Never have I wanted to lose a duel as badly as I want to lose this one. Really.
You see, I'm an Oracle (Nasdaq: ORCL ) shareholder and have been since 2004. Back then, I surmised that the hoo-ha over the company's proposed acquisition of PeopleSoft clouded the market's perception of a business capable of generating heaps of cash. That was proved true, and my initial buy is up more than 26%.
But Oracle's prospects have since improved, leaving the stock still sharply undervalued. So much so that I'm planning to buy more shares. So you'll have to forgive me if I root for my opponent in the faint hope that the market will give me better buy-in prices.
In the meantime, Foolish duty calls. And so I present to you the bull case for Oracle's shares. Let's start with a little history.
Once in a lifetime
Oracle was founded in 1977 as a supplier of relational database software. It went public in 1986. Thanks to the Value Line Investment Survey, I have historical earnings data all the way back to 1989. And it says that, in those years, Oracle never traded for less than 17 times earnings. Today, however, the company trades for 14 times projected 2006 income, according to Yahoo! Finance.
Yet that may not be the best judge. Net income under generally accepted accounting principles, after all, is easy to manipulate. Let's look at owner earnings instead. After stock option expenses, Oracle's trailing 12-month net income equals $2.786 billion. Add in $227 million for depreciation, another $452 million for amortization of intangibles, and $197 million for a one-time event (a write-off for bad debt), and you arrive at $3.662 billion. Subtract $182 million worth of capital expenditures (excluding acquisitions) and you're at $3.48 billion in owner earnings over the last 52 weeks. That translates into $0.68 per share, which means the stock trades for 18.6 times its current owner earnings. Not bad, but not outstanding.
Consulting the crystal ball
A brighter picture emerges when you peer into fiscal 2006. But, to get there, we need to look back over the last 52 weeks again. Oracle's trailing 12-month revenue equals $12.888 billion. Divide its owner earnings from the same period -- $3.48 billion -- by that total and you get the owner earnings margin. Hang on while I pull out my calculator.
Let's see ... 3.48 ... divided by 12.888 ... equals ... 0.27, or 27%. That's pretty solid.
Now, if we apply that margin to next year's projected sales, which Yahoo! Finance has at $15.34 billion, you arrive at $4.14 billion in 2006 owner earnings. Oracle's shares outstanding have barely budged for several quarters, so we needn't make any big adjustments to arrive at owner earnings per share. But let's allow for some modest dilution and assume that the current 5.152 billion shares rises to 5.200 billion. That gets us $0.79 per stub, and a multiple of 15.9 times 2006 owner earnings at current prices. No, it's not 14, but it's probably a truer number and still a hefty discount compared with the current market, competitors, and historical standards.
But no one believes it
As if that mattered. The malaise with which talking heads treat Oracle is best summed up by CNBC Mad Money host and TheStreet.com (Nasdaq: TSCM ) founder Jim Cramer. In December, he featured Oracle in his "danger zone" commentary, saying that Oracle shares ought to be dumped because "if [Oracle] didn't make acquisitions, you'd see the true picture of how bad this company is doing and you wouldn't want it. It's a yesteryear stock. It's not coming back."
Please understand that I think Cramer is a very smart guy, even if he has allowed himself to become the clown prince of investing. And understand, too, that his argument, like so many others, is that the stock can't rally because it hasn't. It's a chartist's view. It's like the guy who sees a beat-up 1973 fastback Ford Mustang but fails to pop the hood and check the V-8 humming underneath.
And this is a V-8. Name another company besides Microsoft (Nasdaq: MSFT ) or Apple (Nasdaq: AAPL ) capable of absorbing $9 billion in debt and then paying off all but $1.5 billion of it in a year, thanks to ample cash flow. Can't? Me, neither.
Far as I can tell, investors are simply afraid of this stock. They've seen it do nothing but go down and sideways since 2000. Where's the profit in that?, they say. Point taken. But also remember that John Neff, former manager of the Vanguard Windsor (FUND: VWNDX ) fund, bought Citigroup (NYSE: C ) in 1987 only to watch it struggle for five years before rewarding his valuation thesis. And he routinely bought more in the face of market pessimism.
That's because he saw improving fundamentals. And that's what I see with Oracle, too. For example, earnings per share are up nearly 40% since 2001.
A future filled with catalysts
Critics will argue that the core database franchise is deteriorating. And I say: Balderdash. Oracle introduced a new version of its database in 2004 that spurred strong sales and difficult comparisons in recent quarters. What's more, acquisitions have substantially bolstered applications revenue while setting the stage for future upgrades.
Think about it. The so-called Fusion product, which merges technology from Oracle, PeopleSoft, and JD Edwards, is under development now. When completed, it should provide a huge boost to license sales. There's no telling exactly how many years the project will take, but the company reported in December that it met its intended milestones for 2005.
Meanwhile, there's the Siebel (Nasdaq: SEBL ) acquisition. The net $3.6 billion purchase of the customer relationship management (CRM) software maker is on track with approval from European Union regulators. And the software should fit well into Oracle's plans to provide an entire stack of products for managing business information.
That's even true in the so-called on-demand space, where smaller rival Salesforce.com (NYSE: CRM ) has fared well. Siebel, you see, has its own Web-based system. It wouldn't surprise me one bit to see Oracle take that software and install simple interfaces that would allow it to call a database for further information, rather than relying on sales staff to input information by hand, a long-known and well-documented flaw with classic CRM systems.
Go ahead; call me a contrarian
All this and more is why CEO Larry Ellison says that he believes his company will generate 20% annual earnings gains out to fiscal 2010. So far, no one believes him. Which, frankly, is fine. It's been that way for close to three decades now. All Ellison has to show for it is a $17 billion fortune and the No. 5 ranking on Forbes' list of the 400 richest Americans. You're welcome to bet against him again if you like. Just don't ask me to.
Wait! You're not done. This is just a quarter of the Duel! Don't miss the Bear opening argument and the Bull and Bear rebuttals. Even when you're done, you're still not done. You canvote and let us know who you think won this Duel.