Oracle Q4 – Further Validation of Oracle’s Consolidation Strategy

Well it’s that time of year again. No we’re not referring to the upcoming July 4th holiday, rather we’re talking about the all important upcoming May fourth quarter report from Oracle.

As longtime observers know, Oracle’s Q4 results are disproportionate to the rest of the fiscal year and typically serve to set the tone for the upcoming year. The May fiscal 2006 performance was a blockbuster which pushed the stock price beyond its longstanding trading range of $12-$14 into an entirely new range of $15-$19. With the quarter having ended two weeks or so ago, the early betting is pointing to another powerful performance which will lead the stock into a higher trading range.

Our checks to date generally confirm these expectations.

• Field sources have been very optimistic and excited throughout the course of the quarter and there have been no signs that the company did not execute well.
• The services ecosystem around Oracle has been going flat out.
• Finally our discussions with various third party contacts including leading market research firms that provide sophisticated deal advisory services all point to a record level of activity and a preponderance of larger deals.

Since we no longer maintain detailed earnings and cash flow models for Oracle we are not going to discuss estimates apart from stating that we would be surprised if Oracle doesn’t beat the high end of their guidance ranges of license revenue growth of 5% to 15% year over year and non-GAAP EPS of $0.34. A big quarter against a tough year ago comparison should further validate the success of Oracle’s consolidation strategy. While our contacts are almost entirely North American based, we have no reason to expect that Oracle’s performance in key international markets wasn’t good. In addition, we believe that a comparatively weak dollar through the quarter didn’t hurt.

So after many years of skepticism towards Oracle, what’s driving the company’s success today? We believe that Oracle’s management of its acquisitions has been highly effective, particularly with respect to providing customers an increasing sense of confidence that Oracle will continue to support these products while extending their capabilities based on the company’s strong DBMS and middleware foundation. In addition we continue to believe that despite many cross-currents in the tech spending environment that Oracle is benefiting from its increased breadth and depth of applications, as well as the company’s larger scale and the realization on the part of many customer organizations that after the boom period they have underinvested for a number of years.

Oracle and Agile a Natural Combination; Where is SAP?

Last night Oracle announced that it has reached agreement to acquire Agile Software for $8.10 per share or approximately $495 million in cash. The deal is expected to close in the second half of July.

The consolidation in the product lifecycle management space has been going on for a while now with Dassault’s acquisition of MatrixOne more than a year ago, and more recently Siemen’s acquisition of Unigraphics. Agile has been an obvious target for sometime given its continuing losses and its stop and go progress on the top line.

The fit with Oracle is pretty straightforward, given that Agile’s software has been built on Oracle’s infrastructure. Moreover, the attractiveness of Agile to Oracle is obvious as part of Oracle’s strategy to surround SAP. The deal will enhance Oracle’s position in the manufacturing sector and more specifically in the high technology and consumer packaged goods verticals. In addition, there is little question that where Agile has struggled to expand beyond its core markets, Oracle’s dramatically greater scale and industry presence should enable Agile to finally fulfill these long standing ambitions.

Agile’s product will become the core of Oracle’s PLM offering. As investors well know the PLM space has been long touted as one of the more strategic, compelling and high growth sectors within the enterprise software space, and yet all of the specialized vendors in this space have struggled to produce the expected growth.

The valuation of Agile with an enterprise value of approximately 2.2x trailing twelve month revenues and 5.2x trailing maintenance revenues is toward the lower end of the range, relative to the valuations for MatrixOne and UGS. However in each of those cases it could be argued that the deal was more strategic to the acquirer. Another point to consider is that despite the prospect of a couple of other companies as possible buyers, notably SAP, IBM and Parametric, we strongly suspect that none of these companies expressed serious interest. While we can understand Parametric being somewhat conservative in this case, moreover although IBM has been an active acquirer of software companies they continue to avoid buying applications vendors, one has to wonder what SAP is thinking. The recent Wall Street Journal article “German Company’s Plan to Globalize Hits Cultural Barriers” Friday, May 11, 2007 did an excellent job summarizing the company’s cultural challenges, which we believe represent a major distraction.

Separately and for what it’s worth, our checks on Oracle’s business momentum for the all important May quarter have been to date quite positive with broad based reports that the field is executing well.

