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Why Oracle's investors got the shivers

March 25, 2006 07:16 IST

Oracle is developing something of a pattern. The big U.S. software maker reports earnings that on the surface look impressive. But when analysts and investors get a closer look, they're less than enthused. That was the case on March 20, when Oracle chief executive Larry Ellison unveiled fiscal third-quarter results.

There was a lot to crow about. Earnings for the period exceeded Wall Street expectations by a penny. Oracle posted a larger-than-expected surge in sales of applications, the software that helps companies manage everything from accounting to human resources. And executives boasted about stealing market share from rivals SAP, BEA Systems, and IBM.

Over the top

Even Siebel, the company bought by Oracle last year, more than pulled its weight. Siebel posted more than $22 million in software-license sales for the one-month period it was owned by Oracle in the quarter. Analysts were expecting only $10 million.

"The Siebel deal pushed us over the top in many accounts in terms of being the strategic application supplier," Oracle president Charles Phillips said during a conference call after the results were released.

Yet, investors pushed Oracle stock in the other direction. In extended trading, the share price slumped about 3%, to $13.28, remaining stuck in the $11-$14 range -- where the stock has been lodged for most of the past four years.

Why the disappointment? Skeptics have two main concerns over Oracle these days. One focuses on its ability to integrate some $18 billion worth of company purchases. The other questions how swiftly Oracle can grow its business in databases, which help corporations manage ever-increasing volumes of computerized information. This business accounts for three-quarters of company revenue. Neither doubt was fully assuaged this go-round.

Rival's maneuvers

The applications business grew 77%. But a lot of that growth came from purchased companies. The year-earlier period included only two months of PeopleSoft and no Siebel or Retek. And the applications business is even less impressive when compared with the comparable period in 2004, when all the companies were operating independently.

Then, the companies including Oracle notched $297 million in application sales, according to research by Pat Walravens of JMP Securities. Oracle's third-quarter application revenue of $269 million doesn't look quite so hot, some argue.

Oracle says that's not a fair comparison, in part because so much time has passed and because the companies' reporting periods don't all line up. That didn't stop SAP, Oracle's bigger software-making rival, from trying to play up the uncertainty.

As is its wont, the German company sent out a press release hours before Oracle's earnings were announced, claiming that some 200 customers have switched to SAP from Oracle or its acquired companies in the past year --

including Waste Management, Jones Apparel Group, and Swiss Army Brands.

Oracle president and chief financial officer Safra Catz countered that the company's renewal rate was high and that its applications growth was triple SAP's. "If anyone would be taking market share it would be us," Catz said on a conference call with reporters.

Long wait?

But SAP may nonetheless have a point: the company is growing off a much larger base, and without any acquisitions, it still grew 18% last year. It's expected to grow at the same rate this year. Excluding PeopleSoft, J.D. Edwards, and other acquisitions, Oracle's original application business grew just over 30% -- from a much smaller base.

"I look at SAP's software revenue numbers and Oracle's, and there's no comparison," says Bruce Richardson, analyst at AMR Research. "If I'm (SAP's CEO of the Americas) Bill McDermott, I'm not losing any sleep tonight."

It may take several more quarters to see just how strong Oracle can become in applications. Even analysts who think the acquisition strategy is sound, such as Lazard Capital Markets' John Rizzuto, don't expect it to impact the stock for another year or more as the company works on the complicated task of knitting together the various strands of acquired software in a process dubbed 'Fusion'.

But that's no excuse for what's ailing the database business. For a third straight quarter, database revenue disappointed, climbing only 4%. Ellison said again on the conference call that database revenues will grow in low double digits for the next few years.

No room to slip

He cited new innovations, such as Oracle's Enterprise Search, a database that can quickly scan all of a company's software to index any invoice, memo, or meeting that occurred with a given customer. "The database market is largely based on innovation, and those innovations are largely based on us," Ellison said.

Oracle blamed unfavorable European currency issues for the weak database showing, saying it would have been 9% otherwise. But even that is lower than the 12% expected by analysts like Kash Rangan of Merrill Lynch -- not to mention lower than the low double digits that Ellison has told investors the company can deliver.

While Oracle's database business isn't going to be its biggest growth driver going forward, it's crucial that Oracle continues to maintain its market dominance if its overall strategy is going to work.

Soup to nuts

Oracle's shopping spree wasn't just about becoming the no. 2 player in applications, with an eye to overtaking SAP. It's also about becoming the most important software company for every business. While IBM is a threat on databases and other infrastructure software, it lacks applications.

Likewise, SAP dominates applications, but lacks a database business. Oracle is trying to build a range of products unmatched by any competitor, except perhaps Microsoft -- though it traditionally caters to smaller companies.

And core to that strategy is the database business. That's the one area in which Oracle is the undisputed leader, and is its position of strength. Until those numbers start trending up, investors will rightfully be worried.

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Sarah Lacy, BusinessWeek