Higher Cloud Revenue Growth Estimates Has Led To Over 20% Rise In Our Valuation Of Oracle

by Trefis Team
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Key Highlights

  1. Price estimate raised by 22% to $54 per share.
  2. Cloud revenue forecast has been increased because of sustained performance
  3. Oracle can scoop out extra $4 billion in gross profit by the end of 2023

See our complete analysis for Oracle

In its Q4’17 earnings released on June 21, Oracle (NYSE:ORCL) delivered $300 million extra in revenues and earned 10 cents per share in excess in comparison to the analyst estimates. This has led us to increase the price estimate for Oracle by over 20%, from $44 to $54. This was our second price increase of over 10% in the last six months because of similar events.

Since the start of this decade, Oracle had been undergoing a shift from its on-premise software model to the cloud-based subscription model. This was hurting its revenue growth because a large part of conventional revenue in the subscription model gets deferred and is realized over a period of time. Moreover, Oracle was a bit late in entering the cloud space which got dominated by the likes of Salesforce in Software-as-a-service and Amazon in Infrastructure-as-a-service, resulting in a stepped up competitive environment.

However, over the last few quarters Oracle has made a U-turn with respect to its top-line growth as the gain in the cloud revenues has more than offset the fall in new software sales, resulting in the net revenue growth for FY’17. Earlier this year, when we raised our price estimate for Oracle from $40 to $45, we kept a margin of safety in our forecasts to account for the fact that these positive changes in Oracle’s financials might be temporary and can reverse once the boost from NetSuite’s acquisition phases out. But, the recent quarter results have strengthened our confidence that this change can stay for longer, allowing us to further raise the valuation.

Here are the reasons behind the changes that have been made:

Larry Ellison Is Stressing On Infrastructure-as-a-Service Growth

Earlier we were estimating Oracle to grab 1.6% share in global IaaS market by the end of 2023. Now we believe that it can gain an extra 1% share to hold 2.6% of global IaaS market by the end of same period. This increased our revenue forecast for 2023 from $3.2 billion to $5.1 billion. It takes into account the fact that Chairman Larry Ellison believes IaaS and PaaS (platform-as-a-service) combined can achieve higher growth rates than SaaS. SaaS has already crossed the 60% growth rate in FY’17.
Apart from this, Oracle has been making investments in its second generation data centers to compete with Amazon’s AWS and to bring Oracle’s database customers onto Oracle’s cloud. If the company successfully achieves that, then it can experience a rapid growth in IaaS revenues.

Software-as-a-Service Revenues May Rise Faster

We have also raised our forecast for Oracle’s SaaS & PaaS revenues in our terminal year of forecast from $17.3 billion to $20.8 billion. Recently, Oracle was in a competitive race with Salesforce to be the first to reach $10 billion in cloud revenues. While Salesforce has almost won this race by giving a guidance of reaching $10 billion in revenues by 2018, it is worth noting that Oracle, too, has reported over 60% rise in its cloud revenues in FY’17. So, even if it manages to grow at a slower rate of say about 50% in the near future, then, too, it can double its cloud revenues in just over 16 months, which means Oracle can reach this mark by 2019. Also, while Salesforce is dominant in CRM (customer relationship management), Oracle has the benefit of operating in a larger market which is comprised of ERP (enterprise resource planning), SCM (Supply Chain Management, HCM (Human Capital Management), CRM, and other SaaS domains as well. Keeping this in view, we believe Oracle’s SaaS business can grow even faster than what we estimated before.

Gross Profit Estimates Increased By $4 billion

Oracle seems well on track to reach its goal of achieving 80% gross margins in the SaaS & PaaS business. The margins of this division have risen from 48% in FY’15 to 62% in FY’17. We believe Oracle can cross the 80% mark by 2019 if it maintains similar performance. This, along with higher revenue estimates, have led to an increase in the company’s total gross margin forecast from 73.5% ($28.2 billion) to 74.5% ($32.6) by the end of our forecast period.

Following table describes the factors that led to an increase in Oracle’s valuation:

 

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