This Tech Giant Just Doubled Down On Cloud Computing

Tim Begany's picture

Tuesday, December 9, 2014 - 1:30pm

by Tim Begany

    

 

Haste makes waste. That's the possible view on the corner offices at software giant Oracle Corp. (Nasdaq: ORCL), which seems to have taken its sweet time in embracing cloud computing.

 

Now, management appears to have a clear vision of how it wants the firm to be positioned in the "cloud." Cloud software is loosely defined as the migration of data storage and analytics to the public internet and away from private, local servers.

 

To be sure, the $38.5 billion (in revenue) behemoth is well behind cloud leaders like Google, Inc. (NASDAQ: GOOGL), Amazon.com, Inc. (NASDAQ: AMZN) and Microsoft Corp. (NASDAQ: MSFT); however, its vast resources and huge customer base make it a good bet to become a top player in what's still an emerging industry.

 

What's more, Oracle doesn't have to make the transition overnight.

 

What investors sometimes forget is the broader movement to the cloud is still relatively new and will be a multi-year process. So Oracle's traditional business remains an enormous asset. In fact, the firm still has 310,000 database customers and about nine in 10 of these renew each year.

 

As a result, things like software license renewals, maintenance and technical support are tremendous cash cows, generating three-quarters of Oracle's sales. And even though database-related products and services will become progressively less important, they're still the main driver of surprisingly strong growth.

 

During the past five years, for example, overall revenues expanded 10.5% annually to their present level, and net income soared more than 14% a year to nearly $11 billion. That's substantially better than Microsoft's sales and net income growth rates of about 8% and 9%, respectively.

 

And though Oracle's top-line growth has lagged tech stocks, such as Google and Amazon, it kept pace with the former in terms of profit growth and blew away the latter.

 

Oracle is doing quite well despite being slow to adopt cloud computing. Now that it established a cloud presence, Oracle is quickly becoming a significant force.

 

The firm is thriving in software as a service, where customers access software virtually rather than having to install and maintain it on-site. Here, the focus is on some of the fastest-growing markets, including human resources, customer relationship management and enterprise resource planning.

 

Another promising avenue for Oracle is platform as a service, in which customers buy online access to things like hardware, operating systems and network capacity.

 

Oracle may be relatively new to these markets. But it's already the second-largest player by revenue, with total sales for the two services of $1.1 billion in fiscal (June) 2014.

 

That's still well below the $4.1 billion generated by the current leader in those markets, Salesforce.com, Inc. (NYSE: CRM). However, Oracle's sales for the two services are improving rapidly, rising 24% in fiscal 2014 after gaining just 4% the year before.

 

Sales in this segment rose another 32% in the first quarter of fiscal 2015, and management expects to report 40%-to-45% growth when it checks in again on December 15. So it may not be long before these two businesses are consistently growing 30% or more a year, similar to the rate seen by  Saleforce.

 

Despite strong words to the contrary, Oracle isn't as aggressively pursuing the other main area of cloud computing -- infrastructure as a service. And that's a good thing.

 

Infrastructure as a service, the market for infrastructure products like virtual server space, network connections, bandwidth and IP addresses, simply isn't as profitable. That's because the dominant player, Amazon, is using the ultra-low-cost approach it applies to retail.

 

Amazon cut prices nearly four dozen times in recent years, prompting some industry observers to accuse it of leading the race to zero margins in the sector. I'd much rather see Oracle devote more attention to the sales and platforms as a service niches, which typically carry margins of 40%-to-50%.

 

Although you might not expect it, the firm's database will be highly useful in promoting its cloud products since the two are compatible. Essentially, existing database customers can be switched to the cloud with the touch of a button, facilitating customer retention, management says.

 

Oracle also plans to take the growth-through-acquisitions route to greater success in the cloud, which can be expensive, but also expedites the company's shift into the cloud.  

 

In June, for example, the company announced a $5.3-billion buyout of Maryland-based Micros Systems, Inc., which makes and sells computer hardware, software and services for the restaurant point of sale, hotel, hospitality and specialty retail markets. The deal should provide ample opportunities to market cloud solutions to Micros customers.

 

A month later, Oracle revealed plans to acquire Ohio-based TOA Technologies, a leading provider of cloud services used to manage delivery drivers and other field service employees. The buyout terms haven't been disclosed.

 

There are also rumors that Oracle may acquire Salesforce, which may not be as farfetched as it seems, even though the two are rivals. The fact is, their cloud solutions are complementary. What's more, Salesforce is an Oracle database customer and the two companies' management teams have a close relationship.

 

Risks To Consider: Oracle has spent tens of billions on acquisitions in recent years, and some analysts believe the company overpaid in many cases. Management disputes this, but it raises the possibility that shareholders aren't getting the best bang for their buck.

 

Action To Take --> Only time will tell for sure if Oracle is paying too much for acquisitions, but it's a risk I'm not overly concerned about. The company has a long history of deal-making and, as you can see, is performing very well. Its balance sheet is healthy, with plenty of cash on hand, steadily rising free cash flow and manageable debt. So I encourage investors to see Oracle not as outdated, but as an evolving tech giant that's apt to be a cloud computing leader. What's more, the firm's traditional database business is still robust, so analyst estimates implying roughly 60% upside for the stock during the next five years look plenty reasonable to me.

 

Cloud computing is a technology of the future and market share is still up for grabs. Investing in companies that operate in emerging sectors can be a quick ticket to triple-digit gains. In fact, StreetAuthority's premium newsletter Game-Changing Stocks specializes in indentifying these trends and opportunities. To learn more about the next company that may revolution its industry -- and potentially the world -- click here.

 

 

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of GOOGL in one or more of its “real money” portfolios.