Oracle: Value Trap Or Buying Opportunity?

Investors in Oracle (ORCL) continue to see their investment trade near post-internet bubble highs even though analysts are getting cautious.

While shares have moved hardly up since the start of the year, they continue to trade near the highs of the past decade. Investors are divided whether Oracle is becoming a "value-trap" like many other tech giants, or whether current levels still offer a great entry point at an attractive valuation, even as growth is slowing down.

Given the recent momentum, after shares have nearly risen by 20% from the lows of the summer, I remain on the sidelines.

Standpoint Research Is Getting Cautious

Analyst Ronnie Moas has lowered the target for Oracle from "Buy" to "Hold." He notes that shares have recovered their entire losses from May till June, and they are now trading above the levels before the disappointing news from June broke out.

Moas notes that shares are valued at over 12 times earnings, which is a fair multiple for a company with a market capitalization of over $160 billion. Moas calls himself a "value guy" exiting the stock, at the same time as momentum players might be stepping in. Moas would recommend locking in gains with shares trading at less than 4% from their highs.

Valuation

Oracle ended its first quarter of its fiscal 2014 with $39.1 billion in cash, equivalents and marketable securities. Total debt stands at $24.1 billion, for a net cash position of $15 billion.

Oracle is scheduled to release its second quarter results on the 16th of December.

Revenues for the fiscal year of 2013 came in at $37.2 billion, up by merely 0.2% on the year before. Earnings rose by 9.5% to $10.9 billion, with earnings per share growth seeing an additional boost on the back of share repurchases.

Trading around $35 per share, the market values Oracle at $164 billion. This values operating assets of the firm at $149 billion, the equivalent of 4.0 times annual revenues and 13-14 times annual earnings.

Oracle pays a relatively modest quarterly dividend of $0.12 per share for an annual dividend yield of 1.4%.

Some Historical Perspective

After shares peaked at levels above $100 per share during the internet bubble, shares fell to levels of just $10 in 2002. Ever since, shares have steadily risen to post internet bubble highs of $35 at the moment.

That being said, shares have only advanced some 6% so far this year as continued pressure on the business model due to intensifying cloud competition is eating into Oracle's prospects.

Between fiscal 2010 and 2013, Oracle increased its annual revenues by a cumulative 40% to $37.2 billion. Earnings grew at double this pace to $10.9 billion. On top of that, Oracle repurchased 7-8% of its shares outstanding.

Investment Thesis

Oracle looks appealing based on the strong balance sheet and the reasonably attractive valuation multiples. Like many other technology moguls like Cisco Systems (CSCO), IBM (IBM), Intel (INTC) and Hewlett-Packard (HPQ), Oracle is facing bigger headwinds in its core markets.

A difficult macro-environment and emerging competition from cloud businesses like Salesforce.com (CRM) and Workday (WDAY) are big threats, possibly even more than competition from other large established players like Microsoft (MSFT) and SAP.

Despite these headwinds and flattish revenue growth, shares trade at their highest levels since the internet bubble thanks to margin expansion and large buyback programs. What is worrying to me is that Oracle's Chief Larry Ellison is also facing increased scrutiny for spending more time on hobbies, like sailing, than to lead the company. In September, Ellison skipped the earnings conference call to join his team on the America's Cup sailing race. A week thereafter, Ellison did not attend Oracle's OpenWorld Conference for the same reason, even though the event drew ten of thousands of attendees.

It is not just competing offerings, but even more so business models which are competing again legacy providers, such as Oracle. The Software-as-a-Service (SAAS) business model relies on monthly subscriptions instead of large upfront investments. As such, corporate companies can simply record these items as operating expenses, opposed to huge upfront investments. Despite these threats Oracle and IBM are still dominating Application and Middleware Software although both companies are feeling the heat of emerging competition.

While growth in the general market is still resulting in flattish or slightly increasing revenue growth rates, many smaller vendors are reporting much greater growth rates, sometimes even into triple digits. This is especially true as the world moves away from structured data toward data being generated more and more through mobile devices, not suited for traditional solutions.

Back in September, after Oracle released its first quarter results, I last took a look at Oracle's prospects. Reported revenue growth still came in at 2% on an annual basis, and would have come in at twice that level in constant currencies. Still, trends are not encouraging and growth rates are much less compared to those of other competing firms. Part of this might be the result of the industry transition to SaaS. Oracle's sales representatives might see lower commissions on contracts which will be based upon monthly sales. Traditionally, vendors recognized the lifetime value of such deals upfront.

As should be clear from other large technology companies, the large current earnings don't say too much as technological changes can quickly erode a company's competitive position in today's fast evolving world.

For now the valuation remains fair, with shares trading around 13-14 times earnings, while paying out decent cash flows to investors, notably through share repurchases. While this provides comfort, investors should carefully monitor the competitive position and revenue growth to avoid the "value-trap."

I remain on the sidelines, as I am not 100% confident in Oracle's ability to transform again.

Source: Oracle: Value Trap Or Buying Opportunity?

Disclosure: I am short WDAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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