Oracle (ORCL) is undergoing a major transition, making 95% of its products and services available on the cloud. The move itself has resulted in significant losses to Oracle’s large software licenses business, but gains in cloud delivered as a service.
The fear among investors is that the cloud is canabalizing its software license business, and that Oracle won’t really grow long-term. However, based on the metrics that Oracle provided in its fiscal first quarter, these fears are overblown.
In Oracle’s most recent quarter, announced earlier this month, the company’s cloud revenue grew 29% year-over-year to $611 million, adding $136 million compared to last year. In comparison, its software licenses revenue declined 9% to $1.15 billion, a loss of $219 million.
At first glance, these numbers don’t look good. They suggest that Oracle lost about $83 million of business in that quarter, the difference between its software license loss and its cloud gain. However, that appearance is very misleading, as investors must understand how Oracle is reporting and realizing revenue under this new business structure.
New Perspective on Oracle Stock
Several months ago, during Oracle’s fiscal 2015 year-end conference call, management explained that a software licensing sale might only create $3 million of profit in its old business structure, but will now create $9 or $10 million in profits over 10 years. The concept is that cloud business is a subscription model, whereas licensing is a one-time sale.
While those cloud sales may have higher upfront costs, margins actually rise long-term as the costs associated with maintaining that subscription fall.
In other words, when Oracle loses licensing revenue now, it doesn’t realize all of that revenue immediately in the cloud business. As a result, investors must monitor Oracle’s cloud bookings, which reflects total revenue that is then paid over a longer term.
As a result, investors need to scrutinize Oracle stock a little differently than we have in the past.
So, when Oracle says that bookings grew 150% during its fiscal first quarter, and that its cloud business is on pace to create up to $2 billion in new bookings this year, that is a reflection of what it will gain through the life of a new deal. According to Oracle, that will be double the new cloud business it sold last year.
Still, the No. 1 concern with Oracle is whether the company is gaining new business or just reporting what would be licensing revenue to the cloud. Last year, Oracle created $8.5 billion in new software license revenue, and its fiscal first quarter accounted for just 16% of that total.
If Oracle’s 9% loss in software license revenue continues throughout this year, Oracle would report a $1.4 billion loss and have $7.1 billion in software license sales this fiscal year. Granted, Oracle has said that year-over-year losses would improve as the year proceeds.
With that said, $1.4 billion of losses in exchange for up to $2 billion in new cloud bookings is a good ratio. It suggests that Oracle is in fact growing its cloud business organically. Given the fact that Oracle is placing such high bets on the cloud, making 95% of its services and software cloud-based, this difference of $600 million is a good indication that the Oracle stock price will move in the right direction
Seeing as how Oracle’s cloud bookings are realized over time, the company’s year-over-year losses should continue through this year. However, in 2017 and beyond, those bookings should all start to carry Oracle forward, producing growth long-term.
So, at just 12 times earnings, and with Oracle claiming that its cloud business will produce higher margins long-term, Oracle stock looks like a great buy.
As of this writing, Brian Nichols was long ORCL.
