The U.S. tech sector has been experiencing a continued weakness trend due to the decline in sales, slowdown of demand and structural changes in the industry, such as the boom of smartphones and tablets. This sector consists of 145,000 companies with combined annual revenue of more than $1 trillion. We are going to analyze two of them and see which one is doing better and thus stands as the best investment.
The Huge Tech Company
Oracle Corp. (NYSE:ORCL) is organized into three businesses: software, hardware and services. In fiscal year 2013, 74% of revenue came from software, 14% from hardware, and 12% from services. In the last quarter the company recorded revenues that were below the estimates, causing the stock price to decline. All of the three areas recorded negative results.
Great Growth Opportunity
The company has been shifting its software offerings to include more software-as-a-service (SaaS) solutions, benefiting from higher spending over the long term. The firm has acquired smaller niche providers, RightNow for $1.5 billion and Taleo for $1.9 billion. Other acquisitions include Acme Packet, Eloqua, Endeca, Vitrue and Collective Intellect. In 2013, Oracle acquired Eloqua for about $900 million. It is expected that each of these companies expand Oracle's SaaS solutions. Two research studies show that cloud computing market will see above-average growth.
Sales growth has slow down by the hardware segment's declining revenues. In this order, the company is thinking in strategies to change this situation. A promising strategy consists of a product mix, where the focus is to sell integrated high-end servers, storage and software systems. But investors should not worry too much because the software segment is a larger portion of sales than hardware and is growing faster.
In terms of valuation, the stock sells at a trailing P/E of 14.5x, trading at a discount compared to the industry average of 23.4x, representing a discount of 38%. Analysts’ expectations imply a forward P/E of 10.58. To use another metric, its price-to-book ratio of 3.52 indicates a premium versus the industry average of 2.36x and the price-to-sales ratio of 4.29x is above the industry average of 1.8x.
A Strong Rival
International Business Machines Corporation (NYSE:IBM) is a major player in the hardware, software and services markets and has been Oracle´s database rival. This giant has evolved from being a computer hardware vendor to a system, services and software company that focuses on integrated solutions.
Growth in Emerging Markets
Revenues in this markets represented almost a quarter of them in 2012, outperforming revenue growth from the developed markets. Increasing investments in areas such as Asia-Pacific, Africa and Latin America provide potential long-term growth opportunities. In those regions, companies in the telecommunications, oil and gas and banking sector increased demand for IBM services and technical support. Emerging markets will present a significant challenge for IBM in the following years. They are expected to contribute 30% to its total revenue by 2015.
Expanding Its Portfolio
IBM announced the acquisition of Softlayer Technologies, a cloud computing infrastructure provider. The deal will expand the IBM SmartCloud Services portfolio, offering customers a robust and comprehensive cloud portfolio. With this deal the company expects to reach $7 billion annually in cloud revenue by 2015.
Looking at the financials, the company has a strong balance sheet: good cash that allows it to reward current shareholders through dividend and share repurchases. Over the last 12 years, the company returned $150 billion of free cash flow back to shareholders.
Its P/E multiple, on a trailing-12 month basis, is 12.4 and the forward P/E multiple is 9.94.
Finally, I always like to see the evolution of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.
|Company||ROE||Compared to Industry Mean (=5.0)|
Looking at the table we can see that both companies show good ratios.
Tech companies´ profitability is mostly driven by their ability to fulfill new requirements of the “database world.” Here we have analyzed two major players in the database industry that are offering Cloud Database, the next driver for growth and innovation in the industry.
In my point of view, the strong acquisition program makes Oracle the most attractive choice. Hedge fund gurus like Louis Moore Bacon, Donald Yacktman, Scott Black and Leon Cooperman added this stock to their portfolios and I would advise fundamental investors to consider adding this stock to theirs as well.
Disclosure: Damian Illia holds no position in any stocks mentioned.