2 Ways to Play Oracle’s Bright Future

by John Jagerson and Wade Hansen | June 15, 2012 10:50 am

2 Ways to Play Oracle’s Bright Future

As many resellers, competitors and former employees can tell you, Oracle (NASDAQ:ORCL[1]) may be a lot of things, but it isn’t a long-term loser. The selling frenzy in early May hurt ORCL a lot, but we believe it has pushed the stock to a support level that should be used as a long entry opportunity. A rally from here could push prices back to $31 per share in the short term and $35 if resistance at $31 is broken.

Long-Term Support Is in Play

From a technical perspective, ORCL is just emerging from a support range based on market lows and highs looking back to late 2009. A strong move to the upside from here partly depends on the cooperation of the major market indexes, but earnings on June 21 could kick off the new trend when the company is expected to discuss better-than-expected progress in the company’s cloud-computing initiatives.

OracleChart 300x172 2 Ways to Play Oracle's Bright Future
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Despite predictions to the contrary, ORCL has been able to fend off competition from free or nearly free versions of its core database and applications business for many years. All 100 of the Fortune 100 are ORCL clients, and that kind of entrenched position isn’t likely to change anytime soon. The “moat” ORCL has built through its domination of the large-cap market is part of the value argument for ORCL and is one reason why it has channeled so reliably in the past.

Oracle Corporation (ORCL): Chart courtesy of MetaStock

Can Oracle Get in Front of New Technology Trends?

ORCL is building and acquiring businesses that are in the vanguard of new enterprise technologies. These include cloud computing, social-network management and CRM solutions. While this is currently a small portion of ORCL’s total business, these kinds of initiatives tend to attract a premium from investors projecting growth in the future.

On June 5, ORCL announced its latest move into these new business lines with the acquisition of Collective Intellect, a company that specializes in turning social-media data into sales and marketing campaigns.

The acquisition of Collective Intellect comes just after Larry Ellison announced significant (if vague) plans to “out-cloud” the existing cloud companies with their own offerings. This should and did sound like a sales pitch, but most of us following the tech sector have started betting on Larry’s pitches because they have a high probability of coming true.

There are two ways ORCL can grow. The first is through initiatives at the front edge of technology, as we have already discussed. Frankly, the prospects for growth in real terms in these areas for a $130 billion company are small in the short term. However, as we know from the recent round of technology IPOs, the outlook for growth in these areas is so high that any progress by ORCL would be seen as very exciting for technology investors.

The second and largest source of growth for ORCL is general-business spending. It’s tough to say which of these growth arguments is the most uncertain, but general-business spending is the one with the potential to create the most gains.

Business spending in the U.S. and Europe has declined, but not as much as some investors might assume from a casual reading of daily news headlines. Clearly, the European recession will continue to have an impact on ORCL, but we believe that much of this has been priced into the stock already.

Oracle Is Good for Traders Trying to Get In Before the Next Rally

Our argument for ORCL can be summarized as a play on a stock that is best-positioned to create big gains when the market as a whole stabilizes or starts to rise again. Remember that the same issues (Europe, credit spreads, etc.) plaguing stocks currently have been a recurring theme since 2009. Once the market starts to pivot, companies such as ORCL stand to gain the most the fastest. For example, the rally following the 2010 market slump resulted in 71% gains in ORCL’s stock price.

One way to think about ORCL’s current value as a function of its future earnings is to discount those potential cash flows to arrive at a fair value that could be above or below today’s stock price. Using projected growth rates of 12% (roughly half the growth rate of the last five years), a constant earnings multiple of 14 and a discount rate of 8%, the present value for ORCL is $32 per share, which is roughly equal to our short-term technical projection.

We believe that these are conservative estimates for a stock at the bottom of its price channel and that ORCL is undervalued.

A Leveraged Option Alternative for Shorter-Term Investors

Many investors (including us) may prefer to take advantage of a potential bounce with long-term options rather than an unleveraged investment in the stock. Because we are looking for an initial move that should complete in several weeks, a call option with a December 2012 expiration is ideal. The at-the-money strike ($27) is currently selling for less than $3, and we like this trade up to $3.50 per share.

A move to our initial price objective would result in a gain of 80% to 100% on the option depending on how long it takes to complete.

Recommendation:

Endnotes:
  1. ORCL: http://studio-5.financialcontent.com/investplace/quote?Symbol=ORCL

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