Another important takeaway from last night's announcement is that the continuing consolidation of the enterprise software market is far from over.

A Brief Post-Mortem on Q1

With Q1 earnings results largely out for the vast majority of enterprise software companies, we thought some high level observations were in order. While we are not going to comment in great detail since there are many financial analysts who have been doing just that at a breathless pace as the earnings reports come out, there are a number of themes that are important.

First and foremost, the overall state of spending on enterprise software continues to gradually improve. This is an easy assertion to make given that each of the largest software companies, Microsoft, IBM, Oracle and SAP, had decent to good to strong quarters. While we are still waiting for BMC and CA’s fiscal Q4 results, we would be surprised if they prove to be visibly disappointing. Likewise while inevitably there have been companies that have disappointed (BEA is one that comes to mind) these can be attributed more often than not to competitive or execution issues.

Software as a service – is still the hot market, even as there is greater recognition of the importance of on-premise for many strategic applications, particularly in larger companies. The continuing success of Salesforce.com, as well as its substantially outsized market valuation is an excellent indication that software as a service is both a strong trend from a fundamental perspective that has an even stronger attraction for investors based on the visibility of revenues. SAP’s big push to build a major on-demand offering to broaden and deepen their penetration into the SMB market is just one of the more recent indications that SaaS is really here.

Market consolidation is ongoing. The recent talks between Microsoft and Yahoo which became public last week are simply the most recent evidence. In addition to Oracle’s pending acquisition of Hyperion for more than $3 billion, there are certainly other deals in progress ranging from the pending acquisition of Mobius by ASG, the Tibco deal, Siemen’s acquisition of Unigraphics, to much smaller transactions such as Thomas Cressey’s acquisition of Embarcadero. It is interesting to note that there is growing evidence of private equity becoming more aggressive in the enterprise software industry. In addition to the stealthily built Infor, NetIQ and Embarcadero’s acquisitions are further indications that enterprise software is attractive to private equity investors. This should hardly be surprising given the increased maturity of the sector, coupled with the increased importance of scale, meaning that many companies with a substantial franchise are effectively thwarted from significant growth and yet have very large and predictable cash flows that can be readily leveraged.

The options scandal appears to be receding into the background. Unlike last year where many software companies were seeing their stocks banged hard by indications of backdated options, this year these types of scandals have been considerably less of a disruptive factor.

Software stocks continue to lag the broader market. The WSJ 5/5/07 article “Technology stocks give rally a boost" underscores the fact that tech stocks generally have been poor performers. While business conditions seem pretty good all things considered, stock performance remains broadly disappointing. With the Dow at an all time high and the S&P 500 closing in on its former all-time high reached in 2000, the NASDAQ is still well below its record high, it has been a good year so far. Year to date gains for the major indices are all up more than 6%. With the notable exception of Oracle (up 10% year to date) and CA (up 24%), other leading companies such as Microsoft (up 2%), BMC (down 2%) and SAP (down 10%) appear to be treading water. Salesforce.com is up 18% year to date. The biggest gainer so far this year is Hyperion (up 45%). Excluding deal activity, there really haven’t been any terribly dramatic gains evidenced in the group certainly among large and mid cap names. Interestingly there are a number of micro cap and small cap companies that have posted some impressive gains.

CA – When will it End?

The recent “special litigation committee” report released by CA’s board late last week, among many other things, states that founder Charles Wang was the mastermind behind the accounting fraud at the company. Mr. Wang, according to various newspaper reports, not surprisingly places the entire responsibility on his one-time protégé and former CA CEO Sanjay Kumar. Mr. Kumar pleaded guilty last fall and has been sentenced to a twelve year prison term. In addition, Mr. Kumar has agreed to make restitution to the tune of $800 million to shareholders hurt by the fraud.

The committee was formed in February 2005 to address ongoing consolidated litigation issues against the company. The 390 page report evaluates CA’s stand on various litigation involving former officers, employees and directors. More specifically these people are divided into the following groups: criminal defendants, former officer defendants, KESOP (Key Employee Stock Ownership Plan) defendants, oversight directors, settlement directors and auditor defendants. The simplest boiling down of the report and how it affects these different groups is as follows. CA should pursue claims against the criminal defendants, former officer defendants and KESOP defendants, and that CA should not pursue claims against the other groups.

