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Another set of earnings meant another disappointment for Oracle shareholders. Earnings, revenue, and key performance metrics all came
in toward the bottom end of guidance, and Fools must be wondering just
how reliable Oracle's guidance actually is? However, the company also
made some reporting changes that should make its earnings easier to
follow in the future, yet most of these adjustments simply reflect a
change in industry-end demand.
In common with its main rival IBM , Oracle is shifting its efforts toward areas of growth such as cloud
infrastructure. The question is, how will Oracle's new guidance help
Fools to better follow the company?
When a technology company misses analyst estimates
and disappoints based on its own guidance, the stock usually gets
punished severely. However, in the case of Oracle the market was much more forgiving, with the stock down barely a
percentage point on the day. Investors' reaction to the news is telling
you a lot of what you need to know about the stock: Oracle remains one
of the most attractive investing ideas in technology.
Oracle disappoints, again First things first, aside from its hardware product sales, it wasn't a great set of results:
There are no prizes for guessing that cloud computing is the IT sector's
hot buzzword is right now. Blue chip tech companies like Google, IBM, Oracle and Microsoft
are all investing in offering infrastructure as a service, or IaaS,
solutions to their customers. In addition, there is an ongoing trend of
incumbent software companies shifting toward software as a service, or
SaaS, based models. For example, Intuit, Adobe, and Autodesk
are all making the change, but what is in it for them? Moreover, what
are the tangible benefits of cloud computing for these companies?
The market's valuation of Oracle continues to suggest doubt over its future direction. It's traditional
on-premise on-license sales are being threatened by pure-play software
as a service, or SaaS, companies like Workday and Salesforce.com. Meanwhile, analysts are also questioning its future margins, given
that management declared an intent to be "price competitive" with Amazon Web Services and Microsoft's Azure. Are the skeptics right about Oracle, or is the stock a good value?
Oracle reports a good second quarter After disappointments from IBM and Cisco,
investors have approached Oracle's recent results with caution, despite
the fact that the numbers came in slightly better than expected.
New software licenses and cloud software subscriptions (26% of
revenue) grew 1% constant currency growth vs. internal guidance of
-4%-6% growth.
Hardware systems product sales declined 2% in constant currency vs. internal guidance of -9%-1% growth.
Non-GAAP earnings were $0.69 vs. internal guidance of $0.65-$0.69.
Although new software licenses and cloud
subscription growth appears weak, Foolish investors should note that the
company came up against some very strong numbers from last year's
second quarter.
Source: company presentations.
Oracle's management articulated that its mix of
software sales had a larger share of renewals and annuity deals versus
new license deals. This kind of shift usually involves trading off some
upfront revenue for an income stream over time. Indeed, Oracle's
management argued, "you would think it would take you a couple to three
years to get to that full productivity of the equivalent of a recurring
stream of revenue to what you would have typically seen in license."
In other words, Oracle's revenue is likely to be
negatively affected in the short term with this shift toward
subscription-based sales.
The geographical breakdown confirmed Oracle's
strength in the Americas, with sales up 5%, along with "good growth" in
China. However, the real talking point is how aggressively Oracle is
seeking to expand its cloud infrastructure services.
Oracle takes on Microsoft, Amazon, and Rackspace As
you would expect from a megacap tech company, Oracle's cloud offerings
include SaaS, applications, and infrastructure. However, on its recent
conference call, Oracle's CEO, Larry Ellison, explained that his
company's plans involve being "price competitive" with Amazon,
Microsoft's Azure, and Rackspace. Ellison also plans to make Oracle "highly differentiated at both the platform level and the application level."
The plan can easily be criticized for potentially
sacrificing infrastructure margins at the expense of chasing future
revenue. The market is competitive enough already, as Microsoft has
already promised to match Amazon on pricing and features.
Oracle needs to address the threat that pure-play
SaaS companies like Salesforce and Workday will grab market share within
their respective niches of customer relation management and human
capital management. Therefore, a strategy like this will help efforts to
retain leadership with long-term recurring revenue from cloud
applications.
Similarly, Microsoft and Amazon have their own
services that will benefit from selling cloud infrastructure at
less-than-optimal prices. The important strategic issue for Oracle is to
remain relevant as SaaS solutions become more important.
Oracle's financial firepower and marginsOracle
has the financial firepower to make these moves. It's trailing twelve
month free cash flow generation of $14.6 billion represents
approximately 9.6% of its enterprise value. Furthermore, Oracle is
investing in dedicated sales teams to compete for business against
Workday and Salesforce. Sales and marketing expenses increased 12% in
constant currency during the quarter, as Oracle built out sales capacity
to win future business in the cloud.
