This week's Foolish Duel features a bare-knuckles brawl over the prospects for database maker Oracle. Fool contributor W.D. Crotty thinks turmoil and tough times await the company, but Tim Beyers disagrees. What's your opinion? Vote after checking out both sides.
As an information technology consultant, I have seen Oracle
With the stock valued at $10 and change, investors -- not to mention, my Dueling Fool Tim Beyers -- may think, "Wow. That's cheap." Think again. With 5.2 billion shares outstanding, we're talking about a $54 billion market capitalization, or 5.2 times sales, for a mature company. That's rich.
That high price-to-sales ratio is not based on torrid sales. The company's first quarter outlook is for 6% to 9% revenue growth.
And take no comfort in the fact the stock trades at 20 times earnings. As you will see, acquisition turmoil might curtail earnings growth -- or worse.
My worthy adversary is certainly going to say, "But look at the cash." Well, there is $8.6 billion. That's a lot. Consider this, though. The company wants to spend $7.7 billion on PeopleSoft
Behind all the "We're buying" acquisition swagger, there are two nasty questions. Will Oracle pay too much? What will be the cost to integrate these companies? Oh, and there is a really nasty third question. With so many acquisitions, and the uncertainty that will surround them, why expect the stock to outperform?
PeopleSoft acquired J.D. Edwards for $2 billion in July of 2003. The acquisition gave PeopleSoft software for a wider array of customers and a second technology base to cherry-pick for great ideas. It was a good fit and swelled PeopleSoft's ranks to 12,400 customers in 150 countries.
To see why a large base of customers is important in software, look at Oracle's last quarter. Software license update and product support revenues were $4.5 billion (45% of sales) and had 88% operating margin. That's a lucrative business!
Consider too that once you make the sizeable investment in an integrated software package, you are not likely to change vendors. In fact, you are likely to buy new software as your business warrants the investment or new software becomes available.
What about the software?
If you have been following the federal antitrust case, Oracle has portrayed PeopleSoft as a company in need of a technical savior. But what's its sales potential?
Think about Big Oil. It is not finding elephant-sized oil fields. Most of the logical places to look have been identified and drilled. Elephant clients in the software field are a declining breed. The elephants have been hunted, wined and dined, and convinced that integrated enterprise software is the best thing since sliced bread.
One elephant that managed to stay free was Mexico's Tax Administration Service (the Mexican equivalent to the IRS, known in Mexico as SAT). PeopleSoft, Oracle, and SAP
Before awarding its $50 million contract (PeopleSoft's largest contract ever), SAT took three months to have three academic and research institutes evaluate the three products in a controlled environment. Speaking as an IT consultant, having a controlled environment is the right way to evaluate software.
According to the PeopleSoft press release, two reasons the evaluation committee unanimously chose PeopleSoft was its "superior functionality" and its "unmatched performance" in the testing environment. In a world were productivity is king, PeopleSoft provided the best productivity for SAT.
So, in a face-off, the biggest and best stepped into the ring and spent heavily to win the SAT contract. FUD (computer slang for fear, uncertainly, and doubt) was spread so every competitors weaknesses were clearly exposed. The result: PeopleSoft showed it is still a healthy competitor.
The PeopleSoft acquisition
How much is PeopleSoft really worth? After offering $9.4 billion ($26 a share), Oracle cut its offer to $7.7 billion ($21 a share). What was wrong with the original offer of $5.1 billion? Ah, it's only money!
At $7.7 billion, Oracle is paying 2.4 times sales. Compared to Oracle's 5.2 times sales, that looks like a bargain. Or is it?
Look at operating margins. Oracle is king and shooting for 40%. SAP earns 25% and PeopleSoft is an anemic 4.6%. Great software or not, PeopleSoft margins need to improve. If you buy the argument that PeopleSoft's products are strong and the argument that PeopleSoft needed technical infrastructure help, you see the opportunity for development costs to increase. Oracle needs to spend to keep the functionality competitive. It also needs to quickly make technical infrastructure enhancements because it has proclaimed this weakness to competitors.
Oracle has used high-profile town meetings to woo current PeopleSoft customers to its side in the acquisition debate. In the short term, to keep these customers happy, taking the axe to PeopleSoft costs would not be prudent. Yes, that is what Oracle will do long term to get reasonable margins. But, over the period covered by this duel, isn't it reasonable for Oracle to let its margins slip to keep rattled customers happy?
Oracle has clearly stated that PeopleSoft has implemented measures to ensure customers stay (and buy) its products and that these measures are destructive to shareholder value. The rhetoric positions Oracle perfectly for announcing "bad news" over the year after the acquisition. With that stage set, do you want to bet the stock will beat the market averages and soar? Expect bad news.
Consider if Oracle is absolutely correct. Why buy a company for billions that is destroying value? Long term, given Oracle's track record and the average margins for software, it might make sense. Short term, it looks like a losing proposition.
Consider too that so many mergers failing to meet expectations -- even when the parties are happy participants. What are the chances for a bitter battle to produce positive results immediately? It is not likely.
There are so many points not covered -- like competition from Microsoft
But, the critical point is that Oracle has set a path that makes its future very uncertain.
Assume that no mergers are made. There is 6% to 9% revenue growth. Wow, that is hardly a market-beating performance that warrants 20 times earnings.
Assume that the PeopleSoft merger will cause a year of disruption for Oracle -- a reasonable assumption given the size of the deal and Oracle's claims of value destruction. That hardly sets the company's stock up for a year of market-beating performance.
Add it up. One way is slow growth. The other is a $7.7 billion migraine.
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