There is little doubt that Mr. Wang is at the very least a fortunate man since the opening of the criminal prosecution effort for this accounting fraud began after the statute of limitations had expired, sparing him the fate of his one-time friend and protege. It is also evident that Mr. Wang whether motivated by the desire to minimize bureaucracy or sensitive to the risks of an electronic or paper trail was a very, careful man as is noted by his aversion to email or voicemail. In any event, apart from a desire to realize a fair and just outcome following an extremely difficult and prolonged period, why after so many years is Mr. Wang finally being pursued? What took so long?

As a former Wall Street sell-side analyst who began coverage of CA shortly after the company came public in 1981 up until my retirement from the street in 2005, I find the continuing saga of CA absolutely remarkable on many, many fronts.

Rumors about financial impropriety at CA swirled for many years before the New York Times article appeared in 2001 which is widely seen as a pivotal turning point with respect to the company’s financial operations. The catalyst for the article had been management’s decision driven by former CEO Sanjay Kumar to transition the company away from recognizing license revenues upfront to a new subscription model which would spread license and maintenance revenues evenly over the term of the agreement.

It is still amazing to us given the highly acquisitive nature of CA back in the 80s and 90s, the $1 billion incentive stock award for key employees, the ever present undercurrent of financial improprietary, that the fraud persisted for so long.

The irony of the past six or more years to long time observers of the company has been that regardless of Mr. Kumar’s guilt in the backdating of contracts, it was Mr. Kumar himself who was attempting to radically reform the company’s accounting in a bid for greater structure, conservatism and yes, ultimately, integrity.

Another irony is that for long time observers of CA it is inconceivable that a company so dominated by its founder, with such a reportedly close relationship with his protégé, that Mr. Wang could have been either unaware or innocent of the accounting fraud taking place at the company.

Finally, perhaps the biggest is that CA was by no means the only company engaging in questionable or inappropriate revenue accounting. In fact it is probably not unfair to suggest that virtually all software companies bent the rules to varying degrees in the bid to manage their revenues and meet Wall Street expectations.

While we by no means want to be seen as apologists for these companies that took liberties in how strictly they applied revenue recognition practices of the time, we do think it is important to point out that unlike many of the companies that engaged in sham accounting during the past decade suggest as Worldcom and Enron, the scale of the fraud is not comparable.

Furthermore we make these points not in the effort to defend either Mr. Kumar or Mr. Wang or for that matter any of the participants in the fraud, but in the case of CA and its shareholders’ to ask a number of questions.

At what point does the continued pursuit wrong doers, cost more than the benefit to shareholders?

To what extent do these continued efforts to resolve these problems represent a distraction to CA’s efforts to regain momentum with its customers?

Last, but not least when does CA believe that this long dark period in its history will finally be history?

Top Ten Reasons Why Oracle is on a Roll

Oracle’s February Q3 results provided further dramatic evidence of the company’s success with impressive performance across all product lines and geographies. License growth of 27% year to year, coupled with GAAP and non-GAAP operating margins of 32% and 39% respectively are BIG numbers particulary when one considers that total quarterly revenues were almost $4.5 billion. As so much has already been written summarizing the specifics of the quarter, we thought it would be more interesting to highlight (in order of importance) the reasons behind Oracle’s strong growth.

#10 Oracle was early in its recognition of the growing maturity of the enterprise software market and the need for substantial consolidation.

#9 Oracle’s CEO Larry Ellison has refocused his energies on technology and vision rather than sales.

#8 Oracle’s sales force is highly motivated by a rich compensation structure and the benefit of a substantially enhanced strategic presence in accounts.

#7 Addition of new offerings in major verticals through acquisitions such as Retek, ProfitLogix, i-Flex, Portal Software and others, have opened up vast new markets

#6 “Lifetime” support for all acquired products, reducing customer anxiety and further reinforcing a customer-centric view.

#5 High performance middleware products are virtually free – allowing Oracle to leverage its leading position in relational DBMSs with the rapid increase of breadth and depth of its applications.

