How Has Oracle’s Server Division Fared Since Its Acquisition Of Sun Microsystems?

In January 2010, software developer Oracle Corp. (NYSE:ORCL) completed its acquisition of Sun Microsystems for approximately $7.3 billion. With the acquisition, Oracle entered the enterprise server and storage hardware businesses to compete with IBM (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ). However, revenues from the division have been steadily declining since the completion of this acquisition for Oracle. Prior to the acquisition, Sun Microsystems reported revenues of $12 billion and $9 billion in calendar years 2008 and 2009 from the sale and service of its hardware products. Post acquisition, Oracle reported revenues of about $7 billion, $6 billion and $5 billion in CY2011, CY2012 and CY2013.

In this note, we look at various trends within the global server shipment industry and Oracle’s hardware business in detail. Our price estimate for Oracle stands at $44, indicating a premium of 16% over its current market price.

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A Look At The Global Server Hardware Market

Hewlett Packard, IBM and Dell continue to remain leaders in the server market globally, with double digit market shares. HP overtook IBM in market share during Q1CY13 as sales in its Divisional, Departmental and Workgroup servers picked up. HP’s ProLiant brand continues to remain a strong driver for the company’s Enterprise division. According to Gartner, HP had a revenue market share of 27.6% while IBM and Dell had market shares of 22.9% and 16.4% respectively as of September 30, 2013. ^[1]

However, smaller players such as Cisco (NASDAQ:CSCO) and Huawei have seen strong growth in their server shipments and subsequently, server revenues in recent times. Both Cisco and Huawei have focused their offerings around the blade server form-factor that has resonated well with their customers. ^[1] On a year-on-year basis, Cisco posted a 43% growth in revenues from shipping servers in its third quarter. Revenues for Cisco reached $600 million in Q3CY13 from $420 million in Q3CY12, crossing Oracle’s Q3CY13 revenues of about $500 million. ^[1] This resulted in a jump in market share for the company, from 3.3% in Q3CY12 to 4.9% by September 30, 2013. Similarly, Huawei posted a year-on-year growth of over 200% in its server shipments in the third quarter to 69,573 units.

Various industry trends such as preference to blade servers over rack servers, lower demand for x86 servers, and decline in shipments of high-performance RISC/Itanium servers have contributed to a weak performance in the global server shipment market. Blade servers have a larger storage capacity over rack servers, indicating a growing need for servers with higher storage capabilities. However, high-performance servers continue to lag the global server market, underpinning the weakness in the global IT environment.

Why Is Oracle Losing Market Share?

Oracle entered the fiercely competed hardware business to provide holistic engineered solutions that club its software offerings with its own hardware. These kinds of vertically integrated solutions provide greater compatibility between hardware and software, improving processing rates and performance, and help Oracle compete with the likes of market leaders IBM and HP. However, vertical integration needs a complete overhaul of older legacy Sun servers that run on Unix-based operating systems. After the acquisition of Sun, Oracle shutdown the OpenSolaris project and converted Solaris into a proprietary software in a bid to migrate customers from the UNIX-based Solaris operating system to Sun’s RISC (Reduced instruction set computing) architecture model called SPARC.

However, weakness in the global server market led to decline in RISC server shipments due to their higher price points. According to Gartner, x86 server shipments registered weak growth of 2.1% while high-performance RISC/Itanium servers registered a 4.5% decline in shipments on a year-on-year basis. ^[1] Consistent decrease in revenues from the hardware division is a result of Oracle’s shift in focus from the low-priced x86 servers to the higher priced SPARC servers. While this shift resulted in a higher average pricing for Oracle’s servers, the number of shipments continued to drop for the company from this shift. This decrease in shipments contributed to the decline in revenues despite a higher average price per server.

Data Center Growth Should Drive High-End Server Demand

Despite this fall in revenues from the hardware division, Oracle has stuck to its strategy of replacing older legacy Sun servers running on an x86 architecture with faster and high-margin SPARC servers and Oracle’s Engineered systems. In its Q2FY14 earnings call, Oracle reported double digit growth in bookings for its Engineered systems’ division, with triple digit growth in revenues from the high-end SPARC SuperCluster line of servers. ^[2] Strong demand for high-end servers arises from the growing need for faster provisioning of services. Globally, colocation hosting services are expected to cross $43 billion by 2018, from approximately $25.7 billion in 2013. ^[3]

Although a recovery in Oracle’s hardware business is not to be seen in the short-term, Oracle stands to benefit richly from its shift from low-priced x86 servers to SPARC servers and Engineered systems as a result of the rise in data centers in the future.

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1. Gartner Says Worldwide Server Shipments Grew 1.9 Percent, While Revenue Decreased 2.1 Percent in the Third Quarter of 2013, Gartner Press Release, December 2013 [↩] [↩] [↩] [↩]
2. Oracle’s CEO Discusses F2Q 2014 Results – Earnings Call Transcript, Seeking Alpha, December 2013 [↩]
3. Global colocation market to exceed $43 billion in 2018, Internap, October 2013 [↩]