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Oracle (ORCL)
Oracle -- One Acquisition Too Many?
Larry Ellison is not known for sitting still. He has built Oracle into the software powerhouse that it is in large part due to acquisitions. He is a banker's dream and does more deals than anybody else in Silicon Valley. We suspect that if you ask him what his most favorite acquisition was, he might give you the same answer as a football player when asked about his favorite championship ring -- i.e. the "next one". Though Oracle has been largely successful in integrating its prey (see PeopleSoft, Siebel, BEA etc.), you have to wonder if one of these days, luck runs out and one of these big deals doesn't pan out. There is a school of thought that believes that the acquisition of Sun, announced April 20th, could be this first mistake. Also, what is with the chatter that Oracle is starting to embrace the software as a service (SaaS) delivery model -- something the company has long derided?
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Let's discuss the Sun (JAVA: Charts, News, Offers) acquisition first. As has been well documented, IBM (IBM: Charts, News, Offers) was in serious talks to buy Sun but the major hang-up was the reluctance on Big Blue's part to give Sun guarantees that the deal would close even if there were major anti-trust concerns. So Oracle swooped in over a weekend and made the deal agreeing to pay $5.6 billion (net of cash and debt) or $9.50 a share for a premium of close to 40%. Oracle could get the deal with the hardware-heavy Sun done because it doesn't have that wide of a hardware footprint (unlike IBM) and therefore, anti-trust concerns were not much of an issue. The question is can Oracle can make this work? Sun just reported earnings a couple of days ago (one of the last times it does so as an independent entity) and they were below analyst expectations as revenue fell 20% and net loss ballooned to $201 million from $46 million in the same quarter a year earlier.
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So Sun is clearly struggling and has been doing so for a while as a lot of its products and servers have been losing relevance. By buying Sun, Oracle is taking on more of a hardware manufacturing role than it has in the past. That is a business Oracle doesn't know too well having built its forte on software, especially database management systems. Not to mention the lower-margins associated with hardware. But another way to look at this deal is to think of it as more of a defensive play on Larry Ellison's part. Buying Sun gives Oracle access to the Java technology Sun pioneered and which is heavily used in Oracle's ecosphere of products. Also, Oracle now has Sun's MySQL department. MySQL is an open source relational database (especially popular among websites) and it competes with Oracle's namesake database products which are more common in enterprise settings. Sun's Solaris operating system which Oracle heavily uses is a nice add-on too. So the bottom line for Oracle is that by buying Sun, not only is it getting access to the fate and development of a number of products that it employs but it is also keeping them out of competitors' hands. Of course, the big problem is that the software goodies came packaged with Sun's declining hardware businesses which Oracle now has to find a way to wring more efficiencies from or sell, with the latter being the more likely scenario. It remains questionable whether the eventual value that Oracle gets out of Sun will justify the $5.6 billion price tag and that is why this deal could prove to be a little dicey. Also, as alluded to earlier, Oracle now holds in its hands the main open source competitor to the Oracle databases and the company will have to walk a tightrope in terms of continuing the advancement of MySQL while still trying to make sure that its pricey proprietary offering does not lose market share. Given how intertwined MySQL is in the web ecosphere, any perceived efforts to tamp down on it would put Oracle in a tough situation. On the balance, Wall Street seems to like the deal since Oracle's stock hasn't sold off heavily since the transaction was announced about 10 days ago.
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Besides the issues relating to the Sun acquisition, a larger more strategic question facing Oracle is what to do about the software as a service business model? Oracle, like most software companies, has traditionally brought home the bacon by selling its software for one-time pricey license fees and then the customer goes away and deploys and maintains the software on his own hardware at his own cost. Of course, if the customer wants help with all of this, he can pay Oracle fat maintenance fees. But with the advent of Google (GOOG: Charts, News, Offers) and Salesforce.com (CRM: Charts, News, Offers), the model is slowly starting to shift to one where the customer just pays a lower monthly license fee and the software is delivered over the internet and is deployed and maintained not the on the customer's hardware but on that of the software provider.
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This is a business model that Oracle has shied away from because it involves more headaches, more maintenance and the license fees are lower. However, Oracle seems to be coming around, according to the Wall Street Journal and Reuters, Oracle is developing software that can be deployed over the internet to help with tasks such as employee management, customer relationship management etc. Oracle will have its hands full adjusting to this new business model and maintaining its profitability. So while the general sentiment is that SaaS represents a threat to Oracle's cash flow, is it important for investors in Oracle not to get too alarmed. SaaS is still a long way from proving itself as a reliable alternative to traditional software given issues relating to performance, stability and performance of complex tasks. So Oracle does have a fair amount of time to get ready for this -- SaaS is still at least 2-3 years away from gaining a real-foothold in the marketplace.
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