Is Oracle’s Server Division a Losing Proposition?

Giant software developer Oracle (NYSE: ORCL  ) is a relative newcomer to the server business, having burst into the scene in January 2010 after its acquisition of Sun Microsystems. The global server business is as competitive as they come, and dominated by such tech titans as IBM (NYSE: IBM  ) , Hewlett-Packard (NYSE: HPQ  ) , Cisco (NASDAQ: CSCO  ) , Dell, and other large hardware firms.

Oracle's revenue from its server division has been trending south ever since the company bought out Sun Microsystems. Just prior to its acquisition, Sun Microsystems reported revenue of $12 billion and $9 billion in fiscal years 2008 and 2009, respectively. This revenue included sales of servers and related hardware.

The business has continued to decline under Oracle, and the segment posted revenue of $7 billion, $6 billion, and $5 billion in server sales and services for fiscal years 2011, 2012, and 2013, respectively. Is this negative trend attributable to Oracle and its execution strategies, or lack thereof, or is it a reflection of a wider global trend, similar to the steady decline in PC sales for all large PC vendors?

Global server market
HP, IBM, and Dell, lead the global server market, with double-digit market shares. Cisco, like Oracle, also came into server business quite recently in 2009, and has a market share comparable to Oracle's.

x86 servers dominate the market with a 90% slice (based on unit sales), while high-performance Unix and Mainframe systems take up the rest. HP claimed the top spot in the first quarter of 2013 after overtaking IBM. Its ProLiant brand has been the top seller.

Smaller players such as Huawei and Cisco have been seeing strong growth in server shipments in recent times. Both companies have been focusing on blade server form factors that seems to resonate well with customers. Cisco posted a huge 43% growth in server shipments in the third quarter of 2013, and took fourth position from Oracle with revenue of $600 million versus Oracle's $500 million. Huawei also recorded a stupendous year-over-year growth of 200% in that quarter, after shipping 69,573 units.

Looking at the bigger picture, slowing server sales seems to be a global trend that cuts across the board, since worldwide shipments fell 3.1%. Oracle's 16% decline, however, is much larger than the market average of 3.7%. Customers have a strong preference for blade servers over rack servers or high-performance Unix-based servers. Blade servers are credited to HP, which introduced them into the market over a decade ago. Blade servers increase the density of computing resources, so it makes sense that Oracle is focusing more on these servers. Oracle's 16% decline is, however, far worse than the average market decline.

Should Oracle just sell?
Oracle's huge decline in server sales is actually by design, not by accident. The software developer's main goal when buying out Sun Microsystems was to acquire Sun's powerful software platforms such as Java and Solaris, and to acquire Sun's high-end customers.

To prove this point, Oracle moved out of the low-margin x86 server business soon after the Sun acquisition and shut down the OpenSolaris project to concentrate on rebranding Solaris as a fully featured Unix-based system. The company then turned its attention to rebuilding Sun Microsystem's RISC microprocessor platform to better compete with Unix platforms of market leaders like IBM's PC-based AIX systems and HP's UX systems.

Oracle has also moved into engineered SPARC servers, which command higher margins. Although the unit selling prices of these high-end servers are much higher than that of the commodity x86 servers, total shipment volumes have been declining due to global server weakness.

One viable option for Oracle would be to issue a "mea culpa" to its shareholders and admit that the server project has been a lead balloon. Last year, IBM considered the sale of its server business to China's Lenovo. This would not be the first time the two companies have done business, since Big Blue sold its PC division to the Chinese giant in 2005 for $1.75 billion.

Foolish takeaway
It is, however, quite unlikely that Oracle will let go of its sever business any time soon. Oracle seems more keen on upgrading old legacy Sun x86 and SPARC servers into higher-margin Oracle Engineered systems. Oracle Engineered systems grew by double-digits in the second quarter of fiscal 2014. Revenue from the company's high-end SPARC SuperCluster servers also managed to grow by triple-digits.

Oracle is banking on strong global growth of demand for data services to drive server sales in the future. According to a recent Internap report, the demand for co-location hosting services, led by robust cloud hosting demand, will drive growth in the sector from the current $25.7 billion to approximately $43 billion by 2018. So, don't hold your breath waiting for Oracle to sell its server division any time soon.

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