These Scenarios Could Lift Our Valuation of Oracle by 30%

+1.81%
Upside
128
Market
130
Trefis
ORCL: Oracle logo
ORCL
Oracle

Oracle Corp. (NYSE: ORCL) is the world’s second largest software vendor and specializes in database software. With annual revenues of $39 billion in calendar 2014 and current market capitalization of over $180 billion, it is preceded by only Microsoft Corp. (NASDAQ: MSFT) in terms of revenues and market size. At a time of rapid change in the industry, Oracle is focusing on key parts of its product offering, as more traditional other software and hardware products. Below, we consider scenarios that offer significant upside to its  current focus. First, we must offer the following contextual information.

Oracle primarily operates in the software industry and derives nearly 80% of its revenues from its software business. It also has a presence in the hardware segment through its acquisition of Sun Microsystems in 2010, and derives a little over 10% of its revenues from hardware sales and support. The remaining 10% revenues are derived from consulting and other services.

In its software business, Oracle is currently focused on expanding its presence in cloud computing. Generally considered as a relatively late entrant in cloud computing, Oracle is not intent on catching up to the market leader and bitter rival, Salesforce.com (NYSE: CRM). Salesforce has an undisputed lead in the Customer Relationship Management (CRM) segment of cloud computing. On the other hand, Oracle is growing its presence in the Software-as-a-Service (SaaS) and Platform-as-a-Service (PaaS) segments. It expects to surpass Salesforce in these segments in fiscal 2016. (Read: Currency Headwinds Dampen Rapid Growth of Oracle’s Cloud Business in Q4)

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Oracle’s secondary focus is on its engineered systems product line in its hardware business. Engineered systems are integrated platforms that are delivered ready for deployment and include hardware, pre-integrated packaged software and support for cloud-services. Oracle is the market leader in integrated platforms [1] and revenues from this product line have consistently grown by double digits each quarter.

Oracle’s undivided focus on cloud in the software business and engineered systems in the hardware business has been accompanied by the poor performance of its other divisions. Its revenues and market share in the on-premise software segment have declined in the last two years. Similarly, its revenues from the hardware business have also plummeted due to the sluggish performance of Oracle’s standalone servers, storage, and networking hardware products. We currently expect this trend to continue in the future.

Our price estimate of $42 for Oracle Corp. is almost in line with its current market price. In this article, we explore certain scenarios that can lead to a significant upside in our valuation for the company.

See our complete analysis for Oracle Corp. here

Higher Market Share in Global On-Premise Software Market (~20% Upside)

The biggest casualty of Oracle’s bid to expand in cloud computing has been its legacy on-premise software business. The company has openly stated that the allocation of its resources, including R&D investments and sales team, is heavily skewed towards its cloud business. [2] As a result, we estimate Oracles’ market share in the global on-premise software market to have declined by a few percentage points over the last two years. Due to Oracle’s continued focus on the cloud, we expect its market share in the global on-premise software market to continue to decline over our forecast period and fall below 3% by 2021.

However, Oracle has stated that many of its customers are not switching over completely from on-premise to cloud hosting for Oracle’s software. Instead, its existing customers are adding cloud functionality over and above their on-premise software and infrastructure. This is driven by Oracle’s exclusive feature by which customers can dynamically shift workloads back and forth between their on-premise and cloud computing capacity. Further, the company has also stated that renewal and attach rates continue to remain high for its legacy on-premise software licenses. [2]

This implies that Oracle’s legacy software business may still have potential. The current onslaught on revenues from on-premise software licenses may be due to Oracle’s intention to expand its cloud business aggressively. Once a certain scale has been achieved, it is possible that the expansion in cloud may even-out and Oracle may reallocate part of its resources back to the on-premise segment. In such a scenario, Oracle’s market share in the global on-premise software market may recover after an initial decline.

As stated earlier, we currently expect Oracle’s market share in the on-premise software market to decline throughout our forecast period and fall below the 3% mark by 2021. The decline in revenues is expected to increase its update and support revenues as a percentage of on-premise software license revenues to over 80% by 2021. If Oracle’s market share in the on-premise software market reaches 5% and its update and support revenues as a percentage of on-premise software license reaches 73% by the end of our review period, then there will be a 20% upside to our current valuation for the company.

Revival of Market Share in The Global Hardware Market (~10% Upside)

Oracle entered the hardware business as an ancillary result of its acquisition of Sun Microsystems in 2010. However, its bet on x86 servers failed to pay off as the market moved overwhelmingly to so-called White Box servers made by Chinese Original Device Manufacturers (ODMs) as well as to cheaper Unix-based servers. Further, the global external storage hardware market has declined in the recent years due to the rapid transition to cloud storage. [3] Oracle has shifted its focus to its nascent engineered systems product line, at the cost of its other hardware segments. Consequently, Oracle’s market share in the global hardware market declined from 3% in 2012 to 2% in 2014. We expect the same to continue declining over the medium term.

Oracle does not report the revenues from its hardware sub-segments separately. It stated in the fiscal 2015 first quarter earnings call that engineered systems account for about a third of its hardware product sales. [4] The growth of engineered systems far outpaced the growth of Oracle’s overall hardware business in fiscal 2015. Therefore, it can be concluded that at the end of fiscal 2015, engineered systems account for much more than a third of the total hardware division. The growing proportion of engineered systems in Oracle’s hardware business is expected to stabilize its market share in the global hardware market over the long term.

However, following the success of its engineered systems product line, it is possible that Oracle may choose to reallocate its resources to the other hardware sub-segments like standalone servers, and storage and networking hardware. This could result in an uptick in its market share in the global hardware market over the long term. If Oracles’s market share in this segment expands to over 5% by 2021, it could result in a 10% upside to our current valuation of the company.

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Notes:
  1. Worldwide Integrated Infrastructure and Platforms Revenues Increase 19.4% in the Fourth Quarter as Demand Outpaces Traditional Systems, IDC, March 26, 2015 []
  2. Oracle Fiscal 2015 Fourth Quarter Earnings Call Transcript, Seeking Alpha, June 17, 2015 [] []
  3. IDC Press Release, March 6, 2015 []
  4. Oracle Fiscal 2015 First Quarter Earnings Call Transcript, Seeking Alpha, 18 September 2014 []