The Tycoon Report

Oracle has dropped BILLIONS of dollars this year on aggressive acquisitions. Was it worth it?

Belated Happy Turkey Day folks! I, for one, definitely enjoyed this Thanksgiving. Good friends, good wine, and most importantly . . . GOOD FOOD. 

I ate so much I felt like . . . like…Oracle Corp! That’s right, I felt like Oracle must be feeling . . .downright bloated! Here is a company that is one of the most highly profitable and most recognizable names in the software business. It earns fantastic margins, high returns on invested capital and has a strong brand image. 

So why then does Larry Ellison feel it necessary to shell out billions of dollars, every eight months or so, on other software companies? Well, let me attempt an explanation . . . or possibly an excuse. Oracle’s cash cow is obviously its database business. As of now, it accounts for well over 70% of total revenues and provides the majority of its growth and profits.

However, this area of its business is extremely vulnerable. Right now, companies like Microsoft are doing their best to steal market share and have slowly been chipping away at Oracle’s chokehold on the industry. Commercial enterprises like Microsoft aside, Oracle faces an even greater threat from the open source community with products like Apache…which are totally free! 

Also, databases are backend software . . . meaning nobody really cares, and most of the time (IT employees aside,) people don’t even know what database system they’re using. As long as it works, most people are content. 

This is why Oracle has to begin to diversify its revenue streams. To do this, Oracle wants to get into the Enterprise Application industry. This space is currently dominated by SAP AG, a German company that commands similar sales and profits to Oracle BUT holds almost 70% of that market! Roughly translated, SAP is a more valuable business . . . it commands more brand loyalty. This will make it easier to push other products through existing sales channels. 

When I think about brand loyalty, I like to think about walking into my local convenience store. Here in New York there is usually one of these on every block. I typically go to the store that’s closest to my place, but if I knew that store didn’t carry my Gillette razors, I would have no problem walking the extra block to the convenience store that did have them. That, my friends, is brand loyalty and is the difference between a franchise business and a commodity business. 

Oracle is in danger of having its database become a commodity product in the coming years, and it’s scared! Maybe this is why it has bucked up almost $20 billion this year on acquisitions alone . . . On companies like PeopleSoft ($10 billion), Retek ($600 million) and most recently, Siebel Systems ($5.9 billion). 

After a quick glance at the financial statements of some of these companies, you can tell Oracle overpaid. It actually paid double Retek’s market cap at the time the bids started . . . most likely because SAP was bidding for the company as well. 

Overpaying for an acquisition, sometimes, isn’t overpaying at all. This is ONLY if the purchase considerably strengthens or defends your competitive position. However, early results from the hostile takeover of PeopleSoft were not encouraging. It actually showed that Oracle and PeopleSoft sold more licenses alone than they did as a combined entity! 

Oracle isn’t the first company to try to make a run at SAP’s market. In the mid 90’s, a company by the name of Baan made a number of high profile acquisitions in this space. A lot of money and an accounting scandal later, Bann no longer exists and SAP is still chugging along. 

Maybe Mr. Ellison should take some of his own advice. He once said that a sign of a struggling software company was one that started writing checks instead of software. I have to say, I hope Oracle’s next version of its database system is written as well as the checks it’s been writing.

Until then I would avoid buying the stock. If I owned Oracle shares I would consider writing calls to generate income against the position. While many don't offer much of a premium I can't imagine a reason why the shares would trade higher in the short-term.