Oracle Flies High Above Wall Street's Carnage

With little exposure to the financial crisis, the software giant faces threats from SAP and the U.S. dollar. An economic slowdown could hurt.

Turmoil in American banking and recent gains by the U.S. dollar have left investors jittery over the potential impact on tech companies such as Oracle (ORCL). The world's second-largest software company allayed some of those concerns Sept. 18, when it reported fiscal first-quarter results in line with analysts' estimates and assured investors that its exposure to the problems of Wall Street financial firms is minimal.

Oracle said first-quarter profit rose 28% to $1.1 billion, or 21¢ a share, vs. 16¢ per share a year ago. Excluding expenses for stock options and acquisitions, profit in the period that ended Aug. 31 was 29¢ a share, beating analysts' expectation for 27¢. Revenue rose 18% to $5.3 billion. Including revenue from acquisitions not counted in its GAAP revenues, sales for the quarter were $5.4 billion, matching analysts' estimates. "Oracle is a great sales organization and very cost-conscious, and that's showing through," says Andy Miedler, a senior technology analyst at Edward Jones Trust, who rates Oracle a buy.

Evidence that Oracle is weathering the economic slowdown came as a relief to money managers, who regard its results as a barometer of the industry's health. "Investors are in a frenzy trying to gauge the exposure of Oracle and other technology companies to a slowdown in financial-services spending," says Mark Murphy, a research analyst at Piper Jaffray (PJC), who has a neutral rating on Oracle's stock. "There really is no firm consensus on that."

Little Dependence on Banks

Within the past week, Merrill Lynch (MER) has been acquired by Bank of America (BAC), Lehman Brothers (LEH) has begun liquidating its assets, and the Federal Reserve bailed out insurer American International Group (AIG). More consolidation among financial-services firms is likely. Those events, and the shocks they have sent through markets, have tech investors trying to calculate the effects on information technology spending. Piper Jaffray estimates financial-services firms account for about 20% of U.S. IT spending.

Oracle Co-President Safra Catz said the percentage of Oracle's sales to U.S. banks was in the "low single digits." Also reassuring to investors was news that sales of new software licenses, a yardstick of future revenue, increased 14%, to $1.2 billion, within the conservative range (BusinessWeek.com, 6/26/08) Oracle had told analysts to expect. Shares of Oracle rallied more than 6% in extended trading on Sept. 18 after having risen 65¢, or 3.6%, before the earnings report was released. Still, the stock is down 16% since reaching an at-least-52-week high in August.

Oracle has been on a tear for the past year, posting increases in sales of its database software and business applications, used by companies to manage payrolls, inventory levels, and billing. Today's news aside, some analysts question whether Oracle will remain immune to the economic slowdown and the forces roiling the financial-services sector. Dell (DELL) on Sept. 16 warned of weakening demand, just weeks after reporting a disappointing quarter. And Goldman Sachs (GS) on Sept. 8 cut its IT spending forecast for the year to 4% growth, from 6%.

Rising Dollar Cuts Revenues

Oracle's sales of new applications licenses fell 12%, to $331 million, during the quarter. Oracle is fighting a pitched battle for applications market share with German rival SAP (SAP), which held 22.4% of the $62.8 billion market in 2007, compared with 12.5% for Oracle, according to tech industry consultant AMR Research.

A stronger dollar is also taking a bite out of revenue. During a Sept. 18 conference call discussing the results, Catz said overall new license sales will rise just 5% to 15% during the second quarter, which ends in November, and that the dollar's appreciation since July will lop another 3% off those estimates. The company expects overall revenue to grow 9% to 12%, including currency effects. Excluding the effects of currency, Oracle's sales may be $6.03 billion, at the midpoint of the company's guidance, compared with analysts' expectation of $6.23 billion. Oracle expects to earn 35¢ or 36¢ a share, compared with analysts' estimates of 35¢.

After more than two years of declines, the dollar has rallied against the euro (BusinessWeek.com, 9/16/08), hitting an all-time low of $1.604 per euro on July 15. That means overseas sales by tech companies amount to less revenue when translated back into dollars. Conversely, SAP will likely benefit from the trend.
Maintenance Fees Add Up

So far, though, Oracle's acquisition machine and flagship database business have continued to fuel sales and profit growth. Oracle has purchased more than 40 software companies for more than $25 billion since the beginning of 2005. New license sales of databases and middleware, which connect other pieces of software, grew 27% during the first quarter, to $906 million, helped in part by Oracle's $8.5 billion acquisition of BEA Systems in January. At Oracle's annual customer conference that begins Sept. 21 in San Francisco, the company plans to announce a new database-related product, Co-President Charles Phillips Jr. said during the conference call.

And Oracle is expanding its profit margins by adding to its revenue stream more of the lucrative "maintenance" fees customers pay for software updates and technical support. The fees now account for nearly 56% of Oracle's sales and yield higher margins than other parts of Oracle's business. "That's a reshaping of our business—the highest-margin portion of our business is now the largest portion of our business," Oracle Chief Executive Larry Ellison said during the call.

Edward Jones analyst Miedler says Oracle has proved deft at integrating the companies it's bought. "They can acquire a company and plug it into the Oracle machinery with few hiccups," he says. "And they can squeeze more profit out of these targets." Amid the Wall Street meltdown, economic malaise, and currency drag, Oracle will need to keep that machine as well-oiled as ever.

Author: Aaron Ricadela @ www.businessweek.com

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