


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