Here’s How Oracle Can Make Billions

Oracle (ORCL)“Put all your eggs in one basket — and watch that basket!”    –Mark Twain

In the past, Oracle Corporation (NASDAQ:ORCL) has put their eggs in two different baskets. In one basket, a massive market share in database and middleware products has placed their hardware segment in a different league than competition like Hewlett-Packard Company (NYSE:HPQ) and Microsoft Corporation (NASDAQ:MSFT), and has given them a comfortable competitive advantage (See why billionaire hedge fund manager Jim Chanos is shorting HPQ). The company’s second basket is its software business, which represents the largest slice of revenue. Larry Ellison, CEO of Oracle, has watched this basket like a hawk. Large companies are the typical customers for Oracle’s software business. Companies use their software to manage various tasks ranging from customer relationship management to enterprise resource planning.

Oracle’s hardware business, which comprised of 16% of 2013 first quarter revenues, has been a drag on financial results, but it strategically places them above competitors in the private cloud market (See Oracle’s earnings analysis). Hardware competitors like Hewlett-Packard and Microsoft just don’t have the same breadth when it comes to products. Competitors can’t offer the whole line of SPARC processors, operating, systems, databases, middleware, and application software like Oracle can.

As customers’ demands have shifted, cloud computing has become one of Oracle’s main focuses. In 2013, the software company plans to unveil its new 12c database program and its expanded line of high-end servers. The 12c database is designed for cloud computing (the c is for cloud) and made to handle an abundant amount of corporate data. Ellison described the new database Sunday during the OpenWorld conference. He stated that the 12c will feature support for multitenancy, providing superior security, control, and efficiency for software services delivered from the cloud. Multitenancy will allow companies to create multiple “pluggable” databases that reside in one database container, or separate memory and processes are allocated to each database. The 12c database has positioned the software company to be a major force in cloud computing. Ellison told analysts on a Sept. 20 conference call that the 12c database will arrive next year and will be able to serve multiple companies’ data-processing needs.

We expect that the shift to cloud computing will slowly roll Oracle’s eggs from their hardware to their software basket. Software sales accounted for 70% of 2012 sales, and with help from their acquisition strategy, sales have doubled in the past five years. Oracle hopes to continue that trend with the release of their new products, which are aimed at giving their clients more power in managing data. Major players in cloud computing, like, Inc (NYSE:CRM), are way ahead of Oracle. While Oracle has signed $1 billion in cloud-computing business agreements, trumps Oracle with $4.1 billion in signed contracts. Brent Thill, an analyst at UBS, has a buy rating on the shares and stated “Oracle’s a savvy company – they always figure out how to come from behind.”

Looking at competitors in each of their segments paints the picture of each segments life cycle, and is proof that Oracle will continue to see their software segment shadow hardware. Hardware companies like Hewlett-Packard Company and Dell Inc. (NASDAQ:DELL) are trading at 0.29 and 0.30 times their sales, and have profit margins of 4.54% and 5.01%. Software companies like Oracle and SAP (NYSE:SAP) are trading at 4.3 and 7.9 times their sales, and have profit margins of 27.55% and 23.44% respectively.

Companies on the cloud are being rewarded for their hindsight and have raked in impressive year-to-date returns. A few examples of year-to-date returns include Salesforce at 48.96%, SAP at 33.39%, and ORCL at 23.46%. It’s evident that the market views software as more lucrative than hardware, and we believe it’s only a matter of time until Oracle’s top brass shifts their focus entirely on this basket.