Oracle Corporation Is a Better Cloud Play than Pure-Play Cloud Companies

Investors were not amused when Oracle (ORCL -0.75%) reported less than stellar fourth-quarter and full-year fiscal 2014 results that sent its shares tumbling. Chief executive Larry Ellison tried to explain to the investing world why the company's profit miss was actually a positive sign of its gradual transition into a cloud-centric revenue model, but it seems that the Street refused to buy the story.

For context, Oracle reported fourth-quarter revenue of $11.32 billion, a 3.4% year-over-year improvement. But, analysts were looking for $11.48 billion. The worst part: net income was down 4.2% to $3.65 billion. The company's saving grace, however, was its strong share repurchases, which helped keep EPS unchanged at $0.80.

Cloud revenues
Cloud growth was the operative word during the earnings call. Oracle's cloud SaaS and PaaS revenues were up 25% to $327 million. Cloud infrastructure, or IaaS, grew at a more modest rate of 13% to $128 million. According to Mr. Ellison, that's good because SaaS and PaaS typically command margins in the 40% to 50% range, while IaaS margins are lower. The company added 870 new cloud customers in the fourth-quarter alone.

For the full-year, SaaS and PaaS grew 24% on a GAAP  basis, and 20% on a non-GAAP basis, to $1.1 billion. IaaS revenue was up 1% to $456 million.

Where Oracle trounces pure-play cloud companies
Overall cloud growth (SaaS, PaaS, and IaaS) for Oracle clocked in at 17.25%. So how does Oracle's cloud growth stack up against the SaaS industry leaders such as Workday (WDAY -1.73%), Cornerstone OnDemand, NetSuite and Salesforce.com (CRM -1.06%)?

Oracle's fiscal year 2014 ended on May 31, 2014, while Salesforce's fiscal year 2014 ended on Dec. 31, 2013. Workday's, Cornerstone OnDemand's, and NetSuite's fiscal year 2014 will end on Dec.31, 2014. We shall, therefore, compare Oracle's and Salesforce's full-year 2014 results with the full-year 2013 results for Workday, Cornerstone OnDemand, and NetSuite.

Source: Workday 10-K, Cornesrstone onDemand 10-K, NetSuite 10-K, Salesforce.com 10-K, Oracle 10-K

Salesforce is one of the most mature SaaS companies. Its revenue has been growing consistently at a 30%-plus annual clip over the last three years or so. Meanwhile, Oracle's cloud subscriptions grew just 4% in fiscal 2013. Its 17.5% cloud growth in fiscal 2014, is therefore, a huge improvement.

Oracle might be a latecomer to the cloud business, but its cloud revenue is already much higher, in absolute terms, than that of growth leaders Workday, Cornerstone OnDemand, and NetSuite. It's quite likely that Oracle's cloud growth will hit a plateau around Salesforce's 30% annual clip.

Let's now look at the main reason why Oracle is a much better cloud play than the other four SaaS companies.

Sales and marketing expenses as a % of revenue
SaaS companies spend very heavily on sales, marketing, and customer management functions so as to rapidly grow their customer base, and also to reduce customer churn. The big difference between old-line software companies and SaaS companies lies in the timing of their sales and revenue expenses in relation to their revenue.

For traditional software companies which sell perpetual licenses, their marketing expenses and revenue are almost perfectly aligned. But for SaaS companies, the story is very different. Customers sign up to use a company's software on an ongoing basis, usually on 12-24 months contracts. This implies that the company spends money on customer acquisition expenses, development and sales of the software, and hosting infrastructure expenses upfront, and the expenses are immediately accrued for. Yet, the revenue comes in gradually as the months roll on.

However, SaaS companies know that if they continue growing their customer base, a time will come when the cash generated from the installed customer base will be enough to cover any new customer acquisition costs, plus any other marketing expenses. The company will then be able to sit back and harvest any incoming cash flow as profits. Moreover, SaaS customers tend to be sticky with low churn rates.

Oracle spent about 24% of revenue as marketing expenses in 2014. Its sales and marketing expenses grew 6% during the year. In comparison, most SaaS companies spend close to half of their revenue, or more, on sales and marketing expenses. This makes it very hard for these companies to turn a profit. None of the SaaS companies mentioned here is profitable, including Salesforce, which has been in business for around 10 years.

Credit: YCharts

However, Oracle is lucky in this respect since it's solidly profitable. Its other businesses insulate it from any losses as its cloud business matures.

Although Oracle spent a good amount of money on sales and marketing functions during the fourth-quarter, and the figure was charged to its balance sheet immediately, the revenue benefits will  appear on its balance sheet gradually as the quarters roll on.

Foolish takeaway
Oracle is solidly profitable, unlike many pure-play SaaS companies. Its cloud business is also growing at a healthy pace. This could make it a better long-term cloud play than pure-play SaaS companies.