Oracle: Stagnant Growth, Surprising Returns at 16% Annually

According to a report by Bloomberg, Larry Ellison, the creator of Oracle, has surpassed Bill Gates to become the fourth wealthiest individual globally. While many people are familiar with Gates and his association with Microsoft, fewer are acquainted with Ellison and the Oracle corporation.

This discrepancy in recognition can be attributed to the nature of their respective companies. Microsoft operates as both a business-to-business (B2B) and business-to-consumer (B2C) entity, with its Office software being widely used by retail customers. In contrast, Oracle primarily focuses on B2B operations, offering software solutions to enterprises for managing various aspects of their businesses, including human resources, finances, and logistics. Consequently, retail customers are less acquainted with Oracle since they do not directly purchase these programs from the company and may not use them personally.

Although Oracle's specialization may seem niche, it is a massive corporation ranked as the 26th largest globally in terms of market capitalization. In the previous fiscal year, Oracle generated a substantial revenue of $42 billion, surpassing its rival SAP, which earned $33 billion. Moreover, Oracle's share price has experienced a notable increase of nearly 40% year-to-date, comparable to Microsoft's performance, while surpassing SAP's gain of 27%.

Following the announcement of its fourth-quarter results, Oracle experienced a further 4% increase in its stock price during extended trading. The company exceeded expectations in terms of both revenue and earnings. Notably, Oracle achieved a remarkable 76% year-on-year growth in its cloud infrastructure revenue, surpassing the growth rates of Amazon Web Services, Microsoft Azure, and Google Cloud.

Nevertheless, despite its commendable performance, Oracle currently commands a relatively modest share of the overall market, amounting to a mere 2%.

In order to bridge this gap and effectively compete with larger competitors, Oracle would need to achieve even more rapid growth in the coming years. This would likely entail substantial investments amounting to billions, similar to the approach taken by Google Cloud.

However, it should be noted that Google possesses greater financial resources to execute such a strategy, whereas Oracle may not be able to allocate funds on the same scale. Consequently, it is likely that Oracle will continue to operate as a smaller player in the cloud industry for the foreseeable future.

The primary source of revenue for Oracle continues to be its Enterprise Resource Planning (ERP) software suite. However, over the years, there have been numerous startups aiming to dismantle and provide specialized services within the ERP domain.

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Salesforce (CRM) has achieved notable success by focusing on customer relationship management, establishing a prominent leadership position in that particular area. Similarly, Workday (WDAY) targets HR and payroll functions, Intuit (INTU) Quickbooks specializes in accounting, MongoDB (MDB) offers an alternative tableless database service, Snowflake (SNOW) provides data warehousing solutions, Elastic (ESTC) aims to enhance internal search functionality, Twilio (TWLO) concentrates on communications, and Monday.com (MNDY) offers project management tools, among others.

With the rapid advancement of cloud technology and significant funding in the past decade, many of these startups have emerged as potential competitors. In fact, Oracle's long-term revenue growth has been relatively lackluster, averaging a mere 1.3% per year over the past decade. In comparison, SAP achieved a growth rate of 6.6%, while Microsoft demonstrated a more robust growth rate of 10.4%.

Oracle appears to be maintaining its existing customer base rather than experiencing growth. The company has established certain advantages that help protect its market share. One such advantage is its offering of an integrated service to clients. Instead of utilizing multiple different software applications, Oracle provides a single platform with a wide range of solutions that can be built upon. This integration allows for streamlined data sharing across departments and facilitates easier compilation of information for management review.

Additionally, many of the startups entering the market tend to target smaller enterprises by providing more cost-effective solutions. Fortune 500 companies, on the other hand, require a broader range of functionalities and prioritize integration over cost savings. Examples of this approach can be seen with Quickbooks and Monday.com, which are less likely to be utilized by larger companies.

Furthermore, the high switching costs associated with changing software vendors act as a barrier for large enterprises. Organizations are generally resistant to change, as switching systems introduces risks. There is always the concern that a new system may be less reliable, potentially leading to operational disruptions. Additionally, the possibility of cybersecurity vulnerabilities and the potential loss of customer data further increase the uncertainty involved in making such a switch. Consequently, if the current software is functioning adequately, enterprises tend to be hesitant to make changes.

These factors contribute to Oracle's continued presence in the market. The company's main focus lies in maintaining the functionality of its software and periodically adapting to industry changes, such as transitioning from on-premise to cloud-based solutions. However, achieving significant growth from this point onward will likely prove challenging, as has been the case over the past decade.

A peculiar aspect to note is the remarkable increase in Oracle's stock price, which has surged by 343% over the past decade, translating to an annual gains of 16%. However, when assessing the company's fundamental performance, these gains appear disproportionate. Over the same period, Oracle's revenue and earnings registered relatively modest growth rates of 1.3% and 2.1% per year, respectively.

The explanation for such substantial stock gains could be attributed to the substantial liquidity injected into the system by the Federal Reserve in the past decade. This influx of liquidity has resulted in a general upswing in stock prices, extending even to companies like Oracle. But that alone is not a reason to buy Oracle.