Oracle (ORCL) has long been admired for having a strong database offering but the cognoscenti truly appreciate their best of breed sales force that resemble sales marines, as Keith Block eloquently espoused in a leaked instant message. The culture started to change when Mark Hurd was hired by CEO Larry Ellison in September 2010 as co-President, along with Safra Catz, as member of the board of Oracle. Initially Mark Hurd garnered a stellar reputation by investors for turning around HP (HPQ) and consistently delivering upside to estimates. However, after departing HP due to a personal scandal, Hurd's reputation became sullied. Hurd was blamed for cutting costs to benefit near-term results while causing real long-term damage by foregoing much needed R&D investments. Mark Hurd's presence three years into his tenure at Oracle appears to be having a similarly adverse impact on Oracle's core sales force and its culture. Following almost unheard of back-to-back quarterly misses, including Q4 nonetheless, ORCL's stock is at best in the penalty box and dead money and at risk of 20% downside from current levels on continued poor execution and the heightened competitiveness from Workday (WDAY).
ORCL data by YCharts
Salesforce Changes Began Little Over a Year Ago...
Over a year ago, head of sales Keith Block left Oracle to join Salesforce.com (CRM) as President and Vice Chairman. Keith Block had a 26-year tenure at Oracle, an incredible accomplishment at any technology company, but more so at Oracle given the high pressure, hyper competitive culture under the legendary but enigmatic Larry Ellison. This past week top salesperson Tony Fernicola, who effectively ran the core database offering, left the company for... yup, you guessed it, Salesforce.com to rejoin Keith Block. News from Business Insider indicates and my sources corroborate that these ar! e not one-off poaches by Salesforce.com. My contacts indicate there has been widespread discontent about Mark Hurd. Turnover in software companies usually occurs during the fiscal first quarter, which happens to be now for Oracle; however, senior level departures of this magnitude are alarming. It appears that Mark Hurd may be disrupting the core strength of Oracle, its top-notch sales force. According to the Business Insider, three other vice president-level salespeople are also expected to leave the company. According to its source-
It's a bloodbath around here.
It appears the bloodletting is not over and I expect more departures over the coming weeks.
Back-to-Back Misses and in FQ4, Oracle is that you?
I have been investing in technology long enough to realize that salespeople are alpha dog creatures whose strong personalities inevitably lead to inter-personal clashes. Also like professional athletes in the post free agency era, top technology salespeople can be lured by a larger comp package, better software to sell and/or a better title. However, when Oracle missed back to back quarters with one being a fourth quarter it would be naive to not take notice. Oracle, like most other software companies, has a much easier time closing a quarter following a missed quarter given the larger pipeline from pushed out deals. When the missed quarter is a third quarter and the pushed out business flows into the fourth quarter it's incumbent upon the salesperson to close all these deals in order to achieve and exceed his/her quota triggering the big payouts. So when Oracle missed this past fourth quarter it was a red flag that something was changing for the worse at the company. Prior to this FQ4 miss Oracle had beaten the midpoint of its license guide every Q4 for the last 10 years by an average of 7%. This Q4 Oracle missed the midpoint of new license revenue on a constant currency basis by 5%. The last time Oracle missed back-to-back quarters was during the 2008/2009 financial c! risis and! even during that time it beat in FQ4.
Enemy of My Enemy is My Friend
A common proverb states that the enemy of my enemy is my friend. According to common wisdom, Oracle would never partner with Salesforce.com given Ellison's personal clash with former protege Marc Benioff. The old proverb rang true again this past June as Oracle and Salesforce.com announced a nine-year partnership whereby Oracle is integrating their Fusion Human Capital Management and financials cloud with Salesforce.com. In truth, insiders have dubbed the partnership smoke and mirrors with Oracle giving Salesforce great price breaks to prevent them from moving to open source competitor PostgreSQL. Others believe it was a savvy marketing ploy by Salesforce's CEO Benioff to greatly reduce its database costs. Bottom line, Salesforce seems to have given up little to gain price concessions as Oracle appears to be operating from a position of weakness and relative desperation. What company caused Larry Ellison to join forces with Salesforce.com, the firm he once labeled the "roach motel of cloud computing"? The answer- Workday.
