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Is It Time to Give up on Oracle?

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Hard times are not over for leading software maker Oracle (NYSE: ORCL  ) , as the company recently issued cautious revenue and profit guidance for the second quarter that fell below Wall Street expectations.

Oracle's first-quarter performance was a mixed bag. While revenue at $8.37 billion fell short of analyst expectations of $8.48 billion -- fueled by a 14% drop in hardware sales -- the company's adjusted earnings at $0.59 per share managed to beat estimates of $0.56 per share.

Investors have reason to worry about Oracle's long-term prospects, which means it's time to delve a little deeper.

Hard times ahead
These are hard times not only for Oracle, but for the majority of companies that derive their profits from enterprise tech spending. With the economy recovering at a slower-than-expected pace, company IT departments do not want to incur heavy expenses. That trend is likely to continue until at least the end of this year, according to a survey conducted by Barclays.

For Oracle, this has again prompted customers to shun its supposedly expensive offerings and instead opt for smaller competitors such as (NYSE: CRM  ) and Workday (NYSE: WDAY  ) .

The cost factor
Oracle has traditionally followed a strategy of combining its database software packages with expensive, self-manufactured hardware that needs to be installed at businesses. Unfortunately, that model is now being increasingly avoided by cost-conscious customers. For them, a far better alternative has been software-as-a-service (SAAS) applications that companies such as Salesforce and Workday offer. Since they essentially comprise web-based software that resides in remotely located servers, it does away with installing hardware and brings down costs to a fraction of what Oracle charges.

Rivals joining hands
Salesforce and Workday have decided to collaborate in an obvious bid to gain market share from bigger rivals Oracle and European software provider SAP AG. Customers will be able to access data from both Salesforce and Workday, a definite advantage since it leads to more integrated services.

The two companies have been recommending each other for a range of specialized services that include customer service management, marketing, accounting, and human resources. Although Oracle had also announced a similar partnership with in the past, the fact that the former is traditionally perceived as a more expensive software vendor is likely to weigh on the minds of potential customers.

So, what's good, after all?
All is not lost for Oracle. The company recorded a 4% jump in new software licensing and cloud-based subscription sales. That's an important metric for potential investors, as any new software sold also generates long-lasting maintenance contracts that add to future profits.

The growth in software licensing has been especially good at 15% on a year-over-year basis in the North and South American markets. Moreover, 60% growth in Exadata and Exalogic -- two different types of hardware marketed by Oracle -- also means that things may not be as bad as they look for the company's hardware division.

Oracle is also updating its product offerings to retain existing customers. Notable among them is its 12c database. Known as the in-memory option, the update is dependent on quicker computer memory rather than hard drives, which in turn, significantly boosts the database's performance. Incidentally, the 12c is Oracle's first cloud-computing database and should prove effective against and Workday.

Foolish final thoughts
Oracle's management seems to have reversed its earlier attitude of holding the sales team responsible for most of its setbacks and has acknowledged the competition. While that might lead to a more cautious approach, that's exactly what is needed as the economy takes time to recover.

At the same time, there is obviously a set of customers who still find it prudent to invest a little more in Oracle's high-end offerings, as evidenced by the growth in new software licensing. The company should do all it can to hold onto such customers, as well as concentrate on pricing its deals more competitively to get new ones. While it's not time to be bullish on the stock right now, it might pay to keep a close eye on future developments.

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9/27/2016 11:25 AM
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