ORCL: Now What?

As a follow-up to the initial note (https://softwaremusings.substack.com/publish/post/82663905).

Since my initial note, the growth story has largely played out as planned and the stock has enjoyed a 50%+ run. Going into its annual CloudWorld conference and analyst day event in September, I thought i’d jot down some thoughts on risk/reward for the next 12 months.

(1) The stock is no longer cheap cheap.

Sure, 21x PE is a bit less than compared to Microsoft at 27x but we’re splitting hairs here. But more importantly, Oracle today is no longer a traditional software business where EBITDA converts to cash flow. Like other hyperscalers, the growth story going forward is contingent on datacenter capex. At a EV/FCF of over 40x, this is not a cheap name so the question is does capex spending yield growth significantly above and beyond others.

(2) I expect the business mix to heavily tilt towards infrastructure.

Sellside is roughly pegging the size of SaaS to IaaS at 2:1 today (~$13B vs. $7B). Given the ho-hum IT environment today, I think you can conservatively assume SaaS grows at 12% CAGR and with the momentum (as reflected in RPO growth) coming from the IaaS business. I’d assume IaaS can grow at least 45% CAGR over the next five years. Modeling this out yields a cloud business thats close to $70B in 5 years. Add in support, services and hardware and residual licenses, I dont think its difficult to imagine a $100B business (give or take a year on timing).

(3) The shift in business mix should = lower margin profile.

If you assume a mature SaaS business margin tops out around 75% and a scaled IaaS business tops out at 35% margin (keep in mind OCI does not have a mature PaaS ecosystem or products like AWS or Azure), then the blended cloud gross margin should be around 50%. Much higher mix of cloud + continued shrinkage of the 100% license business should yield significant margin compression even though dollars should be larger. This all assumes a fairly non eventful database migration story which if it actually played out could meaningfully move the needle (full databases moving to the cloud, their multi-cloud database partnerships with GCP and Azure, Vector etc)

Having said that, with some opex control (which they are known for), i dont think its hard to pencil in $11 of EPS

(4) But AI!

I take the view that AI for the near term is just a GPU game. Microsoft, AWS, OCI and GCP might as well re-brand themselves as “[Hyperscaler], an authorized Nvidia reseller”. The benefits are real as it shows up in the IaaS revenue in a big way but I dont expect there to be quantifiable benefits to the application layer. Fast forward a year, these are all going to be free features. Everyone will have it, and if you dont, your win rate goes down. If you do have it, great you can qualify for the RFP.

What will investors give it credit for?

The billion dollar question ultimately becomes how will investors value a business that MAY have upside on topline growth but lower margin profile?

If we assume a 20x PE on $11 EPS discounted back to today at a 12% WACC, we’re talking modest upside (15-20%).