After enjoying a strong 2017, Oracle (NYSE:ORCL) will be ending the year on a rough note. Its stock on Friday fell to its lowest price in six months in response to the release of its second quarter-earnings report.
The fact that Oracle’s stock price fell at all may appear confusing at first. As Oracle detailed, its GAAP net income rose by 10 percent, total revenues were up 6 percent, and non-GAAP Earnings per Share were up 14 percent to $0.70. Furthermore, all of these numbers surpassed investor expectations.
Nevertheless, Oracle’s stock fell as investors were concerned that its efforts to break into cloud computing have not reached expectations. Oracle’s total cloud revenue went up by 44 percent to hit $1.53 billion compared to expectations of $1.56 billion.
Missing the investor target by $0.03 billion may not seem like a huge problem, especially since Oracle’s cloud services still jumped by significant margins. But Oracle’s failure to meet expectations is just the small tip of a much larger iceberg.
The company may have grown a great deal just like every other large tech company in this bull market, but the decades-old tech giant needs to show that it is growing and keeping pace with new technologies like the cloud. If it cannot do that, where will it find new growth?
Too Little, Too Late?
As a legacy technology company, Oracle has fallen behind competitors such as Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) in offering cloud services and is trying to catch up. As businesses either grow more comfortable using the cloud or develop more products for it, the cloud market has grown in importance. Forbes contributor Louis Columbus reported that analyst firm Gartner found that worldwide cloud spending will hit $219.6 billion in 2017, and will then reach a staggering $411 billion by 2020.
As the cloud market grows in importance, it will crowd out other, obsolete technologies – such as the legacy database software which remains Oracle’s bread and butter. Those older sectors have stagnated thanks to the cloud. All of this shows that Oracle’s efforts are not just about finding new places to grow, but about making sure that the company does not become obsolete.
Oracle can point to its large cloud growth and declare that it will eventually catch up to Microsoft and Amazon. However, there are multiple problems. First, the cloud growth is somewhat augmented by how it is cannibalizing Oracle’s traditional database sphere. Oracle can turn to those companies with which it has signed its famous long-term contracts with and find a user base which will easily accept cloud technology. Oracle’s cloud sector grows as a result, but not Oracle as a whole.
But the bigger problem is that while Oracle’s cloud numbers grew in the second quarter, the rate of growth is lower compared to the previous quarter. As The Street points out, Oracle’s cloud app revenue grew by 62 percent and cloud growth was 51 percent in the August numbers, both higher than the previous quarter. Oracle could eventually find itself in the dangerous position of slowing growth in the cloud sectors while its legacy software crumbles away.
Sustaining Growth Elsewhere
If Oracle’s cloud numbers are a disappointment despite growing so much, then how did it manage to exceed expectations in revenue and net income? Could it look at the sectors where it did exceed expectations and aim for long term growth there?
Not really. Oracle beat revenue estimates because its traditional software license revenue actually rose from $1.25 to $1.35 billion accordingly. This surprising growth came about by Oracle’s Bring-your-own-license (BYOL) program, which forex brokers launched in September. This lets Oracle’s customers renew licenses and bring software to Oracle’s cloud. But as Rodney Nelson with Morning Star observes, the long-term viability of this strategy is uncertain because it lets other vendors such as Salesforce make inroads into Oracle’s consumer base.
A BYOL program cannot hurt Oracle, but its effectiveness should not take away from the fact that Oracle must succeed with the cloud to stay competitive. It cannot count on the traditional software license revenue in the long term like it did in this quarter.
The Threat of Amazon
When it comes to Oracle’s efforts to develop cloud technology, the fundamental question it needs to answer is why consumers should use them instead of Microsoft or the Amazon titan. Oracle has
been making strong efforts by hiring engineers and salespersons to work at developing their cloud network from scratch, and they have a long and loyal consumer base which they can count on to adapt their cloud system for now. But Oracle still has a long way to go in the cloud, and its current failures are critical because it must succeed here in order to remain a tech giant. The company has some room for further growth and should eventually bounce back from the current decline, but investors should wait and see how well Oracle’s cloud efforts succeed before making a move.