5 September 2017 Americas/United States Equity Research Software
Oracle Corporation (ORCL) Rating OUTPERFORM Price (31-Aug-17, US$) 50.33 INITIATION Target price (US$) 62.00 52-week price range (US$) 51.17 - 37.93 Transitioning Like There’s No Tomorrow Market cap(US$ m) 208,199 Target price is for 12 months. Initiating Coverage with Outperform Rating and $62 Target Price: Research Analysts Brad A Zelnick We believe the market underappreciates the staying power of Oracle’s 212 325-6118 technology stack and upside opportunities in the cloud. While traditional [email protected] financial metrics have lagged given a cloud transition, the stock is valued as if Jobin Mathew there’s no tomorrow, or no other side to the transition. Over the years, many 212 325 9676 [email protected] have bet against legendary founder Larry Ellison, but few have ever won. Syed Talha Saleem, CFA ■ Cloud ERP Opportunity: The cloud ERP opportunity is just now heating up, 212 538 1428 and ORCL is in pole position. Our field work suggests ORCL has the leading [email protected] cloud product in the largest of app software categories (ERP, $43bn in 2016) and an advantage given its incumbency. We size the Cloud ERP migration opportunity at $0.66 in recurring EPS, in addition to every five points of ERP share gain contributing $0.4 (currently at 8% share). ■ Database Durability: At 40% of revenue and a greater portion of profit, ORCL’s database lies central to our thesis. When considering the market for the world’s highest value transactional data, ORCL’s position is unwavering. With greater fragmentation of the market today, we expect ORCL to lose lower value units but more than compensate with innovation, pricing, and aggregation of adjacencies with DBaaS. We size the DBaaS migration opportunity at $3.61 in recurring EPS. ■ Aggregation Play: ORCL is our favorite aggregation play. We particularly like companies that can parlay dominant market positions into adjacencies to capture incremental wallet share. This has been a consistent strategy for ORCL over the years (M&A, Exa-series), and Cloud is just the latest chapter. ■ Valuation: Our $62 TP is based on our DCF analysis and equates to 20.0x CY18 P/E vs. 21.9x for MSFT and SAP at 19.2x. Risks to our target price include competition in the cloud and a failure to execute. Share price performance Financial and valuation metrics
5 5 Year 5/16A 5/17A 5/18E 5/19E NON-GAAP EPS (CS adj., ) 2.61 2.74 2.93 3.16 5 0 Prev. EPS (CS adj., US$) 4 5 P/E (CS adj.) (x) 19.3 18.4 17.2 15.9 4 0 P/E rel. (CS adj., %) - 87 90 93 3 5 Revenue (US$ m) 37,056 37,899 39,425 41,002 O ct - 1 6 Jan - 1 7 A p r - 1 7 Ju l- 1 7 Non-GAAP Operating Income 15,784 16,169 17,468 18,459 Net(US$ Debt m) (US$ m) -12,270 -8,169 -16,330 -25,215 O RCL.N S& P 5 0 0 IN D EX Unlevered Free Cash Flow 13,162 12,954 14,012 14,611