#4 Competitor SAP has been slow to react and continues to be focused more on the SMB market than the bigger picture.

#3 Acquisitions of PeopleSoft/JDEdwards and Siebel in particular, combined with Oracle’s very large presence in the DBMS and applications markets, means a huge number of customers have multiple offerings from Oracle and need to re-examine their licensing profile.

#2 Fusion is a compelling open, standards based, vision of applications services that will drive a new wave of profound improvements in business productivity.

#1 Oracle’s revamped management team has proven itself remarkably adept in navigating a complex and aggressive growth strategy, with no obvious missteps.

Oracle Buys Hyperion, Why We're Not Surprised -- plus A Couple of Thoughts on the Quarter

Oracle’s announcement last week that it has reached agreement to acquire Hyperion for $3.3 billion or an enterprise value of $2.9 billion reflecting Hyperion’s net cash position of $450 million is not surprising and makes a great deal of sense. We’re not going to review the numbers here apart from noting that the valuation looks reasonable since the basic financial elements have been widely discussed in the financial community. While we have reservations owing to the challenges of any acquisition – integrating people, offices and systems in an effective manner so as to maintain the customer base and ideally leverage the technology, we think the deal is pretty compelling. Some investors may begin to worry more about these issues given that Oracle has been on a binge that reminds us of Computer Associates buying spree more than a decade ago. Nevertheless, we think Oracle’s internal systems are best in class and that management is up to the task.

So why do we think the Hyperion deal is not surprising and a smart move on Oracle’s part?

• First, we know from our discussions with industry contacts that Oracle is doing extremely well with Siebel’s analytics now known as Oracle Business Intelligence Enterprise Edition (or OBIEE for short).
• Second, we know that Hyperion’s core products are natural complements for these analytics. Hyperion’s more than 12,000 customers including 91% of the Fortune 100 represent a very attractive customer base for Oracle.
• Third, that the Hyperion products performance management products and OLAP engine broadly rounds out Oracle’s offering across all the major categories in the business intelligence space.
• And, finally as has been widely noted Hyperion’s products are broadly implemented in conjunction with SAP and Microsoft products (providing Oracle another key element in its technology stack). Oracle has been working hard to “surround SAP” as evidenced by the acquisitions of Siebel for CRM, PeopleSoft for HR, not to mention the vertical acquisitions in the retail and utilities sectors and the continuing expansion of the Fusion Middleware business.

Regarding the fiscal third quarter which ended last week, our checks have been encouraging but do not suggest a blow out quarter. Discussions with deal advisory contacts indicate a good amount of activity, but broadly represented by small and medium sized deals rather than “mega” deals. Likewise discussions with applications consultants indicate generally favorable attitudes towards Oracle, in sharp contrast to the sentiment a year or so ago and a healthy amount of activity. Finally field checks have been pretty positive. We have heard that Oracle has tightened on expenses a bit, in particular limiting travel by employees for internal meetings. We think this is a good move on several counts, first it helps contain spending, but more importantly it notably increases the time and focus on customers. Our assumption as of now is that when Oracle reports its February quarter results on March 20th that revenues and earnings will be toward the upper end of guidance.

Legal DisclaimerNothing herein constitutes an offer or solicitation to buy any security. Readers are advised to review their own financial situation, risk tolerance, and investment objectives as to any investment. Information provided here is based, in part, from sources believed to be accurate and reliable, although no representations or guarantees can be provided as to its accuracy or completeness. Blue Atlas Management, LLC is our official business entity for consulting related work. In addition, we also have a website for those of you who are interested in learning more about our services. http://www.blueatlasmanagement.com/. Please feel free to contact us at jmendelson@blueatlasmanagement.com, with any comments or questions.

Oracle’s Continuing Bid for Leadership in Enterprise Applications

We recently attended two different Oracle applications events, one aimed at the financial community to discuss the company’s vertical strategies and the other aimed at customers, partners and analysts unveiling Oracle’s “applications unlimited” launch of 5 major new releases of the company’s core ERP applications. Both events were very well attended and received. To the frustration of the financial community, Oracle’s president Charles Phillips did not comment on how the February fiscal Q3 period was shaping up, or to what extent Oracle has closed the deals missed in Q2.

