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Federico Flom
Federico Flom
Articles (110) 

Oracle Corp. (ORCL) - I See 35% Upside According to My Valuation

December 15, 2011 | About:

Oracle, the Redwood City, Ca.-based company, is the largest company in IT that sells IT solutions including databases, middleware, applications and hardware.

Within the different segments, software license updates and product support is the most profitable and accounts for 42% of total revenue.

Oracle has always been focused on acquisitions. Indeed since 2005, it has spent $36 billion on buying promising companies. That created a huge company that cross-sells both hardware and software creating new one-time and recurring revenue streams.

Jeffrey O. Henley, chairman of the board of directors says about Oracle: “So we think that we continue to have a terrific business franchise. We're the world's most complete, open and integrated combined business software and hardware company. (…) And while there are no guarantees of the future, we feel that we're very well-positioned to continue to do well in the future. We get lots of questions about how the stock does.”

The worldwide enterprise software market is expected to grow from 9.5% y/y to $267.0 billion and Oracle will likely benefit from this. I view Oracle’s business model as relatively defensive given the company’s broad portfolio of products, recurring maintenance revenue stream, and large installed base to cross sell products (as I estimate that Oracle generates 80% of license sales by cross-selling/up-selling to the installed base). Furthermore, Oracle products are considered to be the foundational technology for most of the IT environments and support mission critical systems

In 2012, revenue forecast is $288 billion. Furthermore, the company continues with R&D, which has set the stage of a solid product lineup. Management is expending on research and development to differentiate its products and thus boost product offerings.

Oracle is pursuing various strategies related to Sun, which are expected to drive growth. These strategies are three, namely:

  1. Oracle is following a build-to-order model, with which it is expected to launch new high-end systems, such as the M-series and T-series.

  2. Oracle has begun to sell products directly to customers instead of relying on third-party service providers. This is expected to foster new incentives to sales and drive growth.

  3. The long term goal is to drive earnings growth through the sale of differentiated and high-value technologies and not from headcount reductions.

Cost savings are expected to be the key driver of earnings growth in Oracle. Actually, the company has taken cost control measures. Furthermore, cost savings are expected to be based on supply chain efficiency, which will in turn, bring higher margins.

The company will also rationalize, integrate customer support and streamline marketing and back-office spending, lower supply chain fragmentation and reduce shipping and inventory cost.

In a nutshell, Oracle's strategy and cost savings initiatives will boost bottom-line growth.

As regards Oracle's acquisition strategy, although considered good, it will probably cause the company to pay higher prices for an acquisition or to spend more resources to achieve expectations. Also, revenue may be threatened if customers refuse to pay maintenance fees or if competition pushes them down. Furthermore, business process outsourcing remains a viable option for large companies that don't want to handle their own IT operations.

Last quarter results & valuation

Oracle is in solid financial shape. By mid-2011, the company had $31.7 billion in cash and $14.8 billion in debt. Interest coverage levels are adequate and the company has a AAA balance sheet.

Software license sales appear to have been strongest in database, middleware, and business intelligence, and I believe several segments of Oracle’s applications portfolio — predominantly E-Business Suite, Siebel and several early wins for Oracle Fusion Applications (particularly Talent Management, Distributed Order Orchestration, and CRM) — continue to experience strong demand, given enterprises appear focused on boosting revenue growth and improving productivity and are willing to spend on applications addressing these goals. Although I believe PeopleSoft license sales have slowed slightly after having been boosted from the end of Extended Support of HRMS 8.x, activity around E-Business Suite has picked up with the pending end of Extended Support for 11.5.x. Fusion Application deals are starting to close, which I view as a long-term, under-appreciated positive.

My fair value estimate is $40 per share, implying a forward fiscal 2012 price/earnings of 17.1 times, an enterprise value/EBITDA of 12.2 times, and free cash flow yield of 7.8%.

Assumptions reflect 9% average annual software growth and 2.5% average annual hardware growth over the next five years. Moreover, additional acquisitions and maintenance revenue will probably contribute to high-single-digit long-term revenue expansion

Unfortunately, operating margins have declined due to a lower profitability of the hardware segment and price pressures on maintenance contracts.

ORCL has a trailing 12-month P/E ratio of 17.41 and compared to its competition, the company fairs rather well. Actually, it has the most favorable gross margin: 77.3%.


Lawrence Ellison has been CEO of Oracle since he co-founded the company in 1977.

The team is highly talented. Ellison is one of the most respected tech entrepreneurs and he is leading the Company with Mark Hurd, a superb operational manager. As regards the chair, the position is occupied by Jeffrey Henley. Although his compensation is slightly excessive, he plays an essential role in Oracle's vision, strategy and operations.

About the author:

Federico Flom
Equity Research Analyst

Rating: 3.3/5 (14 votes)


Tkervin - 5 years ago    Report SPAM
ORCL is near the top of my watch list. Perhaps not quite 35% undervalued but we are in the same neighborhood.

Not buying anything right now though. Better bargains coming.

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