Oracle Corporation (ORCL) Stock: Don’t Call It a Comeback. It’s Really Not

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After years of underperformance, Oracle Corporation (NYSE:ORCL) stock finally seems to have turned the corner. Oracle stock has racked up gains of 16.8% in the year-to-date, thanks to a terrific 7% jump after the company delivered better-than-expected third-quarter earnings, narrowly missing top-line estimates, but soundly beating profit views.

Oracle Corporation (ORCL) Stock: Don't Call It a Comeback. It's Really Not

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Oracle reported that sales for the quarter clocked in at $9.2 billion, missing the consensus on Wall Street by $60 million, but good enough for 2.1% year-over-year growth. Non-GAAP per-share earnings of 69 cents soundly beat expectations by 7 cents.

This marked the first time that Oracle managed to grow revenue at more than a 2% clip since 2014. The company’s management touted its exploits in the cloud after a healthy 62% increase in cloud revenues. The cloud now contributes 13% of total sales for Oracle, and the company says the segment is big enough to outpace declines in license revenues.

Oracle topped the healthy report with strong fourth-quarter guidance that triggered a series of Wall Street upgrades. But there’s more here than meets the eye.

Oracle’s Mea Culpa

The biggest takeaway from the report was how Oracle has evolved from an old-line software company that mainly relies on selling one-time on-premise software licenses to a cloud company that now enjoys the visibility of a recurring revenue subscription model.

Oracle particularly waxed enthusiastic about its next-generation infrastructure-as-a-service, saying that the company’s Gen 2 IaaS has the ability to run the largest databases by customers, whereas Amazon.com, Inc.’s (NASDAQ:AMZN) AWS can only run small Oracle databases. Chief executive Larry Ellison declared that:

”This is the first time we’ve ever had a technology lead in infrastructure as a service.”

That should immediately ring the tocsin for long-term Oracle investors, because Ellison, in his usual swashbuckling style, had just three years ago famously dismissed IaaS as a low-margin business and a non-starter. True to word, IaaS has remained more of an after-thought for Oracle stock — SaaS and PaaS combined contributed $1,011 million to the top line (11% of revenue) after growing a blistering 85%. In sharp contrast, IaaS contributed just $178 million (2% of revenue) after 19% growth. Ellison though declared that IaaS will soon outpace SaaS and PaaS because:

”We are now in position to help our hundreds of thousands of database customers move millions of Oracle databases to our infrastructure-as-a-service cloud.”

To put it mildly, ORLC will cannibalize its traditional database business to grow its fledgling IaaS business. Basically what Oracle is doing here is simply trying to do some damage control after the tectonic shifts that have hit the IT landscape.

Trouble is Oracle also pitched its IaaS cloud as a general purpose platform that can be used by non-Oracle customers, too. But this is mere marketing bluster because Amazon and Microsoft Corporation (NASDAQ:MSFT) have already built an incredibly huge lead in this segment.

Oracle IaaS might run out of steam soon after the company’s customers have joined its ranks. Then it will all be back to square one.

Bottom Line on Oracle Stock

Many investors might have missed the fact that Oracle’s standout quarter was largely the result of its $9.3 billion NetSuite acquisition, a predominantly cloud business with $244 million in revenue during its last quarter as a standalone company.

Further, the EPS beat came thanks mainly due to copious share buybacks. Oracle has been spending most of its cash buying cloud companies and buying back shares. Oracle’s growth has been almost exclusively inorganic while organic growth has pretty much dried up.

But ORCL might not be able to continue doing this for much longer–free cash flow declined 7% during the last quarter and is set to continue its south-bound journey unless the company can start growing organically. Oracle can conceivably continue borrowing to finance its trigger-happy acquisition strategy. But with the Fed beginning to get aggressive with its rate hikes, Oracle stock might soon run out of options for easy money.

Oracle stock has enjoyed a bright start to the year and is looking to extend its impressive run for at least a few more quarters. But this does not look like a stock that I would be comfortable adding to my portfolio and holding for 3-5 years. Unless the company can start generating sufficient organic growth and free cash flow, the fairy tale comeback by Oracle stock could fizzle out sooner than you think.

As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/03/oracle-corporation-orcl-stock-dont-call-it-a-comeback/.

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