Oracle and the Gaping Legacy Hole
- By Shudeep Chandrasekhar
Oracle (ORCL) is just one of at least three businesses I've covered in the past few months that is dealing with a declining legacy business but has found viable alternatives. The big coincidence is that those "alternatives" are all cloud-related.
IBM (IBM) and Microsoft (MSFT) are the other two, and they've also found their escape route through the cloud. But Oracle possibly stands out because for a long time the company was completely against the concept of cloud, unlike the other two.
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The intrinsic value of ORCL
Here's what the then-CEO Larry Ellison said about cloud computing :
"The interesting thing about cloud computing is that we've redefined cloud computing to include everything that we already do. I can't think of anything that isn't cloud computing with all of these announcements. The computer industry is the only industry that is more fashion-driven than women's fashion. Maybe I'm an idiot, but I have no idea what anyone is talking about. What is it? It's complete gibberish. It's insane. When is this idiocy going to stop?"
Unfortunately, some segments of the media actually supported his view, such as CNET, which reported this incident. They're eating their words now, but back then it did create some amount of mistrust in cloud computing. We don't know how much it actually affected client decisions to move to the cloud, but the fact remains that when a respected tech media company reports (and supports) something like this, a certain amount of damage is done.
Oracle has come a long way since then and this year, 8% of Oracle's top line came from cloud revenues. Unfortunately, only 8% of Oracle's top line came from cloud revenues.
Let me explain.
The King of Database Moves to Cloud
Between 2007 and 2011, Oracle nearly doubled its revenues. From slightly under $18 billion, it moved quickly to nearly $36 billion in 2011, at which point it was growing at a phenomenal 32.8% year over year. From 2012, however, its troubles started. That's about the time AWS was growing at high double-digit rates, and IBM and Microsoft had fully realized the potential of cloud.
At that point Oracle was forced to adopt the very technology it had ridiculed a few years ago, and it started using its strengths in SaaS (Software-as-a-Service) and PaaS (Platform-as-a-Service) to push its cloud agenda, backed by a robust IaaS (Infrastructure-as-a-Service) capability built on their data centers.
Today's Oracle still suffers from a growth deficit because all its segments are on the decline except for cloud.
The one hook that Oracle has on the enterprise segment is the fact that it's not going to lose the bulk of its clients to other cloud providers. There will definitely be this continued slow bleed as more clients move to an off-prem model for their IT infrastructure needs. Moreover, some clients may well opt to use cloud services from other companies, such as Office 365 from Microsoft, or Softlayer from IBM or even Google Cloud Platform.
To counter this scenario, Oracle has to push hard to promote its on-prem hybrid model. This is where IBM rules, but Oracle has the same kind of enterprise relationships to pull it off. Together with its strong SaaS and Paas offerings, Oracle does have the tools to offset current and future declines in its legacy businesses.
The real question is: How soon will we see this happening?
As you can see, it's been losing heavily on new software and hardware products. Including the losses from other segments like hardware and services, which is causing a 3% decline on $37 billion revenues for fiscal 2016.
That's the number we need to keep track of. If it can keep growing SaaS and PaaS at the current 49% year over year, that will translate into a total of $4.9 billion for fiscal 2016. While that may seem a small quantum when compared to software revenues of $26 billion, it will definitely help offset the decline in legacy businesses.
As such, I can see 2018 being the year it come out of the red and into the black. It may happen sooner than that because Oracle is now growing its SaaS and PaaS at the rates that AWS, IBM and Microsoft are growing their cloud revenues. Moreover, the industry itself is growing at around 30%, and that increase in market size year-over-year is exactly what Oracle needs to cash in on.
If it lets the big three cloud providers push it out of the competition, all may be lost. But I don't see that happening. The cloud pie is big enough for several companies to create billions of dollars worth of business, and it is growing at a healthy rate -- and Oracle has already started capitalizing on the SaaS and PaaS side of things. This is where its strength lies and this needs to be its two areas of focus over the next two years.
Moreover, i guitsdance for fiscal year 2017 still has a tinge of doubt, so it's 2018 that we should be looking at.
"Over the full-year for FY 2017, I expect SaaS and PaaS revenue growth will be higher than the 65%, up from 62% in FY 2016. SaaS and PaaS gross margins should exit Q4 FY 2017 much higher than the 57% reported today, as we show steady and continued improvement through the year."
For now, ORCL is a HOLD from me, and it will stay that way until cloud growth is able to sustainably offset declines in hardware and software revenues. The best way is to wait and watch until the company is able to post two quarters with no loss. That's about the only sign of stability an investor should be looking for at this point.
Disclosure: I have no position in any of the stocks mentioned and no intention to initiate any position in the next 72 hours.
This article first appeared on GuruFocus.
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The intrinsic value of ORCL
