Oracle Earnings: Rapid Growth In Cloud Offset By Weak On-Premise Business

The declining trend in Oracle’s (NYSE:ORCL) legacy on-premise business continued in its fiscal 2016 first quarter results reported on September 16th. ^[1] The cloud business continued its strong growth, but due to its relatively small scale did not contribute significantly to the company’s overall growth. Oracle expects revenues from on-premise licenses to stabilize by the end of the year due to renewals and new contracts, but it is not expected to return to meaningful growth. On the other hand, the cloud business is expected to pick up even further in the second half of the year as the company’s sizable deferred revenues start kicking in. ^[2]

Currency headwinds continued to play a major role in the first quarter, and dragged Oracle’s revenues down by 9 percentage points. Software license and update revenues, which account for 56% of Oracle’s total revenues, contracted by 1% in the first quarter. Including new software license sales, total on-premise software revenues fell by 4% year on year. Total cloud revenues, which grew by 29% year on year, still account for just 7% of the company’s total revenues and could not offset the contraction in on-premise software revenues. Weakness in the hardware business continued as well, with revenues declining by 3% year on year. The weakness extended to the bottom line as well, as the company’s non-GAAP operating margin declined by 3 percentage points in the first quarter, compared to the same period last year.

Oracle expects cloud revenues to pick up in the second half of the year, leading to full year SaaS and PaaS revenue growth guidance of 50%. Total software revenue is guided to expand by 3% to 4% as on-premise revenues are expected to stabilize in the second half. ^[2]

Our price estimate of $42 for Oracle is about 10% higher than its current market price.

See our complete analysis for Oracle here

Benefits From Triple-Digit Bookings Growth To Start This Year

In the cloud business model, revenues from a new business model are not booked upfront. Rather, they’re booked in the balance sheet as deferred revenues. Revenues are only recognized in the Income Statement once the cloud infrastructure has been implemented and the customer begins using the services. Consequently, so far Oracle’s cloud revenues have not grown commensurate with the triple-digit growth in SaaS & PaaS bookings that it has been achieving each quarter. Fortunately for the company, this is set to change, as the bookings achieved over the last year are expected to kick in starting in the second half of this fiscal year. ^[2] Since Oracle’s SaaS and PaaS bookings have not slowed over the last year, it is likely that the elevated growth rate may continue into the next fiscal year as well.

Within the cloud division, Oracle’s infrastructure-as-a-service (IaaS) has not kept up with the SaaS and PaaS segment. Revenues from IaaS account for just a quarter of Oracle’s total cloud revenues, and are growing at a much slower pace than SaaS and PaaS revenues. Oracle also does not report IaaS bookings growth, making it difficult to determine if IaaS revenues will gain steam this year. We believe that revenues from IaaS will not benefit from past bookings just yet, since IaaS was released later than SaaS and PaaS. This view is validated by the fact that Oracle expects IaaS revenues to expand at a single digit rate in the near to medium term. ^[2]

Cloud Margins Likely To Expand

As we previously noted in the case of Salesforce (NYSE:CRM), gross margins suffer when a cloud business is in expansion mode. One reason for this is the requirement for heavy investment in data centers, which increases the cost of goods sold due to higher depreciation (while it is non-cash, it still impacts margins). That said, Oracle stated in the first quarter earnings call that a bulk of its data center investments are now largely complete, and capex for the year is likely to be lower than the previous year. ^[2]

The combination of lower capex and economies of scale are expected to lift Oracle’s SaaS and PaaS gross margin to 60% by the fourth quarter of the current fiscal year, and 80% over the next two years. ^[2] In comparison, the SaaS and PaaS gross margin was 39% in the first quarter. However, the benefit of lower capex is not likely to extend to IaaS, as the company did not expand the IaaS business as rapidly as in SaaS and PaaS. Consequently, IaaS gross margins are expected to remain largely stable over the near to medium term.

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More Trefis Research

1. Oracle Fiscal 2016 First Quarter Earnings [↩]
2. Oracle Fiscal 2016 First Quarter Earnings Call Transcript, Seeking Alpha, September 16, 2015 [↩] [↩] [↩] [↩] [↩] [↩]