Oracle's hardware slip: Don't panic

Shares tank after the company reports a decline in hardware revenue, but analysts say the worry is overblown. With video on Oracle's quarterly financial results.

By TheStreet Staff Jun 24, 2011 12:38PM

By James Rogers, TheStreet

 

Investors bugged by Oracle's (ORCL)fourth-quarter hardware numbers should rest easy, as the database giant's falling hardware revenue is just a small part of a bigger, positive picture.

 

Oracle shares tanked after the results, released after market close Thursday. Investors reacted negatively to the decrease in hardware systems revenue, which dipped 6% to $1.2 billion. Oracle's overall revenue, however, climbed 12% to $10.8 billion.

 

The hardware number "spooks investors, but I believe they're reaching the wrong conclusion," Richard Davis, an analyst at Canaccord Genuity, wrote in an email to TheStreet.

 

"We do not want to overreact to trends in a business representing 10% of Oracle's revenue mix," Karl Keirstead, an analyst at BMO Capital Markets, said in a note released Friday. "The other 90% of Oracle is performing well."

 

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Closer inspection also revealed some positive numbers within Oracle's hardware business, which relies heavily on technology acquired last year from Sun Microsystems. For one thing, Oracle pushed its hardware gross margin up to 56% from 46% in the prior year's quarter.

 

Oracle CFO Safra Catz explained on Thursday's conference call that the company runs the former Sun business on a much more profit-focused model. Compared with the fourth-quarter of last year, she said, Oracle has made a big move away from selling products at a loss or reselling other companies' products, like storage gear from Hitachi.

 

While this clearly affected fourth-quarter hardware revenue, Oracle's endgame is to boost profits by placing technology acquired from Sun -- as opposed to third parties -- at the heart of its strategy. "Later this year, I expect the growth of the Sun hardware products to become quite obvious," Catz said.

 

The tech giant also lauded the performance of its Exadata database system, which was once based on HP (HPQ) gear, but it's now running via Sun. Oracle president Mark Hurd explained that there are now more than 1,000 Exadata devices installed around the world. The company's goal is to triple that number during fiscal 2012, he said.

 

Investors should take a long-term view of Oracle's attempts to establish a hardware presence, according to Brad Zelnick, an analyst at Macquarie Securities. "We ultimately view hardware as a vehicle for selling much higher-margin software licenses and maintenance, which have a multi-year tail," he said. "We estimate Exadata drags incremental software purchases that can amount to three times the cost or more" of the product.

 

Oracle, of course, is also eyeing the lucrative cloud market, which will require a significant hardware presence.

 

Company CEO Larry Ellison initially poured scorn on cloud computing centers but has become a major cheerleader for the technology in recent years. Despite stiff competition from rival IBM (IBM), Oracle is expected to be a major player in this space, particularly private clouds, which can be based on customers' premises and accessed via a secure link such as a VPN.

 

While it is still relatively early days for Oracle's cloud strategy, Ellison explained that the company is already clinching some big deals. "This quarter, we did one with the biggest and best name in mobile devices and cloud computing in the world," he said during the call, declining to name the company. "That deal included our database software, Exadata machines, our cloud computing billing system and our cloud email system."

Away from hardware, Oracle put out decent software numbers Thursday. The tech bellwether grew its new software licenses -- a key metric of growth -- by 19% year over year during the fourth quarter, noting that they came without the help of any acquisitions.

 

The company's shares were still slipping Friday afternoon, dropping 3.9% to $31.19.

 

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