All told, these initiatives may trim margins, but
Oracle has a lot of financial leeway, and so does its valuation. Despite
a 20% rise in the last six months, the stock still trades on just 12.5
times forward earnings to May 2014. Operating income margins fell to 36%
in the first half, versus 37% last year, but 80% of the increase in
operating expenses came from investments in sales and marketing.
The bottom line Investors can
be quick to criticize management for failing to adjust to structural
changes, but Oracle is making significant efforts to manage the
transition of software into the cloud. Investments in sales capacity,
infrastructure services, cloud-based acquisitions, and efforts to
respond directly to the threat posed by Salesforce and Workday are all
demonstrations of intent.
Oracle is responding to structural changes in its
marketplace, and it will take time to come to fruition. However, the
stock's valuation suggests it can withstand some margin erosion along
the way.
Shareholders in Cisco Systems
saw their investment crash after lackluster first-quarter results. The
stock is now down around 20% from its yearly high in August. With the
mid-point of its 2014 guidance implying a 1% fall in earnings, is now
the time to give up on the stock, or to buy in?
Cisco's nasty quarter Cisco
beat earnings estimates for the quarter but missed revenue expectations,
and its near-term outlook is horrible. Its orders in the quarter were
$600 million -- $700 million short of its own expectations -- a problem
for a company with 70% of product revenues dependent on new orders each
quarter. With this shortfall in place, its second-quarter EPS guidance
of $0.45-$0.47 came in nearly 8% below analyst estimates at the
mid-point.
There are two key problems.
First, Cisco basically repeated what IBM said earlier in the earnings season
with regard to demand in emerging markets. Both companies had reported
some second-quarter weakness in the BRICs, but IBM's disclosure that its
Chinese sales declined 22% in the third quarter -- with hardware down
40% -- was a big surprise.
Fast-forward to Cisco's third-quarter results, and
the weakness seems to have spread out. Here is CEO John Chambers on the
subject:
Every one of our top 10 emerging countries missed
their forecast and was off by a fair amount. So it wasn't just that it
was down, the last couple of weeks, they kept dropping and dropping...
... it was over half of our shortfall, the last couple of weeks versus
forecast.
Frankly, it's puzzling as to why Cisco's
performance in emerging markets was so weak across the board. China was
down 18% -- in line with what IBM reported -- but why should Russia and
Brazil be down 30% and 25%, respectively?
One possible answer can be construed from something
that CEO Chambers mentioned in the conference call. He argued that
Cisco went into the last month of the previous quarter "a little bit off
the numbers we expected." But in the last two weeks of the quarter, its
orders came in $300 million more than forecast. It's possible that
Cisco's emerging market weakness was exacerbated in this quarter because
in the previous quarter its sales people pushed hard to make the
numbers.
The second issue was the 14% fall in
service-provider video revenues, while orders also disappointed with a
13% decline. Cisco's set-top box sales declined 20%, and since they make
up 20% of revenue from service providers -- which makes up more than 8%
of total revenue -- the impact was significant. Cisco's challenge is
to manage the transition from traditional set-top boxes toward its
set-top boxes that connect with the cloud. In fact, this has been an ongoing issue
this year. It seems that sales of its new products were disappointing,
and Cisco continued to follow a policy of "walking away" from low-profit
deals with the older technology. Good for margins, terrible for revenue
growth.
Four reasons to stay positive? If you can see a clear pathway through the gloom and doom, there are four reasons why the stock looks attractive.
First, Cisco described its U.S. enterprise and
commercial growth as being very strong and cited order growth in the
high single digits. This matches what Oraclesaid at its earnings in September.
Oracle saw its new software-license and cloud subscriptions rise 14% in
America. This is a sign that the U.S. -- particularly in enterprise --
is the standout region for IT spending growth. It's a good sign for U.S.
growth.
Second, the set-top box issue is a structural
problem, but Cisco is managing it, and has products in place. Further,
plenty of IT companies see some issues when they introduce new products
or make transitions in technology. Companies can be reticent to spend on
an old system when a new one is available, yet also careful not to rush
to buy and integrate a new technology. However, provided the underlying
demand is there, these issues can be sorted out in a few quarters. For
example, tech companies like F5 Networks and Check Point Software have seen these issues over the last year.
Third, Cisco was obviously disappointed with its
performance in emerging markets, particularly late in the quarter. This
means it's likely that the updated guidance has been reset with current
trading in mind. If BRIC spending picks up, then Cisco could surprise on
the upside going forward. In any case, emerging-market demand does tend
to be volatile.
