Case Study on the Valuation of Oracle
In 2019, Oracle saw another year of increased competition as more of the large tech players in the United States tried to move their way into cloud-based data management systems. Still, Oracle was named the 2nd largest software company in 2019, behind Microsoft, and continues to push forward with its advancements in cloud-based applications and storage for its number of clients. Unlike Microsoft, which has a large number of different segments bringing in revenue, Oracle primarily brings in revenue from one main segment with two other segments providing a comparatively small portion of the company’s revenue.
Their largest segment by far is their Cloud and License Business which makes up 83% of revenue and is the primary driver behind the software giant. Through this segment Oracle offers a range of products used to help companies manage their day to day operations for things such as invoicing, inventory, accounting, and other essential areas of business. For many years they have offered their products through license arrangements with their customers but are moving more towards a cloud based subscription agreement, also known as a SaaS model, which has helped them increase both their revenue and operating margins.
The other two segments of Oracle consist of their Hardware business which offers necessary hardware such as servers and storage, but makes up just 9% of the company’s total revenue, and their Services segment, which consists of customer support they offer to users of their products for an additional fee. Because such a large portion of the customers that buy their products also sign up for the additional customer support, the revenue brought in by the Services segment is directly correlated to their Cloud and License Business segment.
In 2019, Oracle had total revenues of $39 billion with an operating income of $13 billion, leaving them with an operating margin of 33%, most of which comes from their Cloud Services and License segment which ended 2019 with an operating margin of 66%.
The low capital required to run software companies like Oracle makes their cost of sales comparatively low in relation to most other businesses and allows them to allocate a large portion of their earnings to both marketing and innovation. In 2019, Oracle spent 21% of their total revenue on Sales and Marketing expenses ($8.5 billion) and over 15% of their revenue on research and development ($6 billion).
While it is likely that Oracle will be able to continue earning high returns on their capital, there is little chance that it will be able to earn a similar rate on any incremental capital that is deployed into the business. Another important factor that has the potential to damage the high returns that these technology companies are earning is the increased level of competition in the technology sector, specifically from Microsoft, Amazon, and Google who are all competing for similar business and as history has shown such competition often leads to lower margins.
However, Oracle still holds a strong competitive position in the Cloud-based industry and it is our opinion that they will maintain such a position many years into the future.
As discussed above, a large percentage of Oracle’s revenue comes from their Cloud Services and Licenses business, which makes defining the key variables of this business rather easy. The more dependent corporations are on their Oracle’s products and services in order to run their business the stronger Oracle’s competitive advantage will be over time and the more they will be worth.
Over the past 3 years, Oracle has reported operating earnings of $13.5 billion, $13.2 billion, and $12.9 billion, in 2019, 2018, and 2017 respectively. If we estimate that Oracle will be able to grow their earnings at a rate of 5% per year for the foreseeable future and maintain an adequate level of earnings thereafter, an investor may very well arrive at a valuation for Oracle of roughly $300 billion or $95 per share. However, one should still question when there they would be able to maintain such a growth rate for an extended period of time and what the competitive landscape will look like for Oracle in the coming years.
This valuation is of course based on a number of variables taken into account in any valuation done by Olympus and explained in an article titled “Guide to Olympus Insights” in which we explain the process taken in analyzing a company establishing our valuation.
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Please note: Olympus Wealth Management is a Tulsa based investment fund which may or may not own holdings in Oracle and readers should not take the above statements as a recommendation to buy or sell Oracle stock but instead as an informative article meant to increase one’s knowledge of the company.