While the focus of each of these events was different, there are a number of key themes common to both presentations. The most strategic advantage that Oracle has in its applications business is the strength of the Oracle technology stack. The benefits of Oracle’s leading positions in database and middleware are that this technology is available freely to Oracle’s applications businesses, freeing these development teams to focus solely on building domain expertise and expanding the breadth and depth of application functionality. The next most important benefit is simply Oracle’s scale as measured by the size of the organization as a whole as well as its financial strength.

Oracle’s applications businesses benefit from this scale in that they can provide extensive worldwide support 24 by 7 on a cost effective basis that few companies can match. In addition, particularly with respect to some of the much smaller companies Oracle acquired, Oracle’s scale eliminates customer anxieties not just about support but also about financial viability, which is often a big issue with smaller software vendors. Finally, and perhaps most importantly in light of Oracle’s very aggressive pace of significant acquisitions over the past few years, are Oracle’s promises not to discontinue support for any applications products and to continue to introduce new releases of existing products while continuing its development of its next generation Fusion release.

While none of these key themes are new and all of them have been discussed repeatedly over the past few years, what’s different now is that sufficient time has passed, that customers are able to see that Oracle is serious about delivering on these promises. As we have written on previous occasions this, in our opinion, has been the critical variable in Oracle’s success to date in the applications business. Our checks with various industry contacts have repeatedly underscored that where there was substantial anxiety a year or so over whether Oracle would continue to support its acquired products and whether Oracle would attempt to dictate the timing of upgrades, neither of these fears have been realized. As a consequence the sizeable installed base of applications customers has begun to recommit to Oracle and in many instances are expanding their licenses.

Oracle’s Focus on Verticals – “The Growth Area of the Applications Business”

Oracle’s interest in vertical applications is driven by the simple fact that the market opportunity is on the order of 2x the enterprise resource planning (ERP) market and that unlike the ERP market which has been defined by the packaged applications vendors, the vertical applications market is largely represented by custom built legacy applications. Further enhancing the appeal of the vertical applications market is that the emergence of services oriented architecture (SOA), along with the need to improve compliance and the ongoing dramatic improvements in the technology stack are catalysts to replacement of aging custom legacy systems.

In the bid to capture the vertical market opportunity as quickly as possible, Oracle has made a number of strategic acquisitions in key verticals. As of today Oracle has four vertical business units that have been built around these acquisitions. The largest is financial services which has Oracle’s 88% ownership interest in i-Flex at its core. The second is retail which is leveraging Oracle’s acquisition of Retek. Rounding out the four verticals is communications and utilities. Oracle’s strategy is to leverage its technology stack and to reapply the R&D savings realized toward accelerating the expansion of the functional footprint of these applications.

Oracle’s “Applications Unlimited” (Protect, Extend & Evolve)

Oracle’s Applications Unlimited event was designed to underscore the company’s progress since completing the acquisitions of PeopleSoft/JDEdwards and Siebel more than a year or so ago, with the announcement of new releases across all of these products as well as the Oracle e-Business Suite. More specifically Oracle announced the availability of the following: eBusiness Suite 12, PeopleSoft 9.0, Siebel 8.0, JDEdwards Enterprise 8.12 and JDEdwards World A9.1. The overarching theme of the event was to “protect, extend & evolve” customer’s applications investments so as to provide the utmost flexibility to meet customer needs.

While each of these releases includes significant enhancements in terms of traditional feature/function elements (we will spare readers all of the details), the real appeal is the addition of standard integrations across ERP suites, as well as a standard integration to Oracle’s industry suites and finally one-stop integration for independent software vendors and non-Oracle products. The integration across applications is particularly important since many Oracle customers have PeopleSoft for human capital management (HCM), Siebel for CRM, Oracle for e-Business financials and JDEdwards for plant management. Clearly the ability to integrate across these different applications represents tremendous potential benefits in terms of improving the productivity of operations as well as compliance. While there were many examples of these different integrations, one that resonates loudly is the integration between Siebel and the e-Business Suite in terms of tying Siebel’s “front office” order capture functionality with the “back office” order management capabilities in the e-Business Suite.In addition these latest releases are available via Oracle On-Demand for those customers who prefer a software as service business model. Finally, it is important to note that these new releases do not change Oracle’s continuing support of “stack” offerings from other vendors, such as IBM’s DB2 or BEA’s Websphere as well as other popular products.

