INVESTMENT THESIS
Oracle Corp. (NGS: ORCL). Founder and CTO Larry Ellison has identified two critical Oracle products that will determine the company’s future: its cloud ERP application software and its autonomous cloud database (note the word ‘cloud’ in each of these products). We believe that Oracle’s primary task is to help its installed base of global blue-chip enterprise customers convert to the cloud. Oracle expects to ride the secular wave of enterprise cloud digitization, while also defending its hold on-premise database customers from cloud rivals, including Amazon’s AWS, Microsoft Azure, and the Google Cloud platform. AWS, Azure, and Google have already had a multiyear jump in the cloud-infrastructure-as-a-service market for compute power and storage. In addition, smaller niche competitors such as Salesforce.com and Workday have targeted specific software-as-a-service applications. Apart from its operating fundamentals, we like the company’s shareholder-friendly attitude, as demonstrated by its strong dividend growth and aggressive share buybacks. Of course, appropriate acquisitions that would drive faster revenue growth would also be welcome. ORCL trades near its historical discount to peers.
RECENT DEVELOPMENTS
Oracle reported results for fiscal 2Q21 (for the period ended November 30) after the close on December 10. Adjusted EPS beat the high end of management’s guidance range by $0.04 and beat consensus by $0.06. Revenue was within the company’s guidance range and beat the consensus by $12 million.
Fiscal 2Q21 non-GAAP revenue rose 2.8% year-over-year to $9.88 billion. Cloud services and license support (about 74% of revenue) rose 4%. However, this growth was modestly offset by a 3% decline from Hardware and 7% decline from Services. CTO and Founder Larry Ellison noted that revenue growth in 2Q was constrained by a lack of capacity in the Oracle Cloud Infrastructure business. The company has recently been building out data centers at a furious pace to catch up to competitors in cloud services.
Non-GAAP operating income rose 12% to $4.59 billion, the company’s best OI growth performance since 2012, while the non-GAAP operating margin expanded by 440 basis points to 46%.
As the company switches to a software-as-a-service ratable business model, metrics such as deferred revenue, bookings, and backlog have become more important in predicting future revenue. Short-term deferred revenue was flat year-over-year at $8.1 billion in 2Q21.
On September 19, Oracle announced that it had been chosen as ‘TikTok’s Secure Cloud Provider.’ As part of the deal, Oracle would take a minority 12.5% stake in ‘TikTok Global’ and TikTok would run on the Oracle Cloud. Oracle was expected to provide assurance that ‘U.S. TikTok user data is private and secure.’ This would appear to allay the U.S. government’s initial reasoning for banning TikTok and Oracle’s deal and has been sanctioned by the U.S. president. Tech analyst Ben Thompson has trenchantly pointed out that while the Oracle deal may protect U.S. user data, it does not address a possibly greater threat from the TikTok recommendation algorithm that drives the site. TikTok has already been called out for tailoring its algorithm to Chinese government policies, as any Chinese company is required to do. The possibility of the Chinese government using the TikTok algorithm to influence the U.S. public opinion either through propaganda or though self-censorship is equally if not a more frightening prospect than the possible appropriation of U.S. user data.
ByteDance is the owner of virally popular social media site TikTok, which was originally under a September 20 deadline to sell to a U.S. company or its U.S. business would have been effectively shut down. However, that deadline was, at first extended and now may be moot as a Federal Court judge has granted ByteDance an injunction against the shutdown order. Any deal remains in limbo as negotiations between ByteDance and the U.S. government continue. The status of Oracle’s deal is unknown and Oracle is silent possible outcomes.
The U.S. government had originally pushed for an outright sale of TikTok to a U.S. company with Microsoft part of the bidding. However, China, where ByteDance is domiciled, passed technology export restrictions which in effect prevented a sale.
EARNINGS & GROWTH ANALYSIS
Founder and Chief Technology Officer Larry Ellison believes that the future of Oracle depends on cloud ERP applications and Oracle’s autonomous database cloud infrastructure. Oracle Fusion Suite and NetSuite are the drivers of cloud application growth. Fusion applications revenue rose 33% in 2Q21 and NetSuite ERP revenue rose 20%. Oracle is looking to expand the company’s share in the cloud ERP market while maintaining its database technology leadership through the rollout of its autonomous database. This will enable the enterprise customers that comprise its 50% share of the database market to migrate to the Oracle Cloud (and by inference not to AWS, Microsoft Azure, Google Cloud Platform, or other providers).
Oracle thinks its Infrastructure-as-a-Service segment is superior to those of competitors in terms of both cost and speed, specifically to that of Amazon Web Services and even to new entrant startup Snowflake that went successfully public in September. In October 2018, Oracle introduced the Gen 2 Cloud Infrastructure as a Service (IaaS) solution. While Gen 2 Cloud is aimed at making it easier for clients to migrate on-premise workloads to the Oracle Cloud, it also relies on the company’s so-called autonomous database. The autonomous database provides not only further cost savings but also autonomous software patching, taking out not just human labor costs but, even more critically, human error from the process of software maintenance.
Oracle launched the latest iteration of the Oracle database, called 18c, on February 16, 2018. Larry Ellison described the newest version as the first ‘fully autonomous database’ that automatically provisions, tunes, updates, and patches itself with only 30 minutes of downtime per year. Since the launch, the 18c has added functionality, including autonomous transaction processing. Mr. Ellison believes that full autonomy will enable customers to both save on labor costs and reduce or eliminate human error. Like the rest of the tech industry, Oracle is relying on ‘machine learning’ or artificial intelligence technology to reach this goal. The 18c is also integrated with a new automated cybersecurity system to discover and remediate cyber-attacks while also patching itself. Mr. Ellison has done multiple head-to-head tests of the 18c against industry leader Amazon Web Services. He has noted that the 18c was 9- to 15-times more efficient than AWS and that it could be operated at half the cost.
We think that NetSuite gives Oracle a much-needed boost in the small and medium enterprise ERP market. Oracle has traditionally appealed more to large enterprises.
FINANCIAL STRENGTH & DIVIDEND
The company’s total debt is $70.8 billion, including $7.25 billion in current debt. Similar to many companies, Oracle moved to increase liquidity during the COVID-19 crisis, issuing $20 billion in incremental debt in the May quarter. Oracle’s large recent debt issuance negatively impacted its credit ratings. Moody’s downgraded Oracle by two notches to A3, the lowest A rating, with a stable outlook on May 30. S&P downgraded Oracle a notch to A on June 19 with a negative outlook.
Oracle repurchased 158 million shares for $9 billion in 1H21, after repurchasing 361 million shares for $19.2 billion in FY20 and spending $36 billion on share buybacks in FY19 and $11.5 billion in FY18. We are reiterating our FY21 dividend forecast of $1.02 and our FY22 estimate of $1.02. Oracle has a five-year average dividend growth rate of 12%.
MANAGEMENT & RISKS
The company shifts from an on-premise to a cloud service provider, the initial shift may diminish revenue growth as cloud services cannibalize on-premise. This negative impact on current revenue growth may be exacerbated as the increasing shift to cloud services makes initial revenues appear to decline due to the timing of revenue attribution as cloud services are typically billed ratably over the term of a contract while traditional on-premise licenses typically include a large upfront payment. However, cloud services tend to provide larger contract values over time as capabilities expand.
VALUATION
ORCL shares are up 17.4% On December 15, HOLD-rated ORCL traded at $61.86, up $1.10.
Source: Argus
