Oracle Stock: Is Oracle Hiding Its Head in the Clouds?

Oracle (ORCL) CEO Larry Ellison is widely known in business circles for his charm and charisma. The man really is endowed with the gift of the gab, and is well capable of putting a nice ring on even pretty mundane subjects.

oracle orclMost recently, Ellison has been touting Oracle’s cloud opportunity even as the company’s top line continues to flounder.

While Oracle’s cloud-related annual revenue run rate of more than $2 billion, and 28% growth rate during the second quarter is hardly chicken feed, it’s simply nowhere in the ballpark of Microsoft’s (MSFT) triple-digit growth and Amazon’s (AMZN) 50% growth, not to mention the fact that both companies’ clouds are currently on a $6 billion-plus run rate.

And this reality now seems to be sinking in the heads of Oracle investors. Oracle stock has tanked 4% over the past five days after Citi’s Walter Pritchard released a damning report about Oracle’s cloud ambitions, labeling Oracle as being ‘‘too optimistic’’ about the cloud driving growth for the company.

To be fair, part of the woes facing Oracle stock can be pinned on the broader market downturn. The S&P 500 is down 3% over a similar timespan as the shockwaves being sent by the ongoing turmoil in the Chinese markets continue to reverberate around global markets.

The selloff in Oracle stock hurts more because the Oracle stock price had already been badly pummeled earlier in the year, with the last hammering coming after the company’s lackluster quarterly report.

Oracle stock is now down a jaw-dropping 18% YTD.

Oracle Nowhere Near Break-Even Point

In his analysis of Oracle’s cloud, Pritchard pointed to something that should have become glaringly obvious by now, but which the likes of Larry Ellison have been glossing over: It will take many years before growth in Oracle’s cloud revenue can fully offset the double-digits decline in license revenue.

According to his math, it will take at least five full years before Oracle’s cloud subscription sales can generate as much revenue as traditional upfront licenses. And that’s after making the generous assumption that licenses are heavily discounted by 33% while cloud offerings are sold at list price.

ORCL is in a pretty dire situation. Jefferies had earlier pointed out that Oracle was pricing its HR/HCM offerings aggressively as it sought to steal market share from HR market leader, Workday (WDAY). Aggressive pricing can, of course, lead to serious margin pressure.

Oracle has painstakingly been insisting that its cloud growth is not cannibalizing its traditional licensing business. While that might be true, the real numbers for the two segments tell a different story. During the last quarter, Oracle sold new software licenses worth $3.14 billion, a huge 17% decline compared to the prior-year period. The company also realized cloud revenue of $450 million, an impressive 28% year-over-year growth.

In real dollar terms, Oracle lost $642 million in new license revenue but gained $98.4 million in cloud sales. The net effect is that the two businesses combined shrunk Oracle’s top line by $543.6 million, or about 5%, if you exclude its other business segments.

ORCL Hardware Sales Faltering

Oracle recently acquired Sun Microsystems, an enterprise server manufacturer, for $7.4 billion, the company’s largest acquisition to date. Oracle planned to get hold of Sun’s powerful Solaris and Java platforms to build engineered systems — servers that are geared towards performing specific workloads.

While Oracle is now considered a leader in integrated platforms (a subset of engineered systems), you wouldn’t be able to tell just by looking at its hardware segment numbers. Oracle has racked up eight straight quarters of declining hardware sales, with the latest being a 4% decline.

This trend doesn’t bode well for Oracle stock. Hardware sales are its second-largest segment after the software business, accounting for 14% of revenue. So ORCL is now in a severe conundrum where two its largest businesses are disintegrating.

Don’t Bet on ORCL’s Hazy Cloud Strategy

But Oracle is determined to find a way around these quagmires. The company recently unveiled an expanded cloud platform where Infrastructure-as-a-Service, or IaaS, will take center stage. Oracle’s game-plan? To go after Amazon Web Services’ dominant IaaS offerings by massively undercutting it in price. According to Larry:

“Our new archive storage service goes head-to-head with Amazon Glacier and it’s one-tenth their price.”

The rub with Oracle’s new cloud strategy is that IaaS is already reputed to be a low-margin business. So you can only imagine what selling cloud data storage at a tenth of AWS’ price would do to Oracle’s cloud margins. Unless this is just another marketing gimmick, Oracle’s latest cloud move smirks of desperation.

Oracle stock is hardly a screaming bargain even after the selloff. To compound matters the company appears to be dangerously close to running out of growth runways. Stay away from Oracle stock.

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

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