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Margaret Moran
Margaret Moran
Articles (314) 

The Risk-Reward of Oracle's Tentative TikTok Deal

The slow-growing cloud provider could consolidate its edge over larger competitors

Oracle Corp. (NYSE:ORCL) is a multinational software company that sells database software and technology, cloud engineered systems and enterprise software products. It is part of the S&P 500 and, as of Sept. 21, it trades with a market cap of $181.75 billion.

From this description alone, one might think the stock would command a sky-high valuation as investors pile an increasing amount of money into the stock market in general and tech stocks in particular. However, Oracle's price-earnings ratio stands at 19.01, which is only a little higher than its 10-year median price-earnings ratio of 18.21 and significantly below the software industry's median price-earnings ratio of 30.25. According to the GF Value Line, the stock is trading near its intrinsic value.

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There could be many reasons for the relative undervaluation of Oracle's stock, but two in particular stand out to me – mediocre growth and the lack of flashy products that can capture the imaginations of the general public. Larger cloud competitors like Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT) have both of these things, which is why investors are already pricing in their growth far into the future.

However, Oracle could receive a significant boost in terms of growth and public recognition if its deal to become the cloud provider for TikTok's U.S. operations is completed. Before its proposed deal with TikTok, Oracle was not known to many outside the tech and tech investing communities, but now it is practically a household name, and taking a stake in the company could lead to Oracle achieving more growth in the future.

The terms of the deal

While the original expectation was for a company to "acquire" TikTok's U.S. operations, Oracle and Walmart (NYSE:WMT) will instead become the app's U.S. partners. The app will strip out its Google (NASDAQ:GOOG)(NASDAQ:GOOGL) cloud infrastructure in favor of Oracle's, and Oracle will take a 12.5% stake in TikTok. Walmart has also tentatively agreed to purchase a 7.5% stake in TikTok, bringing the app's U.S. ownership to 20%, while TikTok's parent company ByteDance will maintain 80% ownership for now.

The data for TikTok's U.S. operations will be hosted in the U.S. on Oracle's servers, while ByteDance will get to keep its algorithms and technology, which the companies believe will satisfy all parties involved. The deal will be "somewhere between a new vendor agreement in cloud and a joint venture," commented Jason Davis, associate professor of entrepreneurship and family enterprise at INSEAD.

The partnership will also work towards making TikTok a publicly traded company in the U.S. A Walmart spokesperson said in a statement, "In addition, we would work toward an initial public offering of the company in the United States within the next year to bring even more ownership to American citizens."

Another thing the deal has going for it is that it will bring approximately 25,000 jobs to the U.S. as TikTok expands its U.S. headquarters, which will help assuage national security fears. The new company is set to be incorporated in Texas, if all goes well.

The rewards

Oracle gained some fame recently as Zoom Video Communications (ZM) selected it to expand its cloud infrastructure, passing by market-dominant Amazon Web Services, Google Cloud Platform and Microsoft's Azure Cloud. With the addition of the TikTok deal, the company would effectively be hosting what some analysts say are two of the most important up-and-coming sites in the country, giving a huge boost to its reputation as a quality cloud services provider (though as long as it stays a pure-play cloud company, the stock likely still will not attract as much popularity as diversified tech giants).

The company's equity stake in TikTok also should not be ignored. The chances are high that the partnership will move forward with offering TikTok's U.S. operations via an IPO sometime this year or the next, which could see the value of Oracle's stake in the company increasing dramatically.

Additionally, whether it's by partnering with Oracle as its own cloud provider or helping to potentially draw more customers, the deal may help ramp up Oracle's growth by consolidating any attractive points that its software has over competitors. Oracle has a three-year revenue growth rate of 9.8% and a three-year Ebitda growth rate of 11%, which are neither low nor high, placing near the industry medians. However, growth has slowed down dramatically in recent years.

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The risks

Of course, the biggest risk of the Oracle-TikTok deal is political. On Saturday, President Donald Trump said he has approved the deal "in concept," but the final approval will depend on whether Oracle and Walmart can satisfy the administration's national security concerns via an as-yet-undetermined review process.

Another major concern for investors could occur if the publicity gained from the deal fails to create significant new demand for Oracle's cloud products. Like Microsoft, Oracle is considered a more mature tech company, with new cloud operations growing the business as legacy products business slow to a crawl or even decline. However, Oracle has seen approximately 50% slower growth than Microsoft in recent years, and in 2018, it even stopped separately disclosing the growth of its SaaS (software as a service) and IaaS/PaaS (Infrastructure/Platform as a service) revenues.

Finally, the parties involved in the deal have yet to come to an agreement on what the ownership of the intended U.S. public company (which will apparently be called TikTok Global for some reason) will look like. While accounts over the past week indicated that ByteDance would maintain a majority ownership of the company's equity, Oracle issued a statement on Monday morning.

"Upon creation of TikTok Global, Oracle/Walmart will make their investment and the TikTok Global shares will be distributed to their owners, Americans will be the majority and ByteDance will have no ownership in TikTok Global," Oracle Executive Vice President Ken Glueck said.

Unlike the previously announced partnership deal, this statement seems to indicate that Oracle and Walmart do indeed intent to facilitate a complete public buyout of TikTok's U.S. operations. In other words, this is still very much a developing story, and attempting to predict what will happen in the end is likely an impossible endeavor even for those with insider knowledge, much less the broader investing community.

Conclusion

All in all, the TikTok deal could serve as a boost to Oracle, both through reputation and advertising and through its potential equity stake in "TikTok Global" if it goes public. Given that Oracle's stock is trading near its intrinsic value as of the writing of this article, as well as the growth runway ahead for the cloud industry in general, it could be a good investment opportunity for investors who are interested in enterprise cloud software but who hesitate overpaying the higher valuations for bigger names. According to a study by Fortune Business Insights, the cloud industry is expected to grow to $760.98 billion by 2027, representing a compound annual growth rate of 18.6%.

There are also risks to consider in terms of the deal with TikTok falling through, but in my opinion, the biggest thing to pay attention to here is government and regulatory approval. Despite any disagreements between Oracle and ByteDance, both companies have strong incentives to come to a resolution, as no better alternative has so far been presented to avoid TikTok being banned from the U.S. entirely.

Additionally, the downside risk appears limited. Because Oracle's stock is not dramatically overvalued, it faces a lower risk of volatility in the face of news regarding potential deals, acquisitions and the like, since even if a promised deal doesn't happen, all the company would be losing is potential non-organic future growth.

Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.

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