On 31-Aug-2017 the S&P 500 INDEX closed at 2471.65 Number(US$) of shares (m) 4,136.68 Price/Sales (x) 5.56 Daily Sep02, 2016 - Aug31, 2017, 09/02/16 = US$41.25 Net debt (Next Qtr., US$ m) -12,447.7 Dividend (current, US$) 0.8 Quarterly EPS Q1 Q2 Q3 Q4 Dividend yield (%) - 2017A 0.55 0.61 0.69 0.89 Source: Company data, Thomson Reuters, Credit Suisse estimates 2018E 0.60 0.68 0.73 0.91 2019E 0.67 0.75 0.79 0.95
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 5 September 2017
Oracle Corporation (ORCL) Price (31 Aug 2017): US$50.33; Rating: OUTPERFORM; Target Price: US$62.00; Analyst: Brad Zelnick Income Statement 5/16A 5/17A 5/18E 5/19E Company Background Revenue (US$ m) 37,056.0 37,899.0 39,424.7 41,001.7 Oracle is the second largest software company by revenue globally. EBITDA 18,293.0 18,620.0 20,265.6 21,190.0 The market leader in database software, Oracle offers an integrated Operating profit 15,784.0 16,169.0 17,467.9 18,458.9 array of applications, databases, servers, storage, and cloud Recurring profit 14,622.0 14,975.0 16,461.9 17,660.1 technologies designed to empower the modern business. Cash Flow 5/16A 5/17A 5/18E 5/19E Cash flow from operations 13,561 14,126 15,030 15,831 Blue/Grey Sky Scenario CAPEX (1,189) (2,021) (1,702) (1,763) Free cashflow to the firm 12,372 12,105 13,328 14,068 Cash flow from investments (5,154) (21,494) (1,702) (1,763) Net share issue(/repurchase) 1,336 2,181 0 0 Dividends paid (2,541) (2,631) (3,167) (3,183) Issuance (retirement) of debt - - - - Other (7,227) 3,803 (2,000) (2,000) Cashflow from financing activities (8,432) 3,353 (5,167) (5,183) Effect of exchange rates (115) (86) 0 0 Changes in Net Cash/Debt (140) (4,101) 8,161 8,885 Net debt at end (12,270) (8,169) (16,330) (25,215) Balance Sheet ($US) 5/16A 5/17A 5/18E 5/19E Assets Other current assets 2,591 2,837 2,837 2,837 Total current assets 64,313 74,515 75,586 81,787 Total assets 112,180 134,991 134,966 140,199 Liabilities Short-term debt 3,750 9,797 2,999 5,995 Total current liabilities 17,208 24,178 17,712 20,297 Long-term debt 40,105 48,112 46,995 40,300 Total liabilities 64,390 80,745 72,891 68,800 Shareholder equity 47,790 54,246 62,075 71,398 Total liabilities and equity 112,180 134,991 134,966 140,199 Net debt (12,270) (8,169) (16,330) (25,215) Our Blue Sky Scenario (US$) 71.00 Per share 5/16A 5/17A 5/18E 5/19E This scenario assumes continued transition to SaaS/PaaS/IaaS from No. of shares (wtd avg) 4,306 4,217 4,283 4,304 the on-prem offerings along with share gain and up-sell CS adj. EPS 2.61 2.74 2.93 3.16 opportunities, which results in UFCF growth of 20%/18% in the Prev. EPS (US$) medium term ('20/'21) Dividend (US$) 0.76 0.76 0.76 0.76 Free cash flow per share 2.87 2.87 3.11 3.27 Earnings 5/16A 5/17A 5/18E 5/19E Our Grey Sky Scenario (US$) 42.00 Sales growth (%) (3.1) 2.3 4.0 4.0 This scenario implies slowdown of the SaaS transition and EBIT growth (%) (9.3) 2.4 8.0 5.7 continued disruption in the