Finally, the company has $48.2 billion in cash and
cash-like investments, while total debt is only $16.2 billion. In other
words, its net cash of $32 billion represents around 29% of its market
cap. Cisco has the resources to make earnings-enhancing acquisitions.
Time to buy Cisco? Cisco is
going to attract value hunters. Even on its disappointing $1.95-$2.05
EPS guidance, the stock still sells at a P/E ratio of around 10.5 times
forward earnings. It's not the highest-quality technology company out
there, but it's cheap, and it has opportunities to turn around its
fortunes. Throw in a near-3% dividend yield and you can enjoy some
income while you wait.
There are two key conclusions to be drawn from International Business Machines' (NYSE: IBM)
recent results. First, for the third quarter running, they were
disappointing, and second, the stock is still cheap. Growth-oriented
investors probably won't be turned on by such considerations, but
value-based speculators may see IBM as too good to pass up.
IBM disappoints, but reaffirms targets To put these results in context, here is a graph of its major business segments.
Source: company accounts.
Clearly, the last six quarters have been difficult
for revenue growth. However, it is understandable because IBM's focus
has been on exiting lower-margin businesses and focusing on reshaping
the business toward higher-margin software and services sales. Moreover,
its stated aim is to hit $16.90 in non-GAAP adjusted EPS for 2013, and
ultimately hit $20 in EPS by 2015. Eagle-eyed readers will note that
these earnings would put IBM on P/E of 10.2 and 8.8 times its 2013 and
2015 forecasts, respectively. Since management reinstated these targets,
should investors just ignore the falling revenue and buy a cheap stock?
Believing the numbers Ultimately,
your decision will boil down to how much you believe in the numbers.
The latest evidence suggests that the underlying picture is getting
murky.
Diluted EPS rose 10.5% in the quarter, but pre-tax income actually
fell 5.2%. The difference is due to a large reduction in the tax rate.
Buybacks played a part, too. If you assume that the tax rate and
share count remained constant, IBM's EPS actually fell 5.2% for the
quarter.
Last quarter, IBM predicted low single-digit growth for its global
technology services, or GTS, but they came in at -1% on constant
currency basis.
Last quarter's weakness in the BRICs continued, with Chinese sales
down 22% (with hardware sales falling 40%) and they are not expected to
grow again until the first quarter of 2014.
The weakness in software continues, with sales up just 2% in
constant currency. Indeed, last quarter's strength was arguably due to
rollover deals that were delayed from the first quarter.
In fact, the only segment that really performed
well was its global business services segment, or GBS, which delivered
constant currency sales growth of 5%. This was in-line with IBM's
forecast of mid single-digit growth.
All told, this was a weak quarter for IBM. In common with its major rival, Oracle (NYSE: ORCL)
, IBM reported good growth in business analytics (up 8% year-to-date)
and proudly trumpeted that it delivered $1 billion of cloud revenue in
the quarter.However, cloud revenue only represents 4.2% of total sales,
and the strength in business analytics highlights the fact that there is
growth in IT spending, just not in the areas where IBM gets most of its
revenue.Trends in software spending clearly favor software as a service
companies like Salesforce.com (NYSE: CRM) .
Comparing IBM with Oracle The
analogy with Oracle is a strong one. Both are highly cash-generative
tech giants with cheap valuations. Both are facing some structural
challenges to their hardware offerings due to an increasing willingness
among firms to outsource technology infrastructure to the cloud. As
usage of software as a service, or SaaS, increases, hardware margins
could come under pressure for IBM and Oracle because corporations will
not need to buy hardware systems to run their on-premise on-license
software. In their defense, IBM and Oracle are trying to migrate toward
cloud-based solutions, but it's going to take time to work through the
pressures on their existing sales.
However, there is one key difference between the
two companies. IBM has set its stall out to achieve the $20 EPS target
in 2015, while Oracle has much more flexibility to adjust to changing
market conditions. It's good for IBM to laud the $8 billion it used to
make buybacks (and there is still $5.6 billion remaining in buyback
authorization), but investors surely wouldn't want the company to rack
up debt just to hit the $20 EPS target. Moreover, IBM may be using
resources that it could instead use to make strategic investments in
growth opportunities.
How the Salesforce.com deal demonstrates Oracle's flexibility IBM's
net debt stands at nearly $27 billion (14.3% of its market cap), while
Oracle has $15.2 billion (10.1% of its market cap) in net cash and
liquid instruments. Simply put, Oracle is in a better financial
position to make the kind of game-changing acquisitions that can help
accelerate SaaS-based growth.
