© 2008 MGI RESEARCH, LLC
DECEMBER 16th, 2008
Oracle – A Bellwether prepares to report
We believe there is a sense of trepidation in the air as investors, competitors, and even customers are awaiting Oracle’s announcement of its second quarter (FY2Q09) earnings on Thursday, December 18th. With broad product and geographic exposure, Oracle (Nasdaq ORCL; MGI-X: 2,023; MGI-CV: -33 %,) is an industry bellwether. Given Oracle’s size, reach and maturity and the fact that Oracle’s Q2 results will include October and November of 2008, Oracle may be the proverbial “canary in the coal mine” for the economic health of the tech industry. Beyond the FY2009Q2 results, the tone of the commentary from Oracle’s management could provide either a confirmation of the current trend or a re-evaluation of Wall Street earnings estimates for many IT vendors. Oracle has been a steady performer in recent years, racking up respectable earnings gains, successfully executing acquisitions and consistently posting high MGI-X scores and positive MGI-CV readings. Yet in the August 2008 quarter Oracle’s MGI-CV was -33%, a negative reading indicating a general reduction in business model efficiency. That fact coupled with a number of qualitative factors gives us pause in assessing Oracle's short to mid-term momentum.
In our view, Oracle continues to benefit from a number of positive factors, even in the current recessionary environment:
· In benchmarks of leading applications software vendors conducted by MGI Research, Oracle has consistently ranked among the Top 3 most efficient applications software companies. Most recently Oracle placed 2nd vs. 74 peers in MGI Research’s July 2008 ASV benchmark.
· A highly effective sales organization – among the best at executing.
· A proven track record in managing the bottom line and driving margin improvements.
· The company is benefiting from a database upgrade cycle (movement to Oracle 11g).
· Oracle continues to gain from price increases rolled out in Q1.
· The sales force is getting its arms around the BEA product line.
· Oracle completed its acquisition of the recognized leader in project management software, Primavera, during the quarter.
· A relatively low exposure to SMB spending, which is likely to be most impacted by sharp demand changes.
· Oracle has a substantial recurring revenue stream from maintenance with approximately half of its revenues tied to maintenance – which is highly profitable revenue (likely much more profitable than Oracle actually reports).
At the same time, it would be foolish to assume that Oracle can somehow magically remain immune to industry headwinds.
· During the Dot.com bubble burst, Oracle license revenues dropped over 25%. While we believe that at present Oracle is not as aggressive in selling deals based on big increases in future capacity, there is every reason to believe that this recession will be as bad as or worse than the 2001-2002 tech nuclear winter.
· The strengthening of the $USD will impact Oracle European revenue in Q2. This may also weigh on other US-based tech companies.
· Though emerging markets have been helping in recent past, these markets are being impacted by the recession as well. All four BRIC (Brazil, Russia, India, and China) economies have shown signs of a slow down or outright recession.
· Oracle has significant exposure to financial services, government, retail, consumer goods companies, among others.
Outlook: Oracle remains one of the best-managed companies in the software industry, with broad and deep distribution channels, as evidenced both by its high operating profitability, high absolute MGI-X score and relative placement within its peer group (e.g,. SAP, Salesforce, IBM, Microsoft). The pipeline of deals going into Q2 was built on sales and marketing activities over the past 12 months. While some deals may have slipped in the quarter, Oracle’s FYQ2 only covers the critical months of October and November – and thus has missed the month of December, which by most accounts is looking very bleak indeed. Unlike competitors that are dependent on a strong October-December Q4 to make the fiscal year, e.g. SAP, Oracle’s Q2 is less vital to Oracle’s fiscal year. Most importantly, Oracle’s MGI-CV (MGI Change Vector) turned negative (-33%) in the August quarter – an indicator that tends to be highly sensitive to performance of large tech companies.
Bottom Line: Oracle’s earnings call may prove to be very important to the entire software and IT industry. Given the current environment, the company has little reason to provide an overly optimistic outlook and we expect management’s commentary to be muted, at best. The company has scarce incentive to paint a rosy picture going forward with visibility on close rates being so limited. While we have no reason to believe Oracle has blown the quarter, we see many reasons why the outlook will be painted grey and we expect the rest of the software sector valuations to suffer as a result.