By Jonathan Rudy It has been quite a week for Oracle (ORCL
; accumulate; recent price: $11), with most of the news being very positive for it. On Sept. 9, a federal judge in San Francisco ruled against the Justice Dept. by deciding not to block Oracle's $7.7 billion hostile cash bid for PeopleSoft (PSFT
; hold; $19) on antitrust concerns. This was a significant victory for Oracle as the Justice Dept. had earlier decided that this proposed acquisition was anticompetitive.
However, we at Standard & Poor's believe Oracle still faces significant hurdles to the deal. These include the European Union's antitrust review, as well as PeopleSoft's poison pill, which could make it prohibitively expensive for Oracle to make the acquisition through the substantial issuance of new PeopleSoft shares. Ellison & Co. have filed suit in Delaware to have PeopleSoft's poison pill removed. PeopleSoft has also sued Oracle for $2 billion in damages that it alleges have been caused by the latter's 15-month pursuit.
UPSIDE SURPRISE. We believe the ruling against Justice may provide a catalyst for other mergers and acquisitions in the enterprise software industry. Consolidation would be very positive for the group as a whole as this market needs to shed excess capacity to improve the supply/demand dynamics.
One of the primary issues that came out of the recent court decision is the severe discounting that occurs in this industry. Knowing this, corporate clients put more pressure on software vendors to cut prices during the second quarter of 2004, as demonstrated by PeopleSoft's disappointing results.
On Tuesday, Sept. 14, Oracle posted solid results for its first quarter of fiscal year 2005 (ending May), in contrast to the disappointing June-quarter results for many of its enterprise-software peers. Revenues rose 7%, but more important, license revenues increased 7% as well. We had some concerns that Oracle's license revenue might disappoint because of a more challenging information-technology spending environment. But results were better than expected, thanks to strong performance in Oracle's database-technology business, which increased license revenue 18% year-over-year.
PROTRACTED LEGAL BATTLE? However, Oracle's application business had another disappointing quarter, with a 36% decline in license revenue, to just $69 million. We believe the weak results here illustrate the importance for Ellison & Co. of acquiring PeopleSoft and its application business.
Still, we think Oracle has high profitability levels, with a first-quarter return on equity of 37% and an operating margin that widened to 32%, from 30% a year ago. With the outfit's approximately $9.4 billion in cash and investments, or about $1.80 per share, little debt, and the stock trading at a discount to peers on price-earnings and p-e-to-growth metrics, we believe that Oracle shares remain attractive.
Our 12-month target price for the stock is $15, based on a blend of relative p-e and p-e-to-growth metrics and our discounted cash flow analysis. Our primary concern at this point is the uncertainty surrounding the PeopleSoft tender offer -- and our belief that this protracted legal battle could drag on for quite some time, which may pressure Oracle shares.
Note: Jonathan Rudy has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed here accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com. Analyst Rudy follows software stocks for Standard & Poor's Equity Research