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Oracle: Now for the Hard Part

To hear tell from Oracle (ORCL) higher-ups, there was a lot to be happy about in the software giant's second-quarter results. Excluding costs mostly related to the multibillion-dollar acquisition of PeopleSoft, earnings met Wall Street expectations. Chief Executive Larry Ellison crowed that his outfit was ahead of a plan to increase profit by 20% a year for five years, and Oracle beat analysts' predictions in sales of applications, the programs that handle business tasks.

The good news didn't end there. Software subscriptions were up 36%, now making up more than 48% of total sales. That's important because software subscriptions are more profitable than one-time purchases and they're a sign that customers inherited from PeopleSoft are sticking with Oracle.

Indeed, PeopleSoft subscriber renewal rates are higher now than they were before the acquisition, Oracle President and Chief Financial Officer Safra Catz told reporters after the results were released on Dec. 15. Customers "have gotten comfortable with what it means to be a part of Oracle," she said. Ellison, in a statement, was more succinct. "They're happy," he said of PeopleSoft customers. "We're happy."

CALMER CUSTOMERS. So how come investors aren't happy? The stock dropped 3.5%, to $12.38, in extended trading, after the results were released. For some shareholders, the jury's still out on whether the yearlong $20 billion acquisition bonanza was money well spent. Many of the newly acquired applications won't be knit together, in a Herculean undertaking dubbed Project Fusion, for another year at least.

Oracle has used swift and savvy outreach to reassure once-spooked PeopleSoft and JD Edwards customers that they won't have to upgrade or change software until they're good and ready -- an effort reflected in the customer-retention numbers. Analysts say most are waiting for the outcome of the Fusion exercise.

But that won't start translating into new license sales until at least 2007. In the meantime, analysts like John Rizzuto of Lazard Capital Markets question what will drive growth and the stock in 2006 -- especially since Oracle's core database business has disappointed Wall Street in the last two quarters: growing just 1% in the first quarter and 5% last quarter.

Oracle's Revenues came in at $792 million, lower than the $814 million investors had hoped for. The outlook for database sales won't brighten much in the current quarter either, judging from management's guidance.

SAP'S SURGE. What's more, third-quarter earnings will come in at 19 cents a share, a penny short of analysts' forecasts. "It's going to be a very challenging year for the company," Rizzuto says, pointing to accelerating competition from German software colossus SAP AG (SAP). "Right now, SAP has a better message and better technology. Oracle has the right message and right strategy, but it won't come about until 2007 by their own timetable." Others feel the same way. Over the last year, Oracle's market value has fallen 6% or $5 billion.

SAP is wasting no time capitalizing on the uncertainty (see BW 10/24/05, "SAP's End Run Around Oracle"). It not-so-coincidentally announced a customer steal from Oracle on the same day Oracle announced results. Bill McDermott, CEO of SAP America, says the German company is winning more deals against Oracle, despite the more outfits that company acquires.

He points out that while Oracle's application business was up more than 80% in terms of new licenses in the first quarter, if you compared results to combined revenues from Oracle, PeopleSoft, and JD Edwards before they became one entity, revenues actually fell 48%. "Customers who aren't switching to us are taking a wait-and-see approach," McDermott says.

STILL SHOPPING? Even Oracle boosters agree there's a lot of heavy lifting yet to be done in 2006, despite management's assurances that its acquisition-integration has gone smoother than expected. The Siebel deal hasn't closed yet, as Oracle awaits European regulatory approval (see BW Online 9/12/05, "Now, Oracle May Finally Rest").

On the development side, there are upgrades to almost all of the major applications suites coming out, in addition to the work going on with Fusion. All the while, the company needs to continue its customer outreach.

And neither Ellison nor Catz indicated the acquisition spree was over. "The industry is consolidating and we're going to be a consolidator," she says, adding that while she is focused on Siebel right now, the company is still looking for deals that make sense. More than likely, candidates would include smaller companies that specialize in specific areas, similar to Oracle's deals with Retek in retail and iFlex in banking (see BW Online 11/17/05, "Oracle Keeps on Making Deals").

GREATER FLEXIBILITY. A key metric to watch in 2006 could be sales of Oracle's Fusion Middleware, its new application server that has been gaining market share against competitors like BEA Systems (BEAS) and IBM (IBM). This infrastructure software is the technical backbone to the Fusion line of applications, which will knit together everything Oracle has bought, with the company promising greater flexibility than past application suites.

If customers are buying Fusion Middleware, it may be a sign that they are also buying Oracle's application vision. For Oracle's sake, that had better be the case. There's $20 billion riding on it.

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