The stock of enterprise software giant Oracle (Nasdaq:ORCL) has certainly come alive this summer, but there's more than a little skepticism about the health and durability of the company's growth. While bulls think that engineered systems and Fusion applications will reignite (or at least maintain) growth, skeptics point to Oracle's soft organic growth and threats to its basic enterprise business model. The stock seems undervalued on a cash flow basis, though, and double-digit license growth should tip the balance to the bull camp in the short term.

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A Mixed Start to the Fiscal Year
It seems like there was a little something for bulls and bears alike in Oracle's quarter, as although the numbers were close to in-line, there were clearly some high and low points. Revenue fell 2% as reported, but climbed about 3% in constant currency terms, a result of about 3% shy of the average of sell-side guesses. New software licenses and cloud software subscriptions was solid (up 10% in constant currency) and software license updates and support grew 8% in constant currency, both a little better than expected. However, the 21% constant currency decline in hardware revenue was a meaningful disappointment.

Oracle made up for some of this with better profits. Gross margin was solid and operating margin was better than expected. Operating income rose 7% by GAAP accounting (or 15% in constant currency), while non-GAAP operating income rose 1% as reported and net income rose 6% (non-GAAP).

SEE: How To Decode A Company's Earnings Reports

Can Fusion Lead the Way?
Oracle didn't give quite as much detail this quarter as in past periods, but it looks like Fusion is ramping up (although it's a small part of the total today). Some bulls have put a lot of eggs in this basket, seeing it as Oracle's play on another generational shift in enterprise architecture. Certainly there will be ample competition - SAP (NYSE:SAP), Salesforce.com (NYSE:CRM), IBM (NYSE:IBM) and Workday are all gunning for the same business as Oracle, and this company could definitely use a stretch of sustainable improved organic growth. At the risk of exaggeration, this could be where Oracle either retains its standing in the enterprise market or where its rivals really do some damage.

Hardware and Legal not so Good
Although Oracle's software performance was solid (despite ongoing weakness in Europe), the hardware and legal situation aren't so good for the company. Apparently the company's "Exa-appliances" are showing good growth, and hardware is not core to the company's profitability, but this inconsistent (and frankly poor) performance raises questions about management credibility and execution. That could be particularly relevant given the seemingly endless trend of software-hardware convergence - if Oracle can't do better in hardware, does that create a bigger opening for rivals like IBM?

Oracle has also seen some legal setbacks recently. Hewlett-Packard (NYSE:HPQ) won its case against Oracle over Itanium support and software development, and some believe Oracle could be on the hook for as much as $4 billion if they cannot get the decision overturned. Elsewhere, while the company may have technically won a Java patent infringement case against Google (Nasdaq:GOOG), it looks like a pretty meaningless victory with no many changing hands.

The Bottom Line
Oracle still needs to re-establish that it can grow revenue at a meaningful rate without relying on expensive deals to goose the top line. At the same time, the company's margins are quite good, and the valuation (at least from a cash flow perspective) is not very demanding. Oracle looks about 30% undervalued on the basis of 5% forward free cash flow growth, a valuation that makes the stock worth consideration for those who think the company still has some tricks left up its sleeve in the enterprise software/IT market.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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