Well, on the heels of aggressive acquisition activity, Oracle has turned in another strong quarter.
ypically, a company that spends over $20 billion in the last four years to buy at least thirty 30 companies would drop off my screen for lack of balance sheet transparency.
However, Oracle's balance sheet surprises me -- it is clear and clean. For all of that activity, a single common class, no preferred stock, no off-balance sheet financing (aside from leases), and less than $6 billion in good old-fashioned debt. Such a solid balance sheet compels a deeper look into the valuation of the company.
Using ROIC to Assess Acquisitions
A proper fundamental analysis would still require a science project (e.g., several restructurings: you've got to wonder how much is tucked under the 'extraordinary' carpet).
In this situation, the best I can do is compute return on invested capital (ROIC). The reason I like ROIC here is that purchased goodwill is an asset. So by using ROIC, a metric that is closely related to return on assets (ROA), you are trying to get at the profit as a percentage of the total capital deployed in the business.
And, in this case, total capital includes almost $12 billion in goodwill (goodwill is the cumulative amount spent on acquisitions in excess of the "visible" assets).
If I run the latest ROIC for Oracle, I get an impressive 24.3%!
ROIC is earnings before interest and taxes (EBIT; a.k.a., operating profit after depreciation and amortization) divided by invested capital. Invested capital is total assets minus non interest-bearing current liabilities (NIBCLs).
Why do we subtract NIBLCLs? Total assets is equal to everything on the right-hand side of the balance sheet, which is equity plus long- and short-term debt plus other liabilities. By subtracting NIBCLs, we are excluding liabilities that are not really capital provided to the business (e.g., accounts payable). What remains is everything that is a source of financing for the business
Oracle's high ROIC metric tells me they are not just buying growth. They are certainly earning above their cost of capital. I don't want to get carried away and suggest Oracle would meet Warren Buffet's criteria for a value stock, but it's definitely interesting.
Moving Up the Value Stack
When I first become bullish on Oracle exactly one year ago (after five years of totally avoiding it), it was because of its enviable strategic position in the software industry. This is even more true today with the acquisition of Hyperion (a lot of value is going to get created in the business intelligence sub-sector).
Larry Ellison's (Oracle's CEO) trash talking gets old, I mean really old, but regardless of your view on him, he gets it right more often than not. Much of this recent bravado is, oh well, pretty much true. Oracle has strong offerings up and down the enterprise, and they seem be tying some of these acquisitions together better than expected.
The flagship grid computing database is growing into a monster market. The middleware products have been technically well-received. Finally, Oracle continue to pursue a smart vertical-market strategy (e.g., financial services, human resources, etc.).
As they implied on the recent conference call, industry-specific offerings cannot continue this current sizzling growth rate, but they ought be fast-growing for a long while. And, if indeed some corporate IT buyers do want to reduce the number of their IT vendors, a strong foothold in applications should benefit Oracle in middleware and database.
So, basically, Oracle has been buying application companies so they can knock on more corporate doors with the application offering and then downsell the down-the-stack stuff such as middleware and database.
The open-source threat remains, but I still don't think this is worth fretting over, yet. Oracle is doing the most important thing here -- moving up the value stack. But I also was intrigued that they've started to support Linux and even displaced Red Hat (NYSE: RHT) at Yahoo! (Nasdaq: YHOO). So far, regarding the open source threat, it's win some, lose some.
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