Oracle slightly beat Wall Street’s expectations in its most recent quarter and while that sounds positive, the numbers can be a bit misleading. Applying a more holistic lens to Oracle’s earnings can uncover valuable information customers can use as they contemplate their long-term Oracle roadmap and consider any upcoming Oracle purchases between now and Oracle’s fiscal year-end on May 31. Here we will take a deeper look at what customers can learn from Oracle’s Q2 FY19 results.
Looking Beyond the Surface
Total revenue for the quarter was $9.6B, up 2% year-over-year in constant currency, with EPS up 22% at $0.61. Oracle touted new cloud deals and customers migrating from on-premise to the cloud, stating that this was perhaps their best applications quarter in terms of bookings. But keep in mind that cloud bookings are different than revenue since cloud revenue must be recognized over the duration of the agreement, unlike on-premise license fees which is recognized as lump sum revenue upon contract signing. If we just consider this quarter’s revenue performance, these growth numbers might not be as strong as they appear.
How much of Oracle’s 2% growth is related to true net new product demand and net new customer wins that represent true market demand growth? We cannot accurately derive this answer based on how Oracle reports its numbers, but we can say true growth for the quarter was something less than 2%. There are at least three buckets of revenue sources that we would not characterize as market demand-driven growth.
1. Support Fee Increases
Oracle increases support fees by 3% each year across its entire customer base, except to those customers that have negotiated price protections. While this does not equate to a 3% increase in overall revenue, it is a substantial revenue increase that is contractual in nature without any additional sales.
2. Customer Business Growth
Many customers experience organic growth each year which necessitates increasing their license metrics to remain compliant. These incremental license purchases represent new sales but not in the traditional market demand-driven sense since they are really a license true-up. However, these purchases also add to the support revenue stream, with both the license and first year support fees recognized as lump sum revenue for the quarter.
3. Audit-Driven Purchases
There are always Oracle audits being conducted and settled each quarter. Some of these audit-driven purchases represent a license true-up like the one described in #2 above, while other audit-related purchases are driven by a customer choosing a path of least resistance to settle an audit dispute and avoid significant business disruption.
So, if Oracle is actually growing at less than 2%, how can that be considered a successful quarter compared to the growth metrics of cloud market leaders like Salesforce, Workday, AWS, and Azure?
On the 22% EPS growth, we must consider Safra Catz’s statement that Oracle spent $10B in share repurchases during the quarter and has repurchased over 600 million shares in the past 12 months. This has a significant impact on EPS and is something IBM did for years to mask its declining top line revenue. So, the EPS growth is also a bit misleading when we consider that over 600 million shares have been removed from the market.
What Does This Mean for Customers?
While Oracle is painting a much rosier picture than the results would support, Oracle is still facing significant challenges in gaining cloud market share and migrating its on-premise installed base to the cloud. Customers would be wise to factor this in when calculating their overall negotiation leverage with Oracle between now and the end of May. Oracle does a tremendous job in maintaining a strong poker face during negotiations, but customers should feel confident that behind that mask is a company that needs to close deals and is willing to provide non-standard concessions to customers who are disciplined and execute to a proper negotiation strategy and approach.
Understanding Oracle’s Strategic Initiatives
Oracle sometimes provides key insights into their strategic direction which can be valuable for customers to understand. This is important because it informs you as to what Oracle is communicating to Wall Street and subsequently how Oracle will be evaluated by the institutional financial analysts whose reports and recommendations have substantial influence on Oracle’s stock price.
In this latest call, Larry Ellison spoke of two strategic initiatives/products that he said will determine Oracle’s future. The first one is cloud ERP. Oracle has stated that they are the only company offering a full cloud ERP solution suite. Oracle believes that they will get their ERP on-premise installed base customers to migrate to Oracle’s cloud ERP as well as win new customers who are looking to upgrade or migrate from legacy on-premise ERP solutions. Expanding cloud ERP could enable Oracle to become the world’s largest cloud application company, not just because of ERP alone, but also because cloud ERP generates opportunities to sell other cloud solutions with it.
Think of cloud ERP as the initial foothold for expanding to all other cloud business applications. This helps explain why Oracle has created multiple product line pillars (EPM, HCM, CX, industry-specific solutions, etc.) within their cloud application solution suite. These pillars create negotiation leverage for Oracle as the discounting for each product is dependent on the overall spend within each pillar that the products fall. Discounting is no longer based on overall application spend. Plus, discounting is negotiated on a transactional basis thereby preserving downstream revenue opportunities and margins.
The second product is the Autonomous Database which Oracle has stated provides it with a database technology leadership position that is the largest it has had in its history. Oracle currently has a 50% share of the database market and firmly believe that not only will they be able to migrate that installed base to the Autonomous Database in the cloud, but to also expand market share by winning net new customers as a result of its superior technology.
Similar to cloud ERP, the Autonomous Database is a foothold for expanding sales into the various add-on options such as Active Dataguard, Multitenant, etc. Interestingly, when questioned on the drivers for customers choosing the Autonomous Database in the cloud, Ellison stated that the increased productivity of the Autonomous Database has been the leading reason and not customers seeking lower costs as a result of closing data centers and reducing labor.
Mark Hurd added that they need to change the customer focus to shift their IT budget to Oracle’s R&D budget. As a result, Oracle customers will get to spend less while also getting all of this innovation at the same time. This is an interesting selling point, but it omits the fact that this will result in vendor lock-in which will allow Oracle to charge even higher fees downstream when these cloud deals come up for renewal. Safra Catz also added that the more customers Oracle gets on the Autonomous Database, the more the margins on their PaaS and IaaS businesses will begin to skyrocket.
The takeaway for customers is in understanding where Oracle is focusing its sales efforts, the long-term strategic value to Oracle for closing deals in these two products, and the leverage customers have when considering either one or both of these products. Also, understanding the longer-term implications of buying these solutions enables customers to evaluate and prioritize their negotiation objectives.
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