Will The Latest Acquisition Drive Oracle Stock Higher? Oracle Corporation (NYSE:ORCL)

• Oracle completed the acquisition of NetSuite, showing disciplined behavior by insisting on its initial offer.
• The deal fits well into Oracle’s strategy of promoting its cloud products at the expense of on-premise products.
• The average target price of top analysts is at $44.17, an upside of 10%, which appears reasonable.

On November 5, Oracle (NYSE:ORCL) confirmed that it has finally completed the acquisition of Netsuite (NYSE:N) for $9.3 billion in cash, or $109 per share that the company had initially offered. In my previous article about Oracle, I had suggested that the acquisition of NetSuite, the cloud business application software company, is a smart move by Oracle. What’s more, it is not paying an excessive price for the deal. In fact, Oracle insisted that it will not pay more than what it had first offered despite the resistance from T Rowe Price (NSDQ:TROW) which demanded $133 per share.

T. Rowe had about a 13% stake in NetSuite before the deal, the largest holdings after Oracle’s Chairman Larry Ellison who owned about 40% of NetSuite shares. Although Oracle’s offer represented a premium of 19% on NetSuite’s closing stock price of $91.57 on the day before the bid, T. Rowe was of the opinion that the NetSuite shares were worth more. However, Oracle showed a disciplined behavior insisting on the initial offer, which it considered fair value, and after receiving approval from a majority of the unaffiliated shares of NetSuite (excluding Mr. Ellison’s shares), the deal was closed.

As I explained in my previous article, the acquisition fits well into Oracle’s strategy of promoting its cloud products at the expense of on-premise products. NetSuite has developed a single system for running a business in the cloud for 18 years, and the deal will give Oracle a better access to the mid-market fast-growing commercial software-as-a-service (SaaS) sector, and strengthen its line of SaaS applications.

According to many technology research companies, SaaS application software market will continue to grow strongly in the next few years. What drives this fast growing market is the fact that companies of all sizes have reached the conclusion that cloud software, in addition to on-premise solutions, is very useful.

Also Read: Will Oracle Corporation (ORCL) Execute Its Cloud Strategy In Time?

The information technology research company IDC has given some statistics about the cloud software and the SaaS markets. According to IDC, the cloud software market will grow by an impressive annual compound rate (CAGR) of 18.3% till 2019, with market size reaching more than $113 billion in that year. Moreover, SaaS market will grow almost five times faster than the on-premise software market. Also, the IT research company Gartner sees strong growth in SaaS. It expects SaaS market to reach $37.7 billion in 2016, a 20.3% increase from 2015.

According to Oracle, in its Q1 2017, SaaS and PaaS non-GAAP revenue increased by 82% in constant currency terms, considerably higher than the company’s earlier guidance. The company also said that since its SaaS and PaaS businesses continue to achieve fast growth, it expects the gross margins of its SaaS and PaaS business to increase from 62% in Q1 to the company’s target of 80% going forward. Total cloud revenues came in at $969 million in the first quarter, up 12.8% from the previous quarter and up 58.6% from the same quarter a year ago. In comparison, the revenues of $5,822 million from on-premise software were down 23.2% from the previous quarter and down 0.4% from Q1 2016. However, it is worth noting that despite the impressive growth in cloud revenues they still accounted for only 11.3% of the company’s revenues in the latest quarter.

Source: company’s reports

Oracle Stock Performance

Since the beginning of the year, ORCL stock is up 9.2% while the S&P 500 Index has increased by 7.5%, and the Nasdaq Composite Index has gained 7.2%. However, since the beginning of 2012, ORCL stock has gained only 55.5%. In this period, the S&P 500 Index has increased 74.8% and the Nasdaq Composite Index has risen 106.1%. According to TipRanks, the average target price of top analysts is at $44.17, which indicates an upside of 12.8% from its November 15 close price of $39.17. This appears reasonable, in my opinion.

Valuation

If you look at the valuation metrics, ORCL stock is not expensive. The trailing P/E is at 18.95, and the forward P/E is low at 13.85. The price to cash flow is at 14.40. Moreover, the Enterprise Value/EBITDA ratio is low at 10.02, and the PEG ratio is at 1.69.

Also, Oracle’s Margins and Return on Capital parameters have been much better than its industry median, its sector median, and the S&P 500 median as shown in the tables below.

 

Source: Portfolio123

Oracle has a strong balance sheet, and it is generating strong free cash flow. At the end of the last quarter, the company had $68.4 billion in cash and equivalents and $54.1 billion in total debt.

Oracle started to pay a dividend in April 2009. The current annual dividend yield is at 1.53%, and the payout ratio is only 27.9%. The annual rate of dividend growth  has been very high at 26% over the past three years, and at 23.4% over the past five years.

Also Read: Can Oracle Corporation Take On Amazon.com, Inc. (AMZN)?

Conclusion

Oracle completed the acquisition of the cloud business application software company NetSuite, showing disciplined behavior insisting on its initial offer which it considered fair value. In my view, Oracle will benefit from the acquisition which fits well into Oracle’s strategy of promoting its cloud products at the expense of on-premise products. The deal will give Oracle a better access to the mid-market fast-growing commercial SaaS sector, and strengthen its line of SaaS applications. Regarding its valuation metrics ORCL stock is not expensive; the forward P/E is low at 13.60, and the EV/EBITDA ratio is also low at 10.06. The average target price of top analysts is at $44.17, which indicates an upside of 12.8% from its November 15 close price of $39.17, which appears reasonable, in my opinion.

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