Moreover, with its recent strategic partnership
with Salesforce.com, Oracle is demonstrating its willingness to work
with a former rival. With Oracle now integrating Salesforce.com into its
infrastructure, its mutual customers should benefit from being able to
use Oracle infrastructure to run Salesforce.com's CRM applications,
while also using Oracle's financial and HR applications. The deal should
provide synergy for both companies.
The bottom line Cost-cutting, buybacks, and
foregoing revenue growth at the expense of profit growth are noteworthy.
However, IBM is going to need a couple of solid quarters in order to
convince the market that its long-term earnings objectives aren't
affecting the way it reacts to changing market conditions. This is the
third quarter in a row in which IBM has given disappointing results, and
the company is running out of excuses.
If you favor a value-based, long-term, buy-and-hold investing
strategy, then you must have noticed how cheap some blue-chip tech
stocks are right now. The easy move is to put a bunch of them in your
portfolio and forget about them for 10 years. Unfortunately, tech
investing is rarely that easy. So what do you need to know before making
a decision?
Tech titans First up, let's look at a chart of these tech titans. I've included a mature blue-chip stock, Johnson & Johnson
by way of comparison. Enterprise value over earnings before interest,
tax, depreciation, and amortization, or EBITDA, is used, because EV --
market cap plus net debt -- is a better measure to compare companies.
Moreover, EBITDA is a good proxy for underlying cash flow.
All these companies look relatively cheap. Moreover, on a historical basis they are all a good value. In fact, Intel (NASDAQ: INTC) , Oracle (NYSE: ORCL) , and Cisco (NASDAQ: CSCO) are all trading at substantial discounts to their pre-recession valuations. Why is IBM (NYSE: IBM) the odd man out?
Adjusting early to structural shifts IBM adopted a
different strategy to the rest. It acted early to adjust to structural
changes in the economy. The sale of its PC division to Lenovo in 2004
was a key part of its transition into primarily a software and services
company.
Source: Company accounts
Consider how well Oracle's stock performed compared to Intel and Cisco over the last 10 years.
The charts demonstrate that over the last decade, goods, products,
and services have commanded higher prices based on how "smart" they are.
For example, think of the advanced electronics systems being fitted
into cars, or smartphones versus landlines. The shift is mirrored in the
outperformance of the one software and services company on the list:
Oracle. IBM also did very well, precisely because it made the transition
to selling more software and services.
Going forward, IBM's strategy is to sell its lower-margin businesses,
and increase margin expansion at the expense of revenue growth.
So while its revenues are forecast to be flat from 2012-2014, its EPS is expected to rise 20%.
Oracle now facing challenges The previous 10
years have been very good for Oracle shareholders. However, there is no
guarantee that the next 10 will be the same. The company remains a very good value play,
but it also faces its own structural challenge with its traditional
on-premise, on-license sales being threatened by cloud-based software
providers. Moreover, as cloud-based sales increase, Oracle will find it
harder to bundle its hardware solutions with its software.
Accordingly, analysts have Oracle on low-single-digit revenue growth
for the next couple of years, with only high-single-digit earnings
growth forecast. Oracle is seen as being late to the cloud party, and
its future growth depends on making the adjustment.
Intel adjust its business, Cisco tinkers Intel is
the worst performer of the four, and it's also facing some structural
challenges. It wasn't the only company caught out by the acceleration in
mobile computing at the expense of PCs. Subsequently, Intel has found
its core PC processor market to be challenged as PC sales repeatedly
disappoint, and ARM core processor designs have won out
in the mobile market. Simply put, Intel's refusal to license ARM's
architecture in a meaningful way, has hurt the company.
The good news is that Intel has invested in new processors (Bay Trail
and Haswell) that should start to penetrate the ultra-mobile market as
of this year. Intel will need to do this in order to hit guidance this year.
Cisco's challenges and opportunities are of a different sort.
It's switching and routing divisions still generate low-single-digit
growth, but it's not enough to get excited about the company. Moreover,
its services revenues growth -- services make up around 21% of total
revenues -- is really a function of how well it can sell its products
into the marketplace. The real question is how well Cisco will invest
its cash in growing its peripheral sales.
You can see the point illustrated in the following chart.
Source: Company accounts
What you need to look for Intel will become very
attractive if it can establish a strong foothold in the mobile market.
You'll want to monitor developments later this year.
Oracle needs to halt declines in its hardware sales and demonstrate
that it can shift more revenues to the cloud while retaining margins
with its traditional software. However, the stock is very cheap right
now, and even stabilizing the company to GDP-type growth should see some
good price appreciation.
IBM's story is one of ongoing margin improvements and the execution
of its plan. Look for margin expansion. Cisco is intriguing because its
sits on more than $34 billion in net cash and investments, while its
market cap is $123 billion as I write. In other words, it has the
capability to invest wisely and generate growth. Keep an eye on its
acquisition strategy.
