Oracle’s Cloud Growth Likely Continued in Q2, But Will It Be Enough?

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Software behemoth Oracle Corp. (NYSE:ORCL) is scheduled to report its fiscal 2016 second quarter earnings on December 16th. (The company follows June to May fiscal year.) [1] Cloud revenue growth is expected to pick up sequentially as the company’s substantial deferred revenues begin to kick in. The relative weakness in the legacy on-premise software business, which includes sales of new licenses and support revenue, is expected to continue. Oracle’s tunnel-like vision on growing its cloud business is taking a toll on the growth potential of its on-premise and hardware business segments. Given that the cloud segment still accounts for less than 10% of Oracle’s total revenues, the company cannot afford to ignore its legacy businesses but appears to be doing so.

Oracle’s fiscal 2016 first quarter performance recap:

  • Revenues contracted by 2 percentage points year on year to $8.4 billion (7% growth in constant currency terms)
  • Software-as-a-Service (SaaS) and Platform-as-a-Service (PaaS) bookings grew by 165% year on year
  • Non-GAAP operating margin declined by 3 percentage points year on year to 41%
  • Non-GAAP EPS was $0.53, compared to $0.62 in the prior year period

Our price estimate of $39 for Oracle Corp. is slightly higher than its current market price.

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See our complete analysis for Oracle Corp. here

Cloud Growth to Accelerate

Oracle completed a large portion of its data center investments in the first quarter, to create computing capacity that has been available to customers of its on-demand offering from the second quarter forward. Separately, a number of new contracts booked in recent quarters have yet to generate revenue, as revenue is recognized only when customers start using Oracle’s cloud services post installation. According to the company, this period of revenue recognition from past bookings began in fiscal 2016 and will accelerate in the back half of the year. [2] Thus, Oracle was likely to have seen a sequential increase in cloud revenue growth rate in the second quarter due to the combination of the above two factors. And more substantial growth should occur in subsequent quarters.

It should be noted that this jump in cloud revenues is expected only in the SaaS and PaaS categories. Oracle’s Infrastructure-as-a-Service business is still a nascent segment which came to focus only in this year’s OpenWorld event. (Read: Oracle Has Grand Plans For Cloud Computing – But Is It Too Late To The Party?) Therefore, growth of revenues from IaaS is likely to continue at a relatively low clip in the near term.

Legacy On-Premise Business to Remain Sluggish

As in the previous few quarters, Oracle’s on-premise software licenses business likely grew at a nominal clip in the second quarter. Revenues from the on-premise business (including update and support revenues) account for nearly 70% of Oracle’s total revenues, yet the company seems to be ignoring its biggest revenue stream to pursue the newfangled cloud business. Sales of new software licenses declined year on year in at least the last four quarters. Growth of revenues from update and support services also fell into negative territory in the previous quarter after staying flat for the preceding two quarters.

This is an alarming trend in light of the importance and the share of these revenue streams in the company. Oracle guided total revenue to grow up to 2% year on year in the second quarter of this year. In other words, the flailing on-premise software license sales business is expected to have nearly wiped out the gains in the fledgling cloud business. Nevertheless, it should be noted that revenues from Oracle’s update and support services are expected to pick up and achieve moderate growth in the full year, which could offset a decline in the on-premise new software license sales. The attach and renewal rate of the Company’s customers remains strong, which is the sole silver lining in Oracle’s legacy business. ((Oracle Fiscal 2016 First Quarter Earnings Call Transcript, Seeking Alpha, September 16, 2015))

In summary, Oracle’s focus on capturing a share of the lucrative cloud market is admirable, but the company appears to be intent on doing so even at the cost of its traditional strengths. Given the intense competition in the cloud market, Oracle needs to ensure that at least its bread and butter is secure before embarking on tall ambitions.

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Notes:
  1. Oracle Investor Relations []
  2. Oracle Fiscal 2016 First Quarter Earnings Call Transcript, Seeking Alpha, September 16, 2015 []