5 Things To Watch When Oracle Reports On Thursday

Oracle is expected to report earnings of $0.58 per share on $8.73 billion in revenue. This would represent EPS growth of 9.4% year-over-year, up $0.05 from Q1 '16. However, taking into account the Q1 EPS results of past years—$0.56, $0.69, and $0.53 for '14, '15, and '16 respectively—during which Oracle grew a paltry 3.5% since '14, yearly growth of 9.4% appears to be less of an accomplishment than that number alone might project.

Oracle's software business—its essential bread and butter, generated $26.1 billion, or 78% of Oracle's total revenues for the last fiscal year. License updates in particular are the serious money maker for the company, with $18.8 billion coming in from updates and support fees. Even with support and upgrade costs of $1.14 billion, plus taking into account Research and Development costs of $5.7 billion (which includes all R&D costs, not just software), profit margins on licenses, estimated to be around 90% , remain hefty.

Unfortunately, Oracle has been struggling to sign up new customers. Their core software competitors are IBM (NYSE:IBM) and SAP (NYSE:SAP); in the cloud, competition comes from Salesforce.com (NYSE:CRM) and Microsoft (NASDAQ:MSFT). Clearly, this hurts both short-term as well as longer-term profits. Revenues for new software licenses are down 15% on the year. Worse, this metric has been down eight quarters in a row year-over-year. Both these numbers are huge red flags, given that software is currently the core business segment of the company.

Hardware sales and revenue have also taken a hit lately. This segment will likely relinquish its position as the second largest corporate division behind software, possibly as soon as today's report. This segment subdivides into hardware products such as physical servers, external physical storage and networking equipment, along with hardware support. Right now, hardware products are to blame for most of the loss. Revenues are down 13% this year, after reporting 5% losses in the previous year.

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Obviously, shrinking revenues from hardware support logically follows, since the fewer products sold, the lower the demand for support. Overall, the hardware segment is down 10% for fiscal '16, and after six straight quarters of revenue declines, there's no guarantee this business line will stabilize, let alone reverse to profitability. Plus, customers have been showing a clear and growing preference for cloud solutions over physical servers and storage, negatively impacting Oracle's current—and future—hardware sales.

Oracle's end-of-the-2016-fiscal-year report heralded the impressive growth of its cloud software as a services (SAAS) and cloud platform as a service (PAAS) segments, which together brought in $690 million in revenues, up an impressive 66% year-over-year. Growth in that sector picked up significantly in Q3 and continued to build in Q4. The company expects growth of approximately 75-80% in the coming quarter.

While this augers well for Oracle long term, there is still a hurdle to be overcome. This segment represents about $2.2 billion in revenues for Oracle, or just under 6% of its total annual revenue of $37 billion. The company will need to aggressively continue growing its cloud based services and platform, in order to quickly offset stagnation and losses in its two other, much larger segments.

Cloud computing giant Amazon (NASDAQ:AMZN) and the more service and platform oriented Salesforce are way ahead of Oracle in this segment. Though the cloud market continues to grow, which means that Oracle will continue to see growth from this segment, the company has a lot of catching up to do in order to capture significant market share.

Oracle is a serial acquirer. Thus far in 2016 it has already bought six companies, keeping pace with its average of seven companies purchased every year for the past five years. It is currently attempting to acquire publicly-traded, cloud-software provider NetSuite (NYSE:N), with the goal of bolstering its own cloud environment offering. The deal is reported to be worth $9.3 billion,ORCL's most expensive acquisition since it bought PeopleSoft in 2005.

The deal however, which is considered necessary to continue the strong growth of Oracle's cloud segment, is running into some trouble. T. Rowe Price, the largest NetSuite shareholder (with a 17% stake) after Oracle Chairman Larry Ellison—who, through various family owned entities has a 40% stake—has notified NetSuite that they will oppose the deal for a number of reasons including undervaluation of the company and conflicts of interest between NetSuite, Ellison and Oracle.

Other major institutional shareholders, such as Capital World Investors and the Vanguard Group, haven't publicly commented on the deal. Ultimately, the acquisition is likely to happen, though Oracle might have to sweeten its offer to more than $109 per share, its current proposal, in order to soften T. Rowe Price's stance.

Conclusion

Last quarter, the press release that preceded the company's financial statement was two pages long. The word "cloud" appeared 10 times within the copy. The word "software" only appeared alongside "cloud", but never on its own. The words "hardware" and "licenses" were noticeably missing.

Oracle seems to be blatantly signaling to investors, "don't look at our core business right now. You won't like what you see."

In truth, Oracle is currently attempting a massive transition away from its core business, on a scale that’s rare for giant multinational companies to even attempt. IBM is further along with this type of transition, but it's too early to tell if they'll succeed.

As for Oracle's stock, it's been rangebound at around $40 for the past two and a half years. In our opinion, that price point is too generous, considering that the company's net income fell by 18% over the past two fiscal years. If you're looking to invest in a safe, steady company, with a clear path to growth, Oracle isn't it.

Once Oracle's share price better reflects its growth prospects and net income—either if the price drops or if the company resumes net income growth—we might reconsider.

Written By: Investing.com