Workday, the firm started by two former PeopleSoft executives, specializes in human resources and financials enterprise cloud software. Workday basically offers the cloud equivalent of what Oracle has amassed through its past acquisitions at a discount and in the cloud. Workday professes to save its customers 30-50% over a five-year period vs. on-premise, i.e. Oracle software. The savings come from reduced headcount whether in IT, HR, or finance department depending on the solution. According to a recent Morgan Stanley survey, 10% of Oracle customers are planning to migrate to Workday HCM and 29% while not using Workday are planning to evaluate Workday HCM vs. 2% and 23% 6 months prior, respectively. For financials, 5% of Oracle customers are planning to migrate to Workday while 29% are not using but planning to evaluate Workday vs. 2% and 23%, respectively. Workday founders are still p! eeved at ! having to sell PeopleSoft to Oracle and would like nothing more than causing Oracle major pain by taking their customers away as they move to the cloud. Workday has made considerable inroads with HCM already and is mounting a major campaign to ramp their financials offering by scaling to the Global 2000 within the next 12 to 15 months. Financials is a tougher application to develop as it requires more lines of code, a more complicated architecture, and is much more data intensive. Nonetheless, Workday is squarely focused on penetrating the Oracle customer base and taking their customers away as they upgrade to the cloud.
Workday has Captured HCM, Eyes Now on Financials
Workday has become the clear cut choice for companies who are looking to deploy a new human capital management (aka H.R.) solution especially when the company has decided on moving to the cloud. Human capital talent management and recruiting have been quick to move to the cloud while core HR where PeopleSoft (now Oracle) dominated has been slower given the sensitive nature of the information. Oracle's answer to current PeopleSoft or other application customers is their 'Fusion' offering which is an amalgamation of their application acquisitions over the years in a cloud offering. Unfortunately, clients are not very interested. According to a recent Morgan Stanley survey a staggering 52% of customers responded having already evaluated and passed on Fusion or no plans to evaluate, up from 35-40% in prior surveys.
| 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |
| Enterprise Asset Management | 1.0% | 1.4% | 1.7% | 1.9% | 2.1% | 2.2% | 2.3% | 2.5% |
| Financial Management Systems | 1.5% | 1.8% | 2.2% | 2.8% | 3.3% | 3.7% | 4.0% | 4.3% |
| Human Capital Management | 20.3% | 21.8% | 26.0% | 29.1% | 31.7% | 34.0% | 36.0% | 37.8% |
| Manufacturing/Operations | 1.0% | 1.2% | 1.5% | 1.8% | 2.0% | 2.2% | 2.5% | 2.6% |
| source: Gartner |
According to Gartner, 29% of Human Capital Management has moved to SAAS, well ahead of other subsets of ERP largely because of Workday's prowess. Given their high user satisfaction scores, Workday is on track to successfully parlay its HCM beachhead into the financial apps world. The largest subset of ERP is financial management systems at 41% of total ERP versus 30% for Human Capital Management. Due to the complexity of financial management vs. HCM code, i.e. millions of lines of rows of data vs. hundreds of thousand, and the more sensitive nature of the data, it has been much slower to move to the cloud (see chart above). Financial management SAAS is only at less than 3% of the total according to Gartner. Unfortunately for Oracle, Workday is focused on this area intently and plans to penetrate it en masse over the coming 1 to 2 years. According to a Piper Jaffray survey, 40% (21% in 2014 and 19% in 2015) of CIOs surveyed view Workday financials as a serious competitor to Oracle financials over the coming two years (see chart below).
(click to enlarge)
Beyond losing applications market share, Oracle risks losing its bread and butter database business that is pulled along by applications sales. When app! lications! are moved to the cloud, the SAAS provider buys the database infrastructure themselves instead of the apps customer directly. On the positive side, Oracle does have a database product cycle ahead of them with the 12c (cloud) database with multi-tenant functionality that could offset some of the secular headwind(s). More importantly, losing applications license sales means losing the inordinately profitable maintenance stream that Larry Ellison covets. Maintenance revenue, usually 12-15% of license revenue, continues to pour in for years after deals are signed at 90%+ margins. Losing maintenance revenue is what keeps Larry Ellison up at night and forces him to make partnerships with Marc Benioff.
Upside = Dead Money, Downside 15-20%
Oracle is in the midst of its seasonally weak fiscal first quarter that ends August 31st. After missing back-to-back quarters, Oracle issued normal seasonal guidance for FQ1 -60% sequential, representing 4% y/y at the mid-point. The positives for Oracle are back-to-back missed quarters means the backlog for the current quarter is that much bigger and there was no deliberate sales force reorganization this quarter, besides those running for the exit. If Oracle bounces on a "beat" I would use strength to short the stock as it approaches 12x '13 P/E, its long-term average multiple. I expect multiple contraction going forward as the secular headwinds are better understood by investors as forever changing Oracle's business model. At current levels, the stock trades at 11.5x FY'14 (MAY) EPS and sports a 1.5% dividend yield, not egregious but not cheap either for a company who has not been executing well and who faces numerous secular headwinds. My fair value price target is $27-29 or 10-11x FY'14/CY'13 EPS estimate, representing 15-20% downside from current levels. I would use Oracle as a portfolio short at current levels and add to the short on any rally on a FQ1 beat. One for its last three quarters isn't that bad, or is it? Sorry, Mark.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in ORCL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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