Investing in software shares amid cloud transitions
At first glance, Oracle’s June-to-August quarter results seemed impressive. Revenues rose at a seven per cent annual rate to $9.2 billion, $200 million above consensus. Earnings per share were 62¢, above the 60¢ EPS consensus. Most important, Oracle’s “cloud software as a service” business revenues rose 62 per cent to $1.1 billion. This is the growth engine of the new Oracle, not its legacy database and business software business. Yet the company disappointed sell side software analysts on Wall Street at its conference call. The shares, trading well above 53 after its results were unveiled, plunged below 49 on Friday. The consensus holds that Oracle’s transition from a licensing to a cloud based subscription model can well pressure margins, as the company forecasts suggested. Wall Street expected a rosier growth forecast from Oracle and it did not get it, hence the public execution in its shares.
I believe Oracle is not expensive at 16 times forward calendar earnings, a significant discount to Microsoft. It was dead money in 2013-16 as it began its transition, as Microsoft was dead money in 2010-2013. Yet the stock market cottoned on to the growth transition in Oracle. This was the result the shares were up 35 per cent in 2017 before last Friday’s selloff, when Oracle was the worst-performing major tech share on the Nasdaq down seven per cent.
Mark Hurd himself noted that Oracle’s 62 per cent cloud revenues growth was double the growth rate of its Silicon Valley archrival Salesforce.com. So the stock market’s visceral bearish reaction to management’s slower cloud growth after its conference call seems excessive. Yet it is a fact that Oracle now expects a 0.64-0.68 range for its November end quarterly forecast, below the Wall Street 0.68 consensus. Yet this does not negate Oracle’s cloud transition story. Management forecasts of a 3943 per cent cloud bookings growth rate is from a far higher base. Note Oracle expects to hire 5,000 software engineers and consultants in response to its cloud bookings growth. The op- tions packages for Hurd, Safra Catz and even Larry Elision is designed to target $20 billion in cloud revenues in a single year, up fourfold on current annualised cloud revenues. The Oracle story is intact.
Symantec is unquestionably the champion of the $35 billion enterprise security and storage software market. The cyberhacking attacks that have just gutted Equifax and even poisoned US-Russian international relations make Internet security software a secular growth business. Symantec is the leader in the design of digital security protection and management systems for the world’s leading businesses. Its growth strategy, rising margins and opportunistic acquisitions lead me to believe the shares could well trade to 40 or 22 times its 2018 earnings.
Microsoft has been a must-own stock even since Satya Nadella replaced Steve Ballmer as CEO and led the company’s restructuring and cloud strategy. The Azure and Office 365 commercial cloud platforms have transformed Microsoft’s growth potential. Cloud revenues could well grow at a 30 per cent annual compound rate in the next three years and contribute almost a third of global corporate revenues even as gross margins expand to 48 per cent in the next three years. The tsunami of free cash flow Microsoft will generate will only lead to an acceleration in the share buybacks. True, Microsoft’s spectacular performance in 2017 has captured most but not all of the cloud related valuation rerating potential in the shares. Nadella has also attracted income investors by increasing dividends for the past three years. The scale of Microsoft’s $40 billion shares buyback scheme is such that it has reduced its share count by 25 per cent in the past decade. This trend will continue. Even as this late stages, I would use any Nasdaq correction to accumulate the Evil Empire of Redmond since I believe Microsoft can well trade at 85-90 in the next 12 months.