Each of the four has its own risks and rewards, but a portfolio that contains all four isn't a bad idea for a value investor.
Oracle (NYSE: ORCL)
is one of the most tempting cash-rich plays in the market right now.
The company has an undoubtedly cheap valuation, but is it a long-term
value trap in the way that Dell or Hewlett-Packard (NYSE: HPQ)
have been over the last five years? Moreover, is its current
low-single-digit growth rate signaling the endgame of its relevance as a
growth company?
It's the cash-flow, stupid
Investing
is supposed to be easy. Take a stock like Oracle, which just generated
$14.1 billion in free cash flow over the last four
quarters--representing more than 10% of its enterprise value. In other
words, if you hold the stock for 10 years, even with no growth,
the company will have generated enough cash to buy you another Oracle
for free. Furthermore, it can return that cash flow to shareholders by
increasing its dividend, buying back stock, or increasing earnings
through acquisitions. Sound good?
And that's assuming no growth, when the reality is
that Oracle's forecast revenue growth rates for the next few years are
pretty close to nominal GDP growth.
Why this isn't a no-brainer Superficially, this isn't a hard choice to make, but the market seems to be making some harsh conclusions about Oracle:
The market does not reward tech companies if they cannot generate
growth, and you can stay waiting ages for "good value" to be realized
Corporations are favoring cloud-based software, and Oracle's
traditional on-license, on-premise software will lose sales to providers
of software as a service, or SaaS, like Salesforce.com (NYSE: CRM) . It looks set for a structural decline just like Hewlett-Packard was.
The first concern is an existential
one, and older investors would do well to remember how the mentality of
the market changed after the dot-com bubble burst. During the bubble,
traditional valuations didn't matter, but after the burst suddenly
everyone remembered value. It doesn't matter if Oracle makes database
solutions or chicken tikka sandwiches; if it can return 10% of its
valuation in cash every year then it is good value.
The second is more problematic. It's easy to look
at Salesforce's near 30% growth rates, and conclude that Oracle is being
left behind in the shift to the cloud, but the fact is that Oracle does
have growing SaaS sales. The problem is that they are not enough to
counter slow growth in its traditional software sales. In addition, the
increasing use of SaaS solutions is reducing customers' need to buy
hardware, and negatively impacting Oracle's aim of selling hardware and
software systems to them. Indeed, Oracle's hardware system revenues
(around 14% of total sales) have declined for the last two years.
Hardware revenues are forecast to drop next
quarter. Even worse, Oracle predicted that its new software license-
and cloud-subscription revenue growth (20% of revenues, and the key to
growth) would be -4%-6% in the next quarter. Game over?
It would be a mistake to jump to a negative
conclusion. First, Oracle is up against a very strong comparison from
last year's second quarter for new license and cloud subscription sales.
Source: Company accounts
In fact, the second quarter was so strong last year that there appears to have been a pull-forward effect on the third quarter.
Second, Hewlett-Packard's problems were that its
core profit centers of printers, notebooks and desktops were in decline.
Its challenge was to restructure in the face of a systematic decline
in end demand. In comparison, Oracle's customers still want software;
it's just that more of them want it from the cloud. The company has the
cash pile and cash-flow generation to make significant acquisitions of
cloud based companies (such as its purchases of Taleo and RightNow), and
it's hard not to see it doing some more in future.
Third, there is an element of geographical effect
here. New software license and cloud software subscriptions grew 7% in
constant currency for the first quarter, but they were up 14% in the
Americas. This indicates that it's not necessarily a structural issue.
Where next for Oracle?
The
market looks like it's pricing in some severe problems for Oracle in the
future, but if things don't turn out as bad as many fear, then the
stock has significant upside potential. The company needs to stabilize
its hardware revenues while demonstrating willingness to invest in
cloud-based solutions. It could also do with a quarter or two of beating
the mid-point of its software sales guidance. These are not necessarily
high hurdles to overcome, and the reward of owning the stock could be
significant. Moreover, even if Oracle's growth does graduate into a
"GDP+" type of range, the stock still represents good value.
One of the great IT bellwethers, IBM (NYSE: IBM),
issued mixed results in mid-July. It’s hard to be too critical of a
company that has just raised estimates despite increased currency
headwinds, but a deeper analysis of the company's results reveals some
underlying weakness. It’s been a difficult year for technology, and IBM’s earnings did little to raise investors' spirits.
IBM reports
The two key positives in the report came from the growth in
services backlog (7% at constant currency) and the strength in
higher-margin software sales. In order to demonstrate their impact, here
is a chart of IBM’s segmental growth. All data is sourced from company
accounts.
