Taking Stock: Oracle's Price Needs To Slide A Few Dollars More To Be A Good Buy
An upturn in IT spending should help make Oracle's day.
The recent price slide of Oracle's stock reminds me a lot of one of my favorite spaghetti Westerns, The Good, The Bad, And The Ugly. This Clint Eastwood classic has three parts, just like the Oracle saga.
The good: Oracle (ORCL? Nasdaq) remains the dominant force in relational database-management software, with close to 42% of the market in 2000, according to Gartner Dataquest. It competes in fast-growing application software markets such as supply-chain management, customer-relationship management, and enterprise resource planning. It also competes aggressively in application servers against market leaders BEA Systems and IBM.
Overall, the company had $10.86 billion in sales in fiscal 2001, which ended May 31. It generated net income of $2.56 billion and finished this year's fiscal second quarter, which ended Nov. 30, with net cash of close to $4.96 billion. In addition to making money, Oracle has less than $900 million in long-term debt. Cost-cutting programs are well on the way to meeting the company's goal of saving $2 billion in expenses, which will drive up operating margins despite sluggish sales. Oracle has more than 3,000 sales reps and good business partnerships with many of the major consulting firms.
If business IT spending picks up in the second half of this year, as many predict, then Oracle should be a primary beneficiary. My sense is that many of Oracle's customers may have deferred upgrades to the 9i database until later releases come out. After all, IT managers are well aware that initial versions of upgrades often aren't bug-free.
The bad: Oracle cautioned that results for its fiscal third quarter, which ended Feb. 28, will be a tad shy of the 10 cents per share that most analysts expected. It's most likely to hit 9 cents on about $2.4 billion in revenue. Most of this will be a shortfall in software license revenue. This brings current fiscal full-year earnings-per-share forecasts down to the 41 cents to 42 cents range. Next year, it's likely to be around 44 cents to 46 cents. Most of the weakness was attributed to market conditions in Asia, specifically Japan. Efforts in Japan are directed mainly toward database sales, the core of Oracle's software business and a big driver of profits. This shouldn't come as a surprise, since Asia-Pacific regional sales have declined from 15% of total sales in the fiscal first quarter to 14% in the fiscal second quarter. More important, the growth rate for the region dropped from 24% year-over-year in the fiscal first quarter to only 4% year-over-year in the fiscal second quarter.
As expected, business IT spending is still sluggish and demand remains weak. Investors are skittish, and any weakness will result in a major sell-off. After the earnings warning, Oracle's stock fell 17.8% in two days, from $16.62 to $13.67. What makes this worse is that during the same time, the Nasdaq 100 was up 10%, a spread of almost 28% in two days--not exactly great news for Oracle shareholders.
The ugly: Where do investors go from here? The picture is very confusing. The valuation is high even at $13.67 per share, since that represents a price-earnings multiple of 30.4 on fiscal 2003 earnings per share estimates. That's not exactly cheap for a company expected to grow earnings only 10% next year. This is a concern, especially in light of Microsoft's attack on the low end of the database market with SQL Server 2000, the slow adoption rate for upgrades to 9i, a delay in how the economic rebound benefits business IT spending, and the combined IBM/Informix attack on the enterprise database software market.
Do I think Oracle is going away? No! The company is well established, well financed, and remains aggressive.
My problem remains Oracle's share price. Even after the recent decline, its price should go down further. Fair value should be closer to 20 times earnings or roughly $9 per share. In a more optimistic economic-recovery scenario, you might be able to justify a price as high as $12.75 (the current share price is above $13). As I've always said, I'll buy almost anything at the right price--but this isn't it.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at email@example.com.
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