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Oracle Dives Headlong into Hardware

September 25, 2008

Larry Ellison kicked off his annual speech to Oracle (ORCL) customers by comparing the engineering behind his new America’s Cup racing yacht to Oracle’s products. “Like a lot of families, I’m holding down two jobs,” he quipped.

Oracle’s billionaire CEO Ellison isn’t personally feeling the sting of a weak economy, and he used his Sept. 24 speech at Oracle’s OpenWorld conference in San Francisco to outline how he hopes to shield his company from it, too.

Oracle unveiled its first-ever hardware products, a pair of servers built by Hewlett-Packard (HPQ) that run Oracle software and is designed to speed the performance of Oracle databases running on them. A storage server lets data flow more quickly from disk drives into the company’s database. And the companies’ co-branded “Database Machine,” which towered over Ellison on stage, is meant to deliver big performance boosts to companies that run an Oracle database on it. “Oracle’s going into the hardware business, but we’re not going alone,” he said.

Safe Haven for Investors Sales of database software are powering financial results at Oracle, even as sales of its business applications have faltered. The company has spent $34 billion to buy about 50 software companies since the beginning of 2005, it said this week. That’s propelled Oracle into the market for applications that run payrolls, billing systems, and sales departments. But though application sales fell 12% in the most recent quarter, sales of databases and application-connecting middleware rose 27%, giving succor to investors worrying how well Oracle and other tech companies are weathering the U.S. economic storm.

Oracle’s stock has served as a relative safe haven for investors this year, outperforming the Nasdaq composite index and the Standards & Poor’s 500-stock index. Operating profit margins topped 40% [BusinessWeek.com, 9/19/08] during the first quarter of Oracle’s fiscal 2009, helped by a big dose of highly profitable technical support revenues.

Those margins make the company’s shares “a very nice place to hide” from the market turmoil, even though revenue growth is slowing, says Pat Walravens, a senior software analyst at JMP Securities (JMP), who rates Oracle stock market outperform. “You have a balancing act between operating margin expansion and decelerating growth,” says Walravens. “In this particular quarter, operating margin expansion came out ahead.”

Focusing on Databases Having built up the applications side of Oracle’s business, Ellison’s speech made it clear that he’s now focusing on databases, the engine of Oracle’s sales and profits. The company is the leader in database software, with a 48.6% share of the $17 billion market last year, according to market researcher Gartner (IT). IBM (IBM) controlled 20.7% of the market, slightly less than in 2006. And Microsoft (MSFT) gained a bit of share, to 18.1% of all sales.

Sales of database and middleware licenses, and customers’ technical support fees for those products, accounted for two-thirds of Oracle’s $4.2 billion in software revenue in the first quarter. And its January acquisition of middleware maker BEA Systems gives the company a new weapon against rivals IBM and SAP (SAP). “Anything you can do to reduce the cost of plumbing is a big win for customers”, says Bruce Richardson, chief research officer at industry consultant AMR Research.

Databases have ballooned in size as companies collect reams of information about their customers and store new types of information like e-mail messages and videos to comply with federal regulations and make use of new forms of online media. Last year, Oracle released a new version of its database [BusinessWeek.com, 7/12/07], called 11g, to capitalize on those trends.

Going After Cloud Computing Yet users often need to wait too long for disk storage systems to transfer those terabytes of data into Oracle’s database software. The Oracle-HP storage server is meant to address that problem by performing some of the computer processing closer to disk drives. The Database Machine server can speed up processing of financial transactions or data analysis. Oracle has also taken aim at the nascent market for “cloud computing,” which lets companies run software in large, remote data centers, accessing it over the Internet. On Sept. 23, Oracle and Intel (INTC) announced joint work on database performance and security for cloud computing environments.

Investors are scrambling to gauge the impact on technology spending of the past two week’s events on Wall Street, including the demise of Merrill Lynch (MER) and Lehman Brothers, the Federal Reserve’s bailout of insurer AIG (AIG), and the government’s proposed $700 billion economic recovery plan. There are signs the economic malaise is spilling into the tech sector. Dell (DELL) on Sept. 16 warned of weakening demand. And analysts have been revising their estimates to reflect lower sales expectations for Apple (AAPL) and other tech companies [BusinessWeek.com, 9/24/08] in the current quarter.

During Oracle’s first-quarter conference call, co-president Safra Catz said the company’s percentage of sales to U.S. banks is in the “low single digits.” Oracle’s software isn’t widely used on Wall Street; investment banks’ preferred database comes from Sybase (SY), and financial-services companies tend to spend heavily on developing their own software, vs. buying commercial applications from Oracle, SAP, and others.

Grim Environment for Software But the economy is surely affecting Oracle’s business more than the vendor has let on, says Sarah Friar, a managing director at Goldman Sachs (GS). “They’re denying all knowledge of macroeconomic impact — I find that hard to believe,” she says.

Shares of Oracle closed Sept. 24 up 26%, or 1.3%, at $19.95. But the stock has lost 12.3% of its value since hitting a 52-week high in early August. And the company’s outlook for its second quarter ending in November wasn’t sanguine — it said revenues would grow 9% to 12% after accounting for the effects of a stronger dollar, which lowers revenues of companies with overseas sales. Revenues had grown by 28% during the second quarter of fiscal 2008.

Even as Oracle powers ahead in the database market, sales of its business applications have faltered. The company is fighting for applications market share with SAP, which held 22.4% of the $62.8 billion market in 2007, vs. 12.5% for Oracle, according to AMR. The company underwent a disruptive reorganization of its salesforce in the first quarter and faced a strong quarter for applications sales a year ago, analysts says.

As it taps into the computer hardware market in a search for new sales, Oracle is up against a 2009 spending environment that analysts say will have companies scrutinizing every IT dollar. “In terms of software spending, it’s going to be bad,” says JMP’s Walravens. Ellison is hoping the same can’t be said for hardware.




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