database market from other cloud Net profit growth (%) (10.0) 2.9 8.7 8.3 vendors like AWS. In this scenario, UFCF growth is flattish in the EPS growth (%) (5.9) 5.0 6.9 7.8 medium term ('20-'21) EBIT margin (%) 42.6 42.7 44.3 45.0 Share price performance Valuation 5/16A 5/17A 5/18E 5/19E EV/Sales (x) 5.29 5.28 4.87 4.46 EV/EBIT (x) 12.4 12.4 11.0 9.9 5 5 P/E (x) 19.3 18.4 17.2 15.9 5 0 Quarterly EPS Q1 Q2 Q3 Q4 2017A 0.55 0.61 0.69 0.89 4 5 2018E 0.60 0.68 0.73 0.91 2019E 0.67 0.75 0.79 0.95 4 0 3 5 O ct - 1 6 Jan - 1 7 A p r - 1 7 Ju l- 1 7
O RCL.N S& P 5 0 0 IN D EX
On 31-Aug-2017 the S&P 500 INDEX closed at 2471.65 Daily Sep02, 2016 - Aug31, 2017, 09/02/16 = US$41.25
Source: Company data, Thomson Reuters, Credit Suisse estimates
Oracle Corporation (ORCL)2 5 September 2017
Table of contents
Key Charts 4
Executive Summary 5
Investment Positives 6 Aggregation Play ...... 6 Lawrence J. Ellison...... 6 Margins to Benefit from Cloud Transition ...... 9 Back to Traditional Metrics—We See an Inflection...... 10 Down Market Opportunity...... 11 Cloud Transition Could Be Material Positive to Revenues/EPS...... 12
Investment Risks 13 Database Share Erosion...... 13 License Revenue Volatility...... 15 Public Cloud Competition ...... 16
Markets 18
The Cloud ERP Opportunity 21 Meaningful Revenue Upside in Cloud ERP Migration ...... 24
Durable Database Business 27 Market Fragmentation at the Lower End ...... 31 12c R2 as a Driver?...... 34
Oracle Database User Survey 36
Management and Board 40 Management...... 40 Board of Directors...... 41
Valuation—Initiating with Outperform 44
Appendix 1: Credit Suisse HOLT® 52
Oracle Corporation (ORCL)3 5 September 2017
Key Charts
Figure 1: Many Tech Companies Have Term Limits, Figure 2: Oracle FCF Is Stabilizing and About to Oracle Has Showed Staying Power Return to Growth Indexed to peak market cap, first to peak brought to front Trailing Twelve Months (TTM) Free Cash Flow
Wang Labs DEC Novell CA IBM Oracle TTM FCF yoy $16bn 20%
10% $12bn
0% $8bn -10%
$4bn -20%
$0bn -30% F F F F F F F F F F F F 1 3 1 3 1 3 1 3 1 3 1 3 Q Q Q Q Q Q Q Q Q Q Q Q 1 1 1 1 1 1 1 1 1 1 1 1 2 2 3 3 4 4 5 5 6 6 7 7 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: Thomson Reuters Datastream, Credit Suisse Research. Source: Thomson Reuters Datastream, Credit Suisse Research.
Figure 3: Oracle Dominates the RDBMS Market with Figure 4: The RDBMS Sub-Market Has Added More 42% Market Share Dollars than Other Database Markets Market share of RDBMS Increase in respective Database Markets (2012 – 2016)
Others 7000 Amazon Web Services Teradata 7% 6000 1,644 2% 5000 SAP 3% 7% Oracle 4000 Relational Database 42% Management Systems 3000 (RDBMS): $31,120m 14% 4,746 IBM 2000
1000
23% 0 -477 -1000 Relational Database Management Systems Prerelational-era DBMS Semistructured DBMS Microsoft
Source: IDC, Credit Suisse Research. Source: Gartner, Credit Suisse Research.
