Editor’s note: Oracle (Nasdaq: ORCL), which has a major outpost in the Triangle following its acquisition of Tekelec in 2013, is transitioning to the “cloud.” But the tech giant must find ways to support declining software license revenue, says Technology Business Research Analyst Meaghan McGrath after reviewing Oracle’s most recent quarterly earnings report.
HAMPTON, N.H. – Unfavorable USD exchange rates dampened Oracle’s earnings again, but even in constant currency compares, Oracle’s FY4Q15 new software license sales declined by double digits.
The business as a whole recognized a more than 5% decline year-to-year (3% growth in constant currency). Oracle’s cloud business remains the bright spot on its income statement, generating 29% and 25% year-to-year growth in Cloud SaaS and PaaS and Cloud IaaS, respectively, with 1,217 SaaS customers and 1,419 PaaS customers added in the quarter.
Oracle’s investments, messaging and corporate focus firmly aim to rebrand the company as a leader in the cloud market. By committing to make 95% of its portfolio available in the cloud, incenting sales teams to sell cloud solutions aggressively against competitors in the space and reducing investments in underperforming business areas, Oracle is betting the company on creating dominant market share in the crowding cloud market.
Moving products to the cloud requires significant R&D investment, as evidenced by FY4Q15 R&D expense growing more than 6% amid the corporate sales decline, which contributed to the nearly 19% decline of operating income.
Oracle, as well as most technology vendors, embrace cloud because that is how customers decided they want to consume IT, which TBR believes is a far less-profitable business model for technology vendors that have to make this transition to meet customer demand.
Oracle executives insist that $1 million of SaaS and PaaS revenue will generate $10 million over a 10-year period, while a $1 million license contract will generate only $3 million over the same period. Missing from this justification is what $1 million of license revenue equals in annual subscription value for the same volume of software products.
Oracle’s FY4Q15 gross margin for SaaS and PaaS revenue was 38%, while software license and maintenance gross margin was 96%, which contradicts Executive Chairman of the Board and CTO Larry Ellison’s proclamation that SaaS and PaaS profitability is “about the same as license and support.”
Wait for OpenWorld?
TBR believes these missing pieces cloud analysts’ ability to see the complete financial picture and the long-term implications to the Oracle business.
Oracle will have 95% of its portfolio available via the cloud by OpenWorld 2015 as investments focus on the company’s transition
CEO Mark Hurd announced in April the company’s commitment to moving from 65% of its portfolio currently available via the cloud to 95% by October 2015.
TBR notes the October completion date jives with the company’s annual conference, Oracle OpenWorld, held each year in San Francisco.
As Oracle often floods that market with too many product announcements, TBR believes the company will not wait until October to announce a slew of cloud-based offerings that help it reach the 95% goal. Instead, Oracle will likely transition products, suites, and viable industry-focused solutions to the cloud on a continual basis between now and October. In doing so, the company will be able to message the features and values of the products to better convey a perception of best-of-breed solutions.
To accelerate the adoption of Oracle cloud offerings, the recently formed Accenture Oracle Business Group offers customer road mapping and support that will drive on-premises-to-cloud migration. This customer support protects Oracle’s install base when paired with initiatives such as Customer 2 Cloud, as together the physical pain points of migrating to the cloud will be reduced while customers are offered incentives for migrating before their maintenance contract is up for renewal.
Commitment to retooling nearly all of the company’s traditional products for cloud deployment will require significant investment, evidenced by the previously noted growth in R&D expense amid corporate sales declines.
With that, Oracle will pare back investments elsewhere, exemplified by the reduction of its industry solutions group by 40%. TBR believes these reductions will come from underperforming segments while investments continue across communications, banking, retail and hospitality that continue to be strong segments and worthy of continued investments.