Growth in the second quarter was better than in the first. Moreover,
IBM’s reported revenue decline of 3% was made to look worse due to
currency headwinds of 2%. Based on its backlog, IBM forecasted that
third-quarter revenues in its global business services segment would be
up by mid-single digits, with global technology services increasing in
the low single digits.
The software segment's bounce back toward growth looked robust, and
management pointed out that its 4% reported revenue increase (5% in
constant currency) was the strongest recorded since the first quarter of
2012. IBM spoke of a very good software pipeline, and referenced good
growth in some important niches like branded middleware (up 10%) and
business analytics (11%).
To put this data into context, here is a graph (sourced from company
accounts) of the segmental revenue share and normalized pre-tax income
share.
Clearly, software is its highest-margin business, and its relative
strength in the quarter helped IBM raise gross margins to 49.7% from
48.3% last year.
With the services backlog up 7%, and higher-margin software returning
to growth in Q2, why aren’t these results as hot as they look?
Four reasons it's still tough out there
First, although software returned to growth in Q2, this was partly due to the weakness in the previous quarter. In fact, growth in the first half
was only 1.9%, which compares unfavorably to 2.6% and 11.5% in the two
previous years. Indeed, a glance at the first chart above demonstrates
that IBM is starting to lap some weaker quarters in 2012.
Second, going back to what IBM said last time around,
$400 million in software and mainframe deals were rolling in to Q2
anyway. When asked about these deals on the current conference call,
management stated that less than half closed in Q2, and, more
importantly, rollovers in higher-margin software are actually larger
going into the Q3. This all sounds good, but there is no guarantee that
rollover deals will get closed. In addition, its main rival Oracle(NYSE: ORCL) also reported some weakness in the quarter.
The third reason is that IBM’s forecast for services
revenue growth in Q3 needs to be put into context. Penciling in growth
of 5% and 2% for business services and technology services,
respectively, would give a total services revenue figure for Q3 of
around $14.9 billion. This compares favorably with the $14.4 billion
recorded last year, but rather less so against the $15.3 billion in
2011.
Finally, the macro commentary wasn’t great. America’s revenues
disappointingly declined 3%. However, the real surprise was within its
growth markets. Revenues in Brazil, India, Russia, and China, were flat
(up 1% in constant currency). In common with Oracle, IBM cited specific
weakness in Russia and China, and it expressed a cautious outlook for
its growth markets for the second half.
Key takeaways for the industry
While the tech market remains weak in 2013, there are pockets of
strength. IBM stated that its cloud revenues were up 70%; Oracle also
reported cloud-based strength. This shows a clear shift in corporate IT
spending towards the cloud and away from legacy on-license/on-premise
software.
Furthermore, the relative strength in IBM's middleware and business
analytics numbers suggests that middleware and data analytics company TIBCO Software(NASDAQ: TIBX) and interactions management provider NICE Systems(NASDAQ: NICE) could do well.
TIBCO finally seems to be sorting out its problems with its sales
force in North America. In addition, its increased focus on big data
analytics solutions, and offering its customers its service both
on-premise and via the cloud, is in line with trends in IT spending. Corporations
may be holding back on discretionary IT spending in general, but they
are still keen to invest in niche areas like social media and customer
engagement. Indeed, TIBCO cited specific strength in sectors such as
financial services and retail.
As for NICE, it has a deal with IBM to
integrate the latter’s analytics within its services. Unlike many areas
of tech spending this year, NICE has been reporting earnings that are
in line with expectations. Moreover, it is seeing strength within sales
of its advanced applications, which allow customers to analyze the data
that its systems capture. Again, this is a sign that in a slow global
economy, corporations are willing to spend on analyzing customer
interactions in order to better manage how they sell into their existing
customers.
The bottom line
In conclusion, IBM and Oracle have both reported earnings, and
neither had particularly good news for the IT spending environment.
Conditions appear to be stabilizing, but the broad-based bounceback in
demand hasn’t really happened yet.
With regards to IBM itself, the company’s story is about its ongoing
paring of lower-margin businesses, and how well it manages its shift
toward more software sales. For longer-term investors, I think the stock
will do fine. If it hits the raised adjusted diluted guidance of $16.90
in EPS for 2013, then it will trade on a forward earnings multiple of
11.4 times, as I write. This is attractive enough, but investors need to
be prepared for potential near-term volatility, because tech spending
remains weak.
