Shares of tech giant Oracle (ORCL 2.58%) have fallen more than 20% over the past 12 months, underperforming rival IBM's (IBM 1.11%) 17% drop and the S&P 500's 8% decline. Let's take a look at three of Oracle's biggest weaknesses, and why its stock could fall further throughout 2016.
1. Mixed earnings and soft guidance
Last quarter, Oracle's revenue fell 6.3% annually to $9 billion and missed expectations by $60 million. Revenue growth was flat on a constant currency basis. Its cloud revenue rose 26% to $649 million, but that growth couldn't offset a 7% decline in its on-premise revenue to $6.4 billion, and a 16% drop in hardware sales to $1.1 billion.
In its on-premise business, software license sales fell 18% due to a shift toward cloud services, while license update and support revenue dipped 2%. In its cloud business, combined SaaS (software as a service) and PaaS (platform as a service) revenues climbed 34% to $484 million, while IaaS (infrastructure as a service) revenue rose 7% to $165 million. Non-GAAP net income fell 12% to $2.7 billion as its non-GAAP operating margin declined from 46% in the prior year quarter to 41%. Free cash flow also fell 22% due to the costs of transitioning toward the cloud.
On a constant currency basis, Oracle expects flat to 3% annual sales growth for the current quarter. However, it expects a strong dollar to reduce revenues by 4%, which might cause it to miss the consensus estimate for a 2.2% decline in U.S. dollars. For the fourth quarter, Oracle expects constant currency sales growth between 1% and 3%, compared to the consensus estimate for a 0.2% decline in U.S. dollars. Analysts expect Oracle's revenue and earnings to respectively fall 2.6% and 6.1% for the full year.
2. Cloud growth isn't guaranteed
Oracle's core strategy is to shift away from its aging database and hardware products and toward cloud "as a service" platforms. But by reporting PaaS and SaaS together and IaaS separately, Oracle makes it hard to gauge its competitiveness against higher-growth hybrid PaaS/IaaS platforms like Amazon's (AMZN 2.07%) AWS and Microsoft's (MSFT 1.70%) Azure.
Amazon reported that AWS had an annual run rate of $7.3 billion last October. Last quarter, AWS revenues jumped 78% to $2.1 billion as operating income soared 431% to $521 million. Microsoft doesn't disclose Azure revenues separately, but Forrester Research estimated last October that the unit has an annual run rate of $1.58 billion. The firm estimates that, excluding the SaaS business, Oracle's PaaS/IaaS platforms have an annual run rate of just $681 million. That puts it in the same lightweight class as IBM's IaaS/PaaS platform Bluemix, which has an estimated run rate of $600 million. If Amazon and Microsoft pull further ahead in the IaaS/PaaS race, smaller rivals like Oracle and IBM might have to cut prices and spend more on R&D to compete.
Oracle only expects its cloud revenues to rise 3% to 4% annually in the third quarter and grow 1% to 3% during the fourth. IaaS sales are expected to rise 3% to 7% in the third quarter and slow to 1% to 5% growth in the fourth quarter. On the bright side, Oracle expects non-GAAP gross margin for the SaaS/PaaS business to rise from 43% in the second quarter to 60% by the end of the fiscal year as more billings are converted to revenue.
3. IBM's OpenPower challenge
To expand the use of its Power processors, IBM has been "open sourcing" its processor specifications, firmware, and software of its servers through its OpenPower Foundation. This move could widen Big Blue's defensive moat against Oracle's SPARC chips and Intel's (INTC 1.46%) Xeon E-series processors, which are both designed for high-end servers.
In response, Intel and Oracle set aside their differences in processors to produce Oracle-Intel servers which run Oracle's databases on Xeon processors. Oracle also stated that it would persuade its database and software customers to replace their IBM servers with Oracle-Intel ones instead. At a presentation at Oracle World in San Francisco, Oracle CEO Mark Hurd claimed that these systems will offer faster performance than IBM's "large and costly" systems at a fraction of the cost.
Nonetheless, the disruptive expansion of IBM's OpenPower ecosystem among smaller server makers (especially in China) could cause Oracle's hardware sales to fade at an even faster rate.
The bottom line
Oracle faces a lot of headwinds as it transitions away from its on-premise businesses toward cloud platforms. That transition could be tough due to Amazon and Microsoft's growth in the cloud, and IBM's aggressive expansion in hardware. However, Oracle stock trades at a reasonable 16 times earnings compared to the industry average of 31, so its downside potential could be fairly limited. It also pays a 1.7% dividend to patient investors who are willing to wait for its improvements to kick in.