Legal Disclaimer Nothing herein constitutes an offer or solicitation to buy any security. Readers are advised to review their own financial situation, risk tolerance, and investment objectives as to any investment. Information provided here is based, in part, from sources believed to be accurate and reliable, although no representations or guarantees can be provided as to its accuracy or completeness.Blue Atlas Management, LLC is our official business entity for consulting related work. In addition, we also have a website for those of you who are interested in learning more a little more about our services http://www.blueatlasmanagement.com/. Please feel free to contact us at jmendelson@blueatlasmanagement.com, with any comments or questions.

SAP’s Miss – Part II: New Attack on the SMB Market

When SAP released their disappointing Q4 results a few weeks ago, we raised the critical question as to what do they mean. Was it a company specific issue, or a reflection of a broader weakening of demand for enterprise software companies?

Recently SAP hosted a meeting with financial analysts to discuss in greater detail its results for 2006 and provided a preliminary outlook for 2007.

The 2007 outlook calls for product revenue growth in constant currency terms on the order of 12% to 14%, which is similar to the growth seen in 2006 and for operating margins to take a hit of 1 to 2 percentage points to a range of 26% to 27% owing to the decision to develop an on-demand offering. While the revenue outlook should not be surprising, the lack of license revenue guidance along with the indication that profit margins would decline took the market by surprise and led to a further sell-off in the shares.

The presentations by SAP’s senior management illustrated the challenges to the leading enterprise applications vendor. In its traditional market serving relatively large companies the market share gains that SAP has enjoyed over a number of years owing in part to Oracle’s various fumbling of earlier releases of its eBusiness suite, and later anxiety over the company’s aggressive acquisitions have come to an end. In addition the long standing effort to build SAP’s presence in the strategically important small, medium business (SMB) market has not been as successful as hoped. Or put another way, SAP recognizes the need to address the sizeable portion of the SMB market that wants a different value proposition that emphasizes the low upfront costs and predictability offered by the software as service subscription model. Finally, compounding the fundamental challenges SAP also confronted the significant increase in the value of the Euro which visibly dampened the company’s reported top line growth. Despite the disappointment the actual results in absolute terms are not bad rather management was clearly overly optimistic in initial outlook for the year.

The biggest surprise was management’s intention to sharply increase its investment in building an easy to use, on-demand solution to more effectively address the all important SMB market. The announcement represents an admission that despite SAP’s claims during the past several years of its success in the SMB market, that the company is losing ground to a range of competitors that arguably include a number of traditional ERP software companies (Lawson, Oracle, et al.) not to mention on-demand offerings from Salesforce.com, NetSuite and others. While the move to on-demand makes sense, it raises a lot of questions regarding SAP’s current mid-market offering as well as to the underlying assumptions the company is using with regard to prospective market penetration, revenue contribution and longer term profitability. Our conversations with investors underscore these concerns as does the reaction of the stock.

Perhaps most importantly nothing in SAP’s presentations suggested a fundamental softening of demand for broader IT spending on enterprise software. In fact management continues to characterize the spending environment as “healthy,” which is consistent with the inputs we get from various industry contacts (systems integrators, market research analysts, independent consultants and field sales).

One bit of good news for SAP is that Henning Kagermann will continue at least one more year as CEO, forestalling a much anticipated horse race between leading executive board members Shai Agassi and Leo Apotheker and the risks that one of these key executives will leave.

Legal Disclaimer Nothing herein constitutes an offer or solicitation to buy any security. Readers are advised to review their own financial situation, risk tolerance, and investment objectives as to any investment. Information provided here is based, in part, from sources believed to be accurate and reliable, although no representations or guarantees can be provided as to its accuracy or completeness.Blue Atlas Management, LLC is our official business entity for consulting related work. In addition, we also have a website for those of you who are interested in learning more a little more about our services http://www.blueatlasmanagement.com/. Please feel free to contact us at jmendelson@blueatlasmanagement.com, with any comments or questions.