to Ride Internet Higher
individualinvestor.com
Analyst: Bob Hirschfeld (11/22/99)
When Oracle (NASDAQ: ORCL - Quotes, News, Boards) management announced on November 17 that second-quarter sales looked strong, analysts reacted positively, and shares took off, rising over 10%.
CEO Larry Ellison said Oracle?s pipeline is full and software spending hasn?t been slowed by year 2000 concerns.
Oracle is scheduled to report its second quarter earnings on December 10th. Right now there is considerable optimism that the huge database software vendor, with over $9 billion in annual revenue, will produce a very strong quarter. In the last month alone, shares have climbed over 60%.
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However, Oracle management has previously provided over-optimistic counsel -- then failed to deliver.
We last wrote about Oracle on September 15th, after shares missed their whisper number. We found Oracle management ?lacking in credibility,? and deplored the high multiple (then 40), given Oracle?s long-term decline in revenue growth and lack of earnings consistency.
We wondered why so many analysts were reiterating their bullishness. It turns out they were right to do so.
Oracle is a difficult company to analyze.
A quick check at the Bloomberg terminal confirms that numerous analysts have provided late counsel, both as to their upgrades and downgrades. When we asked Alex Kotlyar of CE Unterberg, Towbin, why that was the case, the analyst said the difficulties stemmed from Oracle?s inconsistent quarterly reports and from the complexity of its numerous software businesses.
Asked whether things were changing, Kotlyar said Oracle has transitioned from a database vendor into a ?complete software solution? company, adding that such recent products as its business-to-business (B2B) exchange puts it in the frame of such hot companies as Ariba (NASDAQ: ARBA - Quotes, News, Boards) and Commerce One (NASDAQ: CMRC - Quotes, News, Boards).
And that, in turn, has spurred Oracle?s ?recent breakout into new multiple territory.? (He?s not kidding. If you compare Oracle?s first quarter ending August, with expectations for November, the multiple on earnings jumped from 40 times to 75 times.)
However, a number of developments make Oracle genuinely attractive, no matter how pricey it appears now. One, Oracle appears to be making good on Ellison?s promise of six months ago to strip $1 billion of operating costs by the end of the fiscal year, ending May 2001. If successful, that effort would add about $0.30 per share of earnings.
Neil Herman, the Salomon analyst, recently reiterated his Buy rating, giving as his basic reason the ?tangible evidence? supporting the case for operating margin expansion. Herman finds appealing management?s plan to remove $200 million from Oracle's IT cost structure and additionally drive marketing expenses lower by shifting to an e-commerce model.
Management?s stated intention is to move 80% of sales to the online Oracle Store over the next 18 months. That move, Herman explains, should allow Oracle to drive revenue growth ahead of employee growth, and improve sales productivity and operating margins.
Herman also expects Oracle to shift its revenue mix toward software licensing and away from consulting in its basic database business, which should further improve operating margins. Overall, Herman looks for operating margins to improve to 22.7% this fiscal year, and a further 26.2% in 2001, up from 21.2% a year ago.
But the fire in investors? eyes is more about Oracle?s expansion into Internet-related software than margins. One example: Earlier this month the company announced an agreement to build a market-oriented Internet site, called World AutoXchange, on which Ford Motor (NYSE: F - Quotes, News, Boards) and its suppliers could post prices and gauge demand, thereby saving both Ford and its suppliers money.
Doug Crook, the Prudential Securities analyst, notes that Oracle is the only ERP (enterprise resource planning) software vendor completely integrated for both front-end and back-end,? offering both customer relations management (CRM) and supply chain management (SCM) applications that are completely built around the Internet.
Crook claims that Oracle has increased its ERP market share at the expense of Baan (NASDAQ: BAANF - Quotes, News, Boards), SAP (NYSE: SAP - Quotes, News, Boards), and Peoplesoft (NASDAQ: PSFT - Quotes, News, Boards) and observes that Oracle ?is becoming a showcase for its own software,? driving customer interest.
Operating margins, vertical exchanges and Internet leverage off an ERM client base are all solid positives. According to Kotlyar, given the upside in licensing revenue off its database business and multiple expansion on its rapidly growing Internet-revenue, estimated at 15%-20% currently, ?Oracle shares could well trade into the $80s and $90s.?
As e-commerce becomes a bigger part of Oracle?s business, the key question remains whether markets will value it more like Ariba (NASDAQ: ARBA - Quotes, News, Boards) and Commerce One (NASDAQ: CMRC - Quotes, News, Boards) or more like a traditional enterprise software provider.
Right now Oracle is trading at 11.3 times fiscal 2000 revenue estimates, a substantial premium to Baan (NASDAQ: BAANF - Quotes, News, Boards) and PeopleSoft (NASDAQ: PSFT - Quotes, News, Boards) at approximately 3.7 times, and a substantial discount to Ariba and Commerce One, each trading at over 100 times fiscal 2000 revenue forecasts.
So far the markets have been hesitant to award ?old-line? technology companies such stellar multiples. We believe the underlying logic of this view is that this ?brave new world? requires a new approach that is not encumbered by traditional ways of thinking.
Newer, smaller companies are able to adjust more rapidly to new developments in a market that is constantly changing. Furthermore, skilled IT personnel are increasingly short in supply, and newer ?dot.coms? have been more successful in attracting and retaining employees through stock options.
The counterpoint to this argument is that established players such as Oracle have tremendous installed bases and financial resources that they can leverage it to support new e-commerce initiatives. A recent Oracle ad in a leading financial magazine noted that 98% of e-commerce companies use Oracle databases.
Bottom Line:
We tend to favor the former view, and doubt that companies like Oracle will ever receive the multiples reserved for newer players like Commerce One. Nevertheless, we believe Oracle is among the better positioned of the mature enterprise players to take advantage of the emergence of the Internet, and would expect continued appreciation of the shares over the long-term. Oracle was recently at $76.50.
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