Can Oracle’s Expansion Plans in China Overcome Nationalistic Tendencies and Heavy Competition?

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Leading database software vendor Oracle Corp. (NYSE:ORCL) hopes to make inroads in China’s lucrative technology market despite nationalistic tendencies and heavy competition in the country. [1] China passed the National Security Law last month, which calls for a “national security review” of the technology industry’s products, services, and foreign investments. [2] The law creates additional obstacles for global technology giants like Oracle, which already face stiff competition from domestic Chinese companies. Nevertheless, Oracle still hopes to increase its presence in China even as rivals like Hewlett Packard (NYSE:HPQ) sell down Chinese assets outside of its core offering.

Our price estimate of $42 for Oracle is over 10% higher than its current market price.

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Oracle’s Plans for China

Oracle has had the Asia-Pacific region in its crosshairs for quite some time. Asia-Pacific countries accounted for 15% of the company’s revenues in fiscal 2015, of which Japan had the largest share at 3.7%. [3] Although China currently does not account for a significant part of Oracle’s revenues, the country’s technology market holds immense potential that defies the broader economic worries. Information technology spending is expected to grow by over 4% in 2015 to reach $339 billion, despite fears of an economic slowdown. [1] This is in stark contrast to a 5.5% decline expected in global IT spending in 2015, [4] which further underscores the boom in China’s IT industry.

Consequently, last year Oracle stepped up its activity in China by partnering with local companies for offering its cloud services. [5] Earlier this year, the company announced plans to expand its Asia-Pacific sales team by 1000, including 260 in China. [6] More recently, Oracle’s co-CEO Mark Hurd recently stated that the trend of global IT companies scaling back on their China investments presents an investment opportunity for Oracle. [1] These steps suggest that Oracle is doubling down on its bet on China while its competitors remain wary of the challenges in the country.

Stifling International Competition in the Name of National Security

If recent trends are any indication, it is possible that Oracle’s competitors may be right in holding back on expanding in China. Earlier this year, Gartner estimated that two-thirds of data center spending in China will be obtained by local vendors. Such vendors include global powerhouses like Lenovo and Huawei, as well as smaller domestic vendors who have been ramping up their R&D, marketing, selling and support capabilities. [7] This prediction was before the National Security Law came into effect in July, which will make doing business in China even more difficult for foreign IT companies.

The National Security Law is part of a recent wave of attempts by the Chinese government to stifle international competition in China in the name of national security. These attempts include the infamous banking technology rules proposed earlier this year, which were subsequently suspended following strong protests from the US government and business groups. Now, the National Security Law calls for a review of the technology industry in order to ensure that the internet and information systems are “secure and controllable”. Unlike the now-scrapped banking technology rules, the new law is vague and open to a wide interpretation, and thus has more potential for abuse. What exactly the “national security review” of technology products and services will include is still not clear. Fears abound that the Chinese government may attempt to access proprietary technology and encrypted information under the pretext of the review, which could be subsequently misused. Therefore, foreign companies like Oracle seeking to do business in China would be well served to proceed with caution, or they may find their trade secrets in the hands of Chinese competitors as has been known to happen in the past.

Competition Expanding Across the Globe

Even as the hurdles faced by foreign companies for doing business in China increase, their Chinese counterparts are expanding their horizons and bringing the competition to the West. A case in point is the online retailing powerhouse Alibaba (NYSE:BABA), which recently announced plans to invest $1 billion for expanding its cloud computing business. [8] The move came soon after Alibaba opened its first data center in the US for offering cloud computing services, with the possibility of opening more data centers in the future. [9] The only respite in this case is that Alibaba is likely to target as Chinese companies operating in the West; since US companies are likely to opt for the reliable home team (including Amazon (NYSE:AMZN), Google (NYSE:GOOG), IBM (NYSE:IBM), Oracle, et al) rather than a foreign newcomer.

Thus, we believe that Oracle is fighting against the wind in its attempt to consolidate its presence in the country. On the flipside, if the company succeeds in establishing roots in China, it could ride the booming IT market in the country and gain a significant advantage over its competitors in the process.

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Notes:
  1. Oracle chief says US software giant’s China expansion on track despite Beijing protectionism, market slump, South China Morning Post, August 24, 2015 [] [] []
  2. Jitters in Tech World Over New Chinese Security Law, The New York Times, July 2, 2015 []
  3. Oracle Fiscal 2015 10-K []
  4. Worldwide IT Spending to Decline 5.5 Percent in 2015, Gartner, June 30, 2015 []
  5. Oracle Seeks Partners in China to Expand Cloud Service, Bloomberg, October 1, 2014 []
  6. Oracle Press Release, March 25, 2015 []
  7. By 2019 Two-Thirds of Data Center IT Infrastructure Spending in China Will Be Obtained by Local Chinese Vendors, Gartner, February 6, 2015 []
  8. Alibaba Plans $1 Billion Cloud-Computing Push, The Wall Street Journal, July 29, 2015 []
  9. Alibaba Opens Data Center in Silicon Valley, The Wall Street Journal, March 4, 2015 []