Oracle Corp. (ORCL, Financial) is a legacy technology company founded in 1977. It is currently the third largest software company in the world by revenue. I decided to take a closer look at this stock because, despite its prominent market position, its share price has lost 29% since December 2021. Taking advantage of the lower share prices, several guru investors that I follow - namely Richard Pzena (Trades, Portfolio), Charles Brandes (Trades, Portfolio) and Primecap Management - were buying shares in the first quarter of 2022. Could the stock be undervalued?
Business model
Oracle is a software giant known for its legacy technology business, which includes the wildly popular programming language Java, which they gained after acquiring Sun Microsystems in 2009. Since then, the company has expanded to enterprise software and is now a leader in cloud databases. Their business products are currently segmented into three parts: Oracle Cloud Infrastructure, Oracle Cloud Applications andHardware and Legacy Software.
Oracle Cloud Infrastructure offers enterprises all the services they need to migrate, build and run their IT operations on new cloud native applications. Enterprises are currently going through a “digital transformation” as they aim to set up their IT networks on the cloud in order to achieve greater flexibility, lower cost and better security.
Amazon's (AMZN, Financial) AWS, Microsoft's (MSFT, Financial) Azure and Alphabet's (GOOG, Financial)(GOOGL, Financial) Google Cloud are the three titans of the cloud market. However, Oracle is gaining traction, and some analysts predict that Oracle could become a cloud leader in the future. Currently, Oracle is the eighth-largest cloud provider.
Oracle Cloud Applications is a suite of SaaS applications which include enterprise resource planning (ERP), supply chain management and human capital management software.
Hardware and Legacy Software includes physical hardware such as Oracle servers and storage, in addition to on-premises applications.
Oracle has recently gained EU antitrust clearance for their planned acquisition of U.S. health care IT company Cerner Corp (CERN) for $28.3 billion, according to Reuters. The acquisition of Cerner is expected to give Oracle access to a vast amount of data and attract more health care clients to its cloud platform as a result.
Financials
For the most recent quarter, which was the third quarter of fiscal 2022, Oracle announced total revenue of $10.5 billion, up 4% year-over-year (or 7% in constant currency). These numbers may not seem spectacular, but this was actually Oracle's highest quarterly organic revenue growth since they began their transition to the cloud. Their cloud revenue reached $2.8 billion, which was up a rapid 24% year-over-year.
Their operating income for the most recent quarter was $3.8 billion. This was mostly stable (down 1% in U.S. dollars but up 3% in constant currency terms). The operating margin came in at 36%, which is higher than the historic average. Oracle has an extremely high gross margin of 79.4%, which is even higher than rival software giant SAP SE (SAP, Financial), which operates at a very high gross margin of 71.4%.
Oracle is in a strong cash position with $22.7 billion in cash and cash equivalents on their balance sheet as of their most recent financial statement. However, they do have an eye watering amount of debt with $72 billion reported in long-term debt, which is worrying.
Valuation
In order to value Oracle, I have plugged the latest financial data into my valuation model, which uses the discounted cash flow method of valuation. I have conservatively forecasted 10% revenue growth per year over the next five years, mainly driven by growth in the cloud segment and new database offerings. I have also predicted margins to increase over time due to the same reason.
Given these assumptions, I get a fair value estimate of $70 per share. The stock is currently trading at $72 per share and thus is "fairly valued" according to the model. This is assuming conservative growth estimates moving forward.
The GF Value chart, a unique intrinsic value estimate from GuruFocus, also rates the stock as fairly valued at the time of writing.
Conclusion
Oracle is a tremendous legacy technology company with a strong heritage of technology innovations and acquiring best in class companies such as Sun Microsystems. The company is currently going through a cloud transformation and is poised to ride this growing market trend. The stock price is fairly valued at the current levels by my estimates, which is rare for a tech giant and thus could present an opportunity.
