The reason behind the pressure Oracle stock has been under this year has a familiar ring to it: transition to the cloud. Oracle made a name for itself as a provider of software, hardware, and networking products and services, the results of which went hand-in-hand with the fortunes of the PC industry. Until recently, Microsoft shareholders could certainly appreciate Oracle's conundrum.
It seems the distinction in investors' minds is that Microsoft's transition to a cloud-first business model has not only taken hold-- its cloud revenue is tracking at an impressive $8.2 billion annual run rate as of last quarter -- but just as important, investors are buying in. It's no wonder Microsoft stock is up about 16% year-to-date, even as Oracle shares have dropped nearly 13% as of this writing.
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Oracle's shift to a cloud-first model has made huge strides since focusing its efforts on the fast-growing market three years ago, and bigger things are expected the balance of this fiscal year -- and beyond. But Oracle hasn't convinced investors or industry pundits that its transition has legs, unlike Microsoft, so its stock continues to meander. And therein lies the opportunity.
It's all about the cloudOne look at Oracle's recent fiscal 2016 first quarter earnings report or a quick listen to the conference call with analysts makes it abundantly clear the future lies in the cloud. Software sales and licensing fees continue to make up the majority of Oracle revenue, but its cloud-related solutions are gaining ground with each successive quarter.
According to co-CEO Mark Hurd, Oracle's "cloud revenue growth rate is being driven by a year-over-year bookings growth rate of over 150% in Q1." Leading the charge are Oracle's cloud-based software-as-a-service (SaaS) and platform-as-a-service (PaaS) solutions, which bodes well for the future. Why? SaaS, in particular, is expected to become one of the fastest growing pieces of the cloud pie going forward, and Oracle expects that it will play a key role in driving earnings.
The upside to SaaS and PaaS cloud sales is the recurring revenue each generates. Per co-CEO Safra Catz, these two critical areas of Oracle's cloud strategy already generate an impressive 40% operating margin. By the fourth quarter of this fiscal year, Catz expects that margin will jump to 60% and eventually rise to a sky-high 80% in just two years. Though the fatter margins from recurring revenue generated from SaaS and PaaS sales won't necessarily appease investors looking for top line growth, it will have "a huge impact on EPS growth going forward," said Catz.
When Oracle's infrastructure sales are included in the revenue mix, cloud sales climbed 29% last quarter to $611 million, led by a 34% improvement in software and platform revenue. Larry Ellison, the longtime face of Oracle, expects new cloud SaaS and PaaS sales of between $1.5 billion and $2 billion this fiscal year, and that's on top of the recurring revenue generated from past sales.
Onward and upward No, Oracle isn't in Microsoft's league -- yet -- but its bevy of cloud solutions are still relatively new. As Ellison noted during the first quarter conference call, Oracle is just now "entering the rapid-growth, scale-out phase of our cloud business." It's easy to forget now that Microsoft stock is bumping up against 52-week highs, but it was only a year or so back that it was rowing upstream in the same boat as Oracle is currently. What changed? Continued growth in cloud-related sales certainly helped, as well as investors and pundits finally recognizing Microsoft isn't just about the PC industry any longer.
Assuming Oracle continues delivering on its all-important cloud businesses, it's only a matter of time before it's viewed as Microsoft is today: a rapidly growing cloud product and services provider, first and foremost. In the near term, Oracle's second quarter guidance of flat revenue growthprobably won't excite investors. But look a bit closer to what really matters: Are cloud sales still skyrocketing? Are recurring revenue and margins continuing to improve?
The answer will likely be a resounding "yes". It's also worth noting that at just 13.5 times future earnings, Oracle is also one of the top, long-term tech values around. It just needs some time.
The article Why Are Investors Shunning Oracle Corporation? originally appeared on Fool.com.
Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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