This duel is over valuation. My opponent, if he sticks to his old arguments, is going to say, "Look at the cash." But let's look at Oracle's free cash flow malaise and how the company is spending its cash on acquisitions. Then let's decide if the shares are value-priced.
Big fish eat little fish
In 2003, No. 3 enterprise resource planning (ERP) company PeopleSoft decided to digest JD Edwards for $1.75 billion. PeopleSoft's bid was a 19% premium to JD Edwards' closing price before the offer.
The deal would propel PeopleSoft into the No. 2 position in the lucrative ERP market ahead of Oracle (Nasdaq: ORCL ) . Oracle reacted by offering $5.1 billion for PeopleSoft, a 6% premium to its previous closing price. Oracle's CEO labeled the JD Edwards merger "very risky" in an effort to dissuade PeopleSoft from making that deal.
PeopleSoft completed the JD Edwards merger, and Oracle continued to chase PeopleSoft. Oracle finally won PeopleSoft's hand in marriage for $10.3 billion. Yikes. Oracle more than doubled its original offer and got JD Edwards, an asset it clearly didn't want.
But, a pattern is set. Diamond Jim -- oops, I should have said Oracle CEO Larry Ellison -- is willing to pay well over stock market prices to buy assets.
So, how much is $10.3 billion? Oracle's trailing annual earnings before interest, taxes, depreciation, and amortization, or EBITDA, is $5 billion. So, Oracle paid twice an entire year's EBITDA to buy PeopleSoft, a company with a trailing annual operating margin of 4.6% before the merger. Oracle's margin at the time was 38%. It's no surprise that Oracle's trailing annual operating margin today is 33.8%.
The feeding frenzy continues
No. 1 ERP company SAP (NYSE: SAP ) took a liking to retail management software company Retek last year and offered to buy it for $8.50 a share -- a 42% premium to its previous day's close. Oracle decided that it was time for another bidding war and snatched Retek for $11.25 a share. Diamond Jim was spending at well above market prices again.
In September, Oracle also admired No. 1 customer-relationship management company Siebel Systems (Nasdaq: SEBL ) and offered $5.8 billion ($3.6 billion if you subtract Siebel's cash) to purchase it. The 17% premium to the previous closing price didn't set off a bidding war, probably because Siebel is valued at 45 times analysts' projected 2006 earnings. That Diamond Jim really pays top dollar!
Add up those three buyouts -- and these are not all the acquisitions that are taking place -- and you are talking about $15.8 billion. So, what is Oracle trying to do? Its mainstay database and middleware business was three-quarters of new software license revenue last quarter. It's a slow growth business, but very lucrative. Business software, which can also help sell database products, is growing faster and is lucrative, too.
Let's look at the cash
Bolstered by PeopleSoft, sales last quarter increased 19% over the year-ago quarter. But while the top line bloomed, the bottom line faded. Net income fell 2%.
The numbers were not pretty for free cash flow, either. For the last six months, it's down 2%.
So, after spending $10.3 billion for an acquisition, net income and free cash flow are headed down. And, there is another multibillion-dollar purchase on the way.
Oracle is bulking up for its fight with SAP for ERP supremacy and is trying to keep Microsoft (NYSE: MSFT ) at bay in the lower end of the ERP market. When you consider that Oracle is trading for 22.5 times trailing annual earnings and is expected to grow earnings 11% a year for the next five years, there is hardly reason to expect it to outperform the market averages.
If you are still aching to buy Oracle, take a look at its five-year chart. It isn't pretty. It looks that way because over the last five years, Oracle has compounded earnings by a negative 1.3% (according to Yahoo! Finance). Guess what? Net income fell slightly more than that last quarter. This company is in a groove, and it isn't headed up.
Wait! You're not done. This is just a quarter of the Duel! Don't miss the Bull opening argument and the Bull and Bear rebuttals. Even when you're done, you're still not done. You can vote and let us know who you think won this Duel.
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