Amid a diabolical concoction of rising rates, high inflation and fears of a recession, the tech sector few hiding places for investors†
The market is avoiding the fast-growing, profitable software stocks that propelled the industry during the pandemic. Consumer-oriented e-commerce and hardware inventories are dwindling, plagued by dwindling demand; social media takes a beating as ad buyers cut corners; and supply chain issues are hitting chip stocks. Nearly all tech stocks have fallen this year, with dozens discounting more than 50%.
In previous columns I have advocated betting on cloud computing, and I think the story will continue to be captivating. Such as recent earnings reports from
(GOOGL) made clear, the demand for cloud-based computing services is both massive and growing. The promise of the cloud—improved agility and reduced costs—is fundamentally changing the way every business handles computing.
In a research paper last week, Credit Suisse analyst Phil Winslow wrote that public cloud business spending should exceed IT spending on on-premises infrastructure by 2024. It is cloud computing, not just software, that is eating the world. Winslow argues that Wall Street underestimates the growth potential of Microsoft Azure. I see Microsoft and Amazon as the best long-term bets on the cloud.
But I also see opportunities in another cloud game that is still hiding in plain sight. In February 2021 I wrote a bullish cover story about
(ORCL), claiming that the enterprise database and applications company had quietly evolved into an underappreciated cloud story.
The company forced its customers to use cloud-based versions of its software, while also launching Oracle Cloud, a fledgling rival to the public cloud’s Big Three. Oracle’s move to the cloud was gaining traction, but investors didn’t notice. It turned out that Oracle was a great stock to own in 2021, rallying more than 70% by mid-December as its quarterly results showed steady progress on cloud strategy.
And then two things happened that blew up the stock. At the macro level, the technical sell-off was gaining momentum. As the sale kicked off with pandemic darlings like
Zoom video communication
(PTON), it quickly spread everywhere, and Oracle was not immune. But the bigger problem was Oracle’s announcement in late December of a $28 billion cash deal to buy Cerner, an electronic health record company that serves hospitals and healthcare systems.
Oracle has made many major acquisitions over time — PeopleSoft, Siebel, Sun Microsystems — but Cerner is the biggest deal ever. Oracle is strongly committed to the digitization of healthcare. It’s also a gamble that it could move Cerner’s software to the Oracle Cloud, yielding huge savings. While Oracle has said the deal will be an immediate boost to earnings, the transaction raises concerns about integration risk, requires Oracle to take on additional debt and moderates an extremely aggressive share buyback plan.
Since peaking just before the Cerner deal was announced, Oracle stock has fallen 38%, losing some $100 billion in market value.
Deutsche Bank analyst Brad Zelnick says Cerner’s acquisition casts some doubt on Oracle’s shift to the cloud, the reason behind the stock’s rally in 2021. The deal provided ammunition to the skeptics already worried about Oracle’s cloud commitment.
But over the past week, Oracle’s earnings new evidence provided that the transition is still underway.
For its fiscal fourth quarter ended May 31, Oracle reported revenue of $11.8 billion, up 10% when adjusted for currency, in the company’s best growth quarter since 2011. The figure beat the company’s own expectations. and Wall Street estimates.
Meanwhile, Oracle’s cloud business grew 22% in the quarter — and Oracle CEO Safra Catz told investors that cloud revenue growth should accelerate to 25% to 28% in the August quarter and 30% or more in fiscal 2023. (On Friday, it announced TikTok that it will send all its US user traffic to the Oracle Cloud.)
Oracle shares rose after the report and ended the week even higher, a rare success in an otherwise bleak week for equities.
Zelnick, who maintains a buy rating and a $110 target on Oracle stock — a potential return of 70% — says Oracle’s guidance involves continued high single-digit revenue growth for the overall company on a currency-adjusted basis.
While Zelnick admits that no company is immune from a deep recession, he believes other dynamics will tip the scales at Oracle in the coming months, paving the way for a stock rally. “They’re transforming their own business, they’re taking costs out of Cerner,” and, he says, “inflation is actually good for Oracle.” There are inflation-index-linked increases built into Oracle’s customer contracts, explains Zelnick. Meanwhile, Oracle software switching costs are so high that customers show little resistance to price increases.
The selloff in Oracle stock has made it cheap by most measures. At a recent $68, it is trading against less than 13 times Zelnick’s forecast for fiscal May 2023 earnings of $5.36 per share and less than four times its post-Cerner earnings forecast of just under $50. billion. On both measures, that’s less than half of Microsoft’s valuation.
If Oracle’s vision for cloud growth comes true, the stock should recover regardless of whether there is a recession.
write to Eric J. Savitz op [email protected]