The last thing the tech market needed right now was a disappointing set of earnings from Oracle (NASDAQ: ORCL),
but unfortunately that is exactly what it got. It would be an
understatement to say that it has been a difficult 2013 so far for the
tech industry and these numbers will do little to assuage many fears.
But what do they mean for Oracle and how do they relate to the rest of
the tech world?
Oracle disappoints, again
Looking back atan analysis of the previous quarter’s earnings
Oracle missed its own guidance and this quarter saw some key numbers
coming in at the low end. For example Oracle had forecast 1-4% overall
revenue growth (they came in at 2% in constant currency), new software
license and cloud subscription growth was forecast to come in with 1-11%
growth (the result was 2% growth). The one ‘bright’ spot was that
hardware systems product growth was forecast to be negative 12-22% and
came in at the high end with a negative 12%.
Clearly the numbers came in towards the bottom of the guidance
ranges. All of which is somewhat disappointing given that many investors
have been hoping for a second quarter (2Q) bounce back. Last time
around Oracle blamed some sales execution issues and the timing of the
sequester. However it calmed investors by describing its pipeline as
being up and, claimed that the issue was really about the timing and
execution of deal closure.
Well it was a different story this time around with sales execution
quoted as improving ‘significantly’ and economic weakness cited in a few
areas like Brazil, China and Australia. Moreover, transaction sizes
were described as being smaller (a sign of economic pressure).
The good news from a geographic perspective was that its US and EMEA
performance were as expected with 4% and 5% new license growth
respectively. The problem was with Asia-Pacific down 7%. This is a
worrying sign for the industry because many technology companies are
relying on Asia for growth.
What the industry is saying
As a bellwether Oracle’s results will be closely watched and those of
us hoping for some sort of confirmation of a return to better days
would have been disappointed. In a sense it is a mere continuation of
what we have been seeing elsewhere. For example, Palo Alto Networks(NYSE: PANW) recently reported results. It missed estimates and guided lower than the market consensus
for the next quarter. Although Palo Alto is in a different area (IT
security), I found its results interesting because other companies in
the sector had previously reported weakness in April. Unfortunately Palo
Alto came out and confirmed that conditions in May were only ‘in line’
with the reduced expectations created by a weak April. Another indication of weakness and it appears to be linear.
One interesting aspect of Palo Alto is that its telco service
provider revenues do not make up a significant part of its revenues.
This is in contrast with other tech companies like say F5 Networks and Fortinet.
These companies missed estimates and disappointed with guidance. Both
cited weakness in their service provider verticals and this may well
continue into the current quarter. On the other hand Palo Alto's results
are more indicative of the wider tech spending environment and
investors will need to hear some more positive noises from bellwethers
like IBM and Oracle before feeling very confident with Palo Alto.
Moreover Oracle is facing some operational challenges as
it shifts revenues towards cloud-based solutions. It described its SaaS
(software as a service) based revenues as having a $1 billion run rate.
This is fine but to put it into context its full year revenues are
closer to $37 billion. In addition some cloud-based companies like Rackspace Hosting(NYSE: RAX)
have reported some weakness as enterprises still seem keen to use any
excuse to withhold IT spending. In fact in its last quarter it declared
that its revenue per server declined to $1,308 from $1,310 last year.
This is not a good sign for a company supposed to be in a high growth
phase. In Rackspace’s case it was partly due to customers delaying purchases of legacy systems
while they appraised its new OpenStack public cloud offering. Rackspace
also has increasing competition from the likes of Amazon Web Services
(who has been cutting prices) and I take this to be another sign that
conditions have weakened in technology in 2013.
With regards to Oracle’s direct competitors like IBM(NYSE: IBM) and SAP(NYSE: SAP),
these results are obviously not great news and they got marked down in
sympathy. Moreover Larry Ellison was quite candid on his view that SAP’s
Hana database was ‘virtually never’ seen in the market and even
referenced some large German industrial companies that had bought
Oracle’s rival Exadata database machine in order to run SAP’s
applications. He also suggested that Hana could never successfully
compete with Exadata. Frankly there is no love lost between SAP and
Oracle, even when it comes to yachting,
and this sort of comment has been heard before. Moreover I think SAP’s
investors can take some heart from the fact that EMEA (its core market)
was a bit stronger than expected for Oracle.
As for IBM, Oracle’s report was a bit worrying. It pretty much
reported a similar story to Oracle last time around by blaming things
like sales execution, the sequester, the weather and even the change in
the Chinese Government. Will it do the same this time? It’s hard to tell
but IBM didn’t lower its full-year forecast last time around and
announced it would take some workflow rebalancing in Q2. All of which
will put some pressure on it to deliver in the current quarter. As for
the issue with the Chinese Government, did we see signs of this in the
weak results that Oracle just reported?
