Oracle misunderstood on Wall Street

One market seer believes the company deserves more credit than it gets.

By TheStockAdvisors Mar 22, 2012 12:13PM
By Paul McWilliams, Next Inning

Some company executives are very good at making it easy for Wall Street to fall in love with their companies. Some aren't. Oracle (ORCL) falls into the latter group.

As a matter of fact, there are times when I think Oracle founder Larry Ellison goes out of his way to make it hard for Wall Street to even like his company. This, more than anything else, is why I think the price of ORCL is failing to respond to a very strong quarterly report and optimistic outlook.

Oracle reported non-GAAP earnings of $0.62 versus the $0.56 consensus, and guided for fiscal fourth quarter 2012 (ending May 2012) non-GAAP earnings in the range of $0.76 to $0.81. This compares favorably with the $0.76 consensus, as well as with the $0.75 ORCL reported for the same quarter last year.

However, in spite of these results and stronger than expected guidance, the price of ORCL is currently below $30, which is down slightly from Wednesday's close.

As I see it, Wall Street simply doesn't understand Oracle and its strategy -- particularly as it applies to the coupling of hardware and software.

There are cases where specialized data center hardware make sense -- and there are cases where it doesn't. In Oracle's back office environment, it makes sense if there are advantages to leverage.

While there is certainly room to debate this, I think the computer technology company will successfully leverage its acquisition of Sun Microsystems and realize these advantages. With this, I think it will further distance itself from the pack.

Wall Street continues to grouse about less-than-inspiring hardware revenue at the tech giant. In my opinion, this is a myopic view of the situation. Oracle didn't buy Sun to enter the hardware business per se; it bought Sun because Sun's core technology would provide Oracle with what it needed to develop solutions that fully optimized back office operations running its software.

In my view, there are three factors that have led to less-than-inspiring revenue results for Oracle's hardware initiative:
  1. The company has been divorcing itself from the commodity businesses Sun had when it was acquired.
  2. It has been redesigning the core Sun systems to optimize them for its purpose-built applications.
  3. This is a big ship to turn around, and once it is turned it takes time to build traction and momentum with the new complete solution strategy.
I think all three of these factors will come together during fiscal 2013 and, if I'm right, Wall Street will raise the valuation multiple it is willing to give ORCL's stock from the current 10.7 times forward earnings plus my estimated balance sheet value.

Bottom Line: Oracle closed the February-ending quarter with net current assets worth $1.25 per fully diluted share. If we credit back deferred revenue liabilities worth $1.24 per fully diluted share, the estimated balance sheet value is $2.49.

While I believe the current non-GAAP fiscal 2013 (ending May 2013) earnings consensus of $2.59 will prove to be 10% too low, in an effort to keep my projections at what I believe to be a conservative level, I'm using the consensus in my valuation model.

If we couple these metrics with a range of valuation multiples running from 12 to 14, the resulting three- to six-month target range for ORCL runs from $33.21 to $38.33.

Personally, I think ORCL should be valued at 13 to 15 times forward earnings, which would boost the target range to run from $35.77 to $40.89.

However, I think it will take longer than six months (if it ever happens at all) for Wall Street to cozy up that tightly to the prickly Ellison. Due to this, I'm sticking with my more conservative 12 to 14 multiple range for now.

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