It appears that the market’s patience with Oracle’s (ORCL) transition to cloud-based services is wearing thin, as shares in ORCL fell sharply Thursday on disappointing earnings.
True, Oracle has no choice but to move away from selling software that runs on customer’s computers. Businesses want to run software on hardware owned and operated by Oracle and other cloud companies. It’s just simpler.
Unfortunately for ORCL, moving to the cloud is also a long and messy process.
Transitioning away from software licenses to cloud services requires a vast investment in data centers, for one thing.
Companies are also required to recognize revenue over the life of the contract. That can help smooth out revenue, but it also means no more big bumps from landing a big software sale.
The market knows all this and was initially very supportive. Less than a year ago, ORCL stock was hitting record highs on promising results from its big strategic shift.
But the good feelings didn’t last. Maybe the market is simply being impatient, but ORCL still has a ways to go before the cloud services can makes up for declines in sales of software licenses.
It also doesn’t help that the strong dollar is taking a big bite out of results.
ORCL’s Uninspiring Earnings
For the three months ended Aug. 31, Oracle earnings declined 20% to $1.75 billion, or 40 cents per share — down from $2.18 billion, or 48 cents a year ago. Foreign exchange effects contributed 12 percentage points of that decline.
Revenue, meanwhile, slipped 2% to $8.45 billion from $8.6 billion in last year’s fiscal first quarter. Were it not for the impact of the stronger dollar, revenue would have increased 7%.
On an adjusted basis, which is what the market cares about, Oracle earnings came to 53 cents per share. That figure beat analysts’ average estimate by a penny, according to a survey by Thomson Reuters.
However, investors are more worried about the direction and composition of revenue, and in that regard, ORCL was a disappointment. Revenue came up short of Wall Street estimates for the third quarter in a row.
Of greater concern is the pace at which revenue from software licenses is declining relative to growth from cloud services. ORLC’s bread-and-butter of license sales — the business it is transitioning out of — fell 16% in the quarter. Even after stripping out the hit from the greenback, the division’s top line declined 9%.
That would be fine if cloud were taking up more of the slack. ORCL management remains optimistic that the cloud services are ready to contribute in a big way as it scales up and sees major margin expansion.
In the latest quarter, cloud revenue did continue its rapid rise. It grew 34% on a constant currency basis. The rub is that ORLC’s cloud operations accounted for only 7% of total revenue.
ORCL has no choice but to make this historic switch, and there were bound to be stumbling blocks — the strong dollar in particular is hardly ORCL’s fault.
It may take longer than investors want, but ORCL’s transition is the right move. Another year or so of patience should prove bulls right.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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