Where next for Oracle?
The positives in this report were that the transition to new hardware
product systems is going a bit better than expected and the US and
Europe are doing okay. In a sense it is another story of current macro
weakness amidst ongoing change in Oracle’s business as it shifts to
cloud based solutions and new hardware products.
In the last quarter it made sense to pick up some Oracle stock after
disappointing results and I wouldn’t be surprised if the same applies
this time too. The stock trades on an enterprise value to EBITDA
multiple of just 7.4 and generates huge amounts of cash flow that
currently represent over 10% of its enterprise value. On a value basis
the stock looks cheap and I wouldn't be surprised to see Oracle
increasing its returns to shareholders in future. It looks a good long
term hold but be prepared for volatility as the tech spending
environment still looks a little weak this year.
It’s been an unusual earnings season so far. The market has kept
moving higher even though many tech companies have warned. This can
appear counter intuitive because tech is usually seen as a cyclical part
of the economy. In other words, if tech is slowing down, then the
economy will do too. Surely, if tech companies are warning, the market
should be pricing in a slowing of growth rather than moving up in
anticipation of stronger growth?
Pricing in a recovery?
One explanation for this is that the first quarter saw a weakness in
technology spending which should be rectified in coming quarters.
Indeed, I have suggested some reasons why this might be the case in an article linked here.
If this argument is correct, then buying after the tech companies warn
should be a good tactic. The chances are that expectations will have
been lowered and the falls would have created some decent entry points.
In order to avoid the dangers of relying on anecdotal evidence and
hearsay, I decided to take a bit of a methodological approach and see if
the data supported the idea.
The companies in this graph are those that warned or gave
disappointing results in the current earnings season. They were garnered
from the NYSE Arca Tech 100 Index. I have excluded biotech and focused
on the IT hardware and software companies.
The blue lines are the stock’s performance since the day after the
warning and the green lines are how they have performed against the
S&P 500 since they warned. The data is current till April 20.
I think the evidence is pretty clear. Tech companies have tended to
outperform the market since they warned. I appreciate that part of this
effect might have been investors looking to buy stocks that looked
‘cheap’ in a rising market, but on the other hand, the evidence above is
pretty broad based.
If I am right about this, then investors should start to look at potential tech company warnings as buying opportunities.
Who said what?
It’s time to look at a few of these companies to see what the
specific issues were. This is useful because it helps us understand what
is causing this effect.
I’m going to start with Oracle and International Business Machines Oracle blamed its disappointing earnings on sales execution failures.
This is partly a consequence of adding significant numbers of new
salesmen and the inevitable disruption that this causes. In addition,
its management argued that the pipeline was still in place, it was just
that deals were not completed at the rate that they had expected. Oracle
expects these issues to be ironed out ‘quick’ and argued that it wasn’t
losing any market share.
Thinking longer term, Oracle does have question marks
over some hardware product transitions and dealing with the affects that
the shift to the cloud (Oracle still has substantive legacy software
sales) will have on its revenue.
IBM delivered a very rare miss and I took it as an opportunity to buy some more.
In a familiar refrain, it blamed sales execution but also managed to
discuss the sequester, the change of Chinese leadership, the timing of
Easter, and even the weather.
The good news is that -- just as Oracle did -- it argued that the
pipeline hadn’t been reduced and deals weren’t lost to competition. It’s
just that its sales guys just had a hard time closing deals in the
quarter. The response was to do as IBM does and make some operational
adjustments (workforce re-balancing) in the next quarter.
Citrix Systems
also saw revenue and earnings come in lighter than expected. In
addition, its Q2 earnings guidance was significantly below estimates. In
actuality, it was a mixed quarter for Citrix. Its Netscaler product (an application delivery controller that competes with F5 Networks)
saw good growth, but its core virtualization growth was disappointing.
The latter has higher margins, so the net effect was to reduce
expectations for overall margin growth in future.
It’s always worrying to see a company’s core activity slowing, but
Citrix had a feasible excuse. It launched its XenMobile mobility
solution in Q1 and it is entirely understandable if some of its
customers may have decided to hold off purchases while they assess
buying the new product. Again, Citrix outlined that its full year plans
were ‘on-track’.
The bottom line
In conclusion, all three companies saw what looks like some temporary
weakening caused by hesitation among customers rather than a reduction
in overall spending plans. Although they all had their own reasons for
disappointing, there was a common theme. All three saw their pipelines
intact but customers exhibiting caution in their spending decisions. If
this dissipates in future quarters (and it may do so after the media
stops talking about the sequester) then buying these names, and others
within technology, will prove to be a wise choice.
