Even Oracle Isn't Immune to the Slowdown

A disappointing third quarter highlights the software giant's vulnerability to the ripple effects a sluggish economy is having on IT

Tech investors looking for a stock haven amid roiling markets of late have turned to industry consolidator Oracle. Shares of the software company rose nearly 14% over a three-week span in March as investors bet on Oracle's formidable lead in database software and its aggressive acquisition strategy in business applications as an antidote to the economic malaise that's throttling IT budgets.

Some of those shareholders reconsidered their strategy on Mar. 26 after Oracle (ORCL) released fiscal third-quarter results that fell short of analysts' forecasts. Oracle reported sales of new business application software licenses, a barometer of future revenue, that were about $100 million less than Wall Street expected.

Total sales fell $70 million short of expectations in the period that ended Feb. 29, and Oracle shares fell in extended trading. "Our checks suggested [the results] were going to be pretty solid all around, so we're surprised by this," says Jeff Gaggin, an enterprise software analyst at Avian Securities.

Ellison Looks Ahead

Oracle executives attributed the shortfall to customers who are taking longer to sign off on IT purchases as the economy slows. "Deals are getting done, although they took a bit longer than expected in the last few days of the quarter," Safra Catz, Oracle's co-president and chief financial officer, said during a conference call with investors to discuss the results. Oracle Chief Executive Larry Ellison added that the company faced a difficult comparison with the year-earlier period, when new application license sales rose 57%. Ellison predicted a rebound in the business during the current quarter, which ends in May.

But for now, it's apparent Oracle isn't immune to the slump that's causing some corporations to curtail IT spending, darkening the outlook for a host of tech bellwethers, from Cisco Systems (CSCO), to Intel (INTC), to Dell (DELL). Dell's profits fell by 6.5% in its fourth quarter ended Feb. 1, as financial services companies slowed spending, Intel said on Mar. 3 it expects lower first-quarter profit margins on weaker flash memory prices, and Cisco on Feb. 6 issued a disappointing sales forecast for its third quarter (BusinessWeek.com, 2/8/08), which ended in April.

At Oracle, third-quarter application license revenue increased a mere 6.6%, to $451 million, far short of Wall Street's expectations for 30% growth, to $553 million. Oracle, the dominant supplier of database software, is counting on rapid growth in business applications, which companies use to manage payrolls, chart financial performance, and keep track of inventory levels, to expand in size and take market share from rival SAP (SAP). Oracle has bought about 40 software companies for more than $25 billion in a little more than three years to gain share in the market.

A Fine Ride for Shares

Despite the disappointing third-quarter growth, analysts say Oracle is still well positioned for the future. "Given the environment we're in, it was a decent quarter," says Andy Miedler, a senior technology analyst at Edward Jones. "Make no mistake about it—Oracle, and technology in general, is an economically sensitive area," he adds. "Customers are prudently being more cautious. You'd expect deals will take a little longer to close than they would just a few months ago."

Total revenue rose 21%, to $5.35 billion, in the third quarter, compared with $4.41 billion a year ago. Net income rose nearly 30%, to $1.34 billion, compared with $1.03 billion. On a per-share basis, Oracle earned 26¢, or 30¢ excluding special items, in line with analysts' estimates. But Oracle's revenues fell short of the $5.42 billion expected by analysts surveyed by Thomson Financial (TOC). Operating margins increased to 41%, vs. 39% a year ago.

For most of March, Oracle shares have been on an upward ride. During the three-week period between Mar. 5 and Mar. 26, the shares rose 13.56%, handily outperforming the Nasdaq Composite Index as well as large-cap tech stocks such as Microsoft (MSFT), IBM (IBM), Cisco, and SAP. Oracle shares closed Mar. 26 down 14¢, or 0.7%, at $20.94, and had fallen by more than 8% in after-hours trading.

Oracle forecast results for the quarter ending May 31 that were in line with analysts' estimates. The company said it expects new software license revenues to increase by 10% to 20%, including applications, databases, and middleware. It expects to earn 37¢ or 38¢ per share, compared with 31¢ a year earlier.

Cautious optimism

Moreover, Oracle's flagship database business continues to steam ahead. New license sales for database and middleware software grew 20% in the third quarter, to $1.17 billion, and the company signed database contracts with customers including RealNetworks (RNWK), Salesforce.com (CRM), and Omni Hotels. As Oracle continues to acquire companies, it's positioned itself as a supplier of more of the software its customers use to run their operations.

Oracle added to its middleware portfolio when it bought BEA Systems (BusinessWeek.com, 1/17/08) on Jan. 16 for $8.5 billion after a protracted takeover negotiation. The deal is expected to close during the current quarter. The same day, Oracle acquired document management software maker Captovation for an undisclosed amount.

The net result is that Oracle has a broader palette of products to sell to its customers, which results in sales reps being able to close deals for more products with each customer, UBS (UBS) software analyst Heather Bellini said in a Mar. 6 research report. In a Mar. 26 note she called Oracle's third-quarter application license sales "clearly disappointing," however.

During the company's conference call, Oracle's executives sought to reassure investors that the scope of its third-quarter troubles were limited. "We've been through this before, and we know how to adjust to it," said Oracle Co-President Charles Phillips. The argument is finding some takers. "In a big global economic downturn, should that occur, these guys are well positioned to weather that storm," says Avian Securities' Gaggin.

In the short term, though, investors who have turned to Oracle as a harbor could find the waves a bit rough.