Oracle of Omaha Abandons Oracle’s Stock After Just 1 Quarter

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Warren Buffett's Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) invested about $2.1 billion in Oracle (NYSE: ORCL) in late 2018. That was a bullish vote of confidence for the enterprise software company, since Buffett had only invested in a handful of tech stocks after shunning them for most of his career.

However, a recent SEC filing revealed that Berkshire sold its entire position in Oracle after a single quarter. That was a surprising move for Buffett, a champion of long-term investing who famously claimed that his favorite holding period was "forever". So why did the Oracle of Omaha abruptly dump Oracle?

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Understanding Oracle's business

Oracle, like many other mature enterprise software companies, is struggling to grow its sales in a saturated market. Analysts expect its revenue to fall 1% this fiscal year (which ends on May 31), compared to 6% growth last year.

Oracle is pivoting away from its slow-growth, on-premises businesses, like database hardware and software, toward higher-growth cloud services. Oracle previously disclosed its cloud-based SaaS (software as a service), IaaS (infrastructure as a service), and PaaS (platform as a service) revenues separately, and investors often measured Oracle's turnaround by the strength of those businesses.

However, the growth of that cloud revenue decelerated significantly throughout fiscal 2018. In the fourth quarter of 2018, Oracle stopped reporting the growth of its SaaS, IaaS, and PaaS revenues separately.

Instead, it combined those units with its legacy businesses into two new (and arguably opaque) reporting segments: "Cloud Services & License Support" revenue and "Cloud License & On-Premise License" revenue. However, the performance of those two new segments over the past three quarters indicated that Oracle's cloud growth was still decelerating:

Metric

Q4 2018

Q1 2019

Q2 2019

Cloud Services and License Support

$6.8 billion

$6.6 billion

$6.6 billion

YOY growth

8%

3%

3%

Cloud License and On-Premise License

$2.5 billion

$867 million

$1.2 billion

YOY growth

(5%)

(3%)

(9%)

Oracle reported flat year-over-year revenue growth last quarter. This indicates that Oracle is struggling to compete against bigger fish in the cloud services market like Amazon (NASDAQ: AMZN) Web Services (AWS) and Microsoft's (NASDAQ: MSFT) Azure.

Amazon's AWS revenue rose 45% to $7.4 billion last quarter, and it retained its title as the largest IaaS/PaaS platform in the world. Microsoft's commercial cloud revenue -- which includes Azure, Office 365, Dynamics, and other SaaS products -- climbed 48% to $9 billion last quarter. Within that total, its Azure revenue surged 76%.

Enterprise customers are clearly flocking to either AWS or Azure, which leaves very little room for cloud underdogs like Oracle and IBM (NYSE: IBM). Berkshire also sold its entire stake in IBM last year amid concerns about its cloud competitors.

An addiction to buybacks

I believe Oracle is on the verge of making the same mistakes as IBM. Buffett was initially drawn to IBM in 2011 after Big Blue pledged to double its EPS within five years -- but to reach that goal (which it ultimately failed to do), IBM dramatically cut costs, sold business units, failed to invest in new technologies, and aggressively repurchased its stock. As a result, IBM's revenue growth flatlined and it fell behind Amazon and Microsoft in the cloud market.

Last quarter, Oracle spent $10 billion on buybacks. That's why its non-GAAP EPS surged 16% as its net income only rose 3%. In other words, Oracle "bought" an earnings beat, and analysts expect those buybacks to boost its non-GAAP EPS by 9% this year. Oracle recently authorized another $12 billion in buybacks.

Buying back stock is only a smart move if a company can't find meaningful ways to reinvest its cash into its business. It would be wiser for Oracle, which is sitting on $49 billion cash and marketable securities, to acquire more cloud service companies to boost its sales growth and aggressively challenge Amazon and Microsoft.

Oracle bought seven companies in 2018, but the largest acquisition, Grapeshot, only cost about $400 million. Oracle's operating expenses also rose less than 1% annually last quarter, which suggests a lack of urgency regarding the growth of its cloud businesses.

Berkshire doesn't want to own another IBM

Oracle's stock looks cheap at 14 times forward earnings, but Berkshire Hathaway probably doesn't want to own another stagnant tech stock like IBM. Oracle is arguably in better shape today than IBM in 2011, but Berkshire likely noticed too many similarities to stick with what is likely to be a long-term loser.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Berkshire Hathaway (B shares). The Motley Fool owns shares of Microsoft and Oracle. The Motley Fool is short shares of IBM and has the following options: long January 2020 $30 calls on Oracle. The Motley Fool has a disclosure policy.