Figure 5: Meaningful Opportunity in Cloud ERP Figure 6: Technology Business Turning a Corner
Opportunity from Share Gain in Cloud ERP
ORCL Share in ERP Today (A) 8%
Potential Steady State Market Share (B) 20%
Size of Market in 2020 ($mn, C) 54,250
Incremental Revenue Opportunity ($mn, D=(B-A)xC ) 6,456
Incremental Net Income ($mn) 4,198
Incremental EPS $0.99
Note: We assume 85% operating margin and 23.5% tax rate
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL)4 5 September 2017
Executive Summary Initiating with Outperform; Target Price of $62 Gives 24% Upside We are initiating coverage of ORCL with an Outperform rating and $62 target price, as we believe the current valuation underappreciates the durability of Oracle’s database business and overall aggregation opportunity. Oracle, more so than any other company we cover, has defied natural forces of obsolescence and maintained its relevance, if not dominance, across several technology paradigm shifts over the past several decades. While the success of any company rarely comes down to any one thing, one decision, or even one person, we attribute much of Oracle’s durability to the tenacious winning spirit, vision, and ingenuity of founder Larry Ellison. Along with every enterprise technology hype cycle over its 40-year history, pundits have prognosticated Oracle’s demise, only to be proven wrong. Oracle has consistently defied the conventional wisdom dictating that technology companies have their term limits. Common to Oracle’s strategy over time has been a drive to maximize share of customer wallet. We believe the cloud is no different in this regard when compared with prior success in consolidating the industry years ago through M&A as well as engineered systems and core database innovation. In our analysis, there is a margin of safety whereby the company can lose some lower end unit share in its respective markets and still drive significant dollar share gains through aggregation. Our $62 target price is based on the base-case scenario of our DCF analysis, in which FCF is expected to grow 12% a year in FY20/21 and then gradually transition to 2.5% a year in our terminal growth stage. Our target equates to 20.0x P/E (CY2018) vs. 21.9x for MSFT and SAP at 19.2x. Risks to our target include database share erosion, public cloud competition, and failure to execute.
Figure 7: ORCL Trades Relatively In-Line with the Peer Group P/E EV/FCF Price Market Cap ($mn) EV ($mn) CY1 CY2 CY1 CY2 IBM $143 133,295 140,145 10.4x 10.3x 12.4x 11.9x MSFT $75 575,897 529,110 24.0x 21.9x 18.0x 16.5x CSCO $32 161,052 124,277 13.4x 13.0x 10.1x 9.1x AAPL $164 847,097 693,920 17.3x 14.9x 12.7x 11.1x HPE $18 29,334 24,934 12.7x 13.6x NM 13.0x SAP $105 128,590 130,637 21.1x 19.2x 27.9x 23.9x Average 16.5x 15.5x 16.2x 14.3x ORCL $50 213,802 205,633 17.8x 16.3x 16.0x 15.1x ORCL TP $62 262,806 254,637 21.9x 20.0x 19.8x 18.7x
Source: Thomson Reuters, Credit Suisse Research, AAPL/MSFT have GAAP estimates (include impact of stock-based compensation)
Oracle Corporation (ORCL)5 5 September 2017
Investment Positives Aggregation Play Per our industry thesis, we see significant opportunity in identifying aggregation and disaggregation opportunities. Outsized returns have been garnered by identifying these forces ahead of others. In simple terms, an aggregation strategy involves selling a broader solution to the same customer by addressing adjacent requirements, thereby creating value for the end customer with a single source solution, pre-integrated, and generally with lower total cost of ownership. Straightforward examples of aggregation strategies include: ■ salesforce.com in the CRM market ■ Workday in the HCM market, as well as many other SaaS companies ■ Oracle’s engineered systems strategy ■ Check Point’s transition from selling software to appliances ■ VMware by consolidating x86 server capacity ■ Amazon and Microsoft relative to the entire infrastructure stack We believe the full-on thrust into cloud, in SaaS, PaaS, and IaaS, represents a significant aggregation play, as Oracle can capture incremental dollars and share of wallet, even without increasing unit share within its respective markets. We believe there’s real potential to do so, especially in Cloud ERP. We believe Oracle’s dominance at the high end of the relational database market is an advantage for consolidating adjacencies and capturing incremental wallet share. See our industry note titled [Buy Aggregation, Avoid Aggravation] for more details on aggregation strategies in software.
Lawrence J. Ellison We have the deepest respect for Oracle founder Larry Ellison and believe that he is truly a living legend, a visionary, and one of the fiercest competitors in the game. As the game changed, he has continued to change with it and continued to win. Countless times, many have predicted Oracle would succumb to various threats du jour, yet the company has thrived and emerged stronger than before. When the game was about sales and marketing, Larry oriented the company to outsell what some would argue were better technologies, like Sybase. When the game was about consolidation, he rolled up over 60 companies in a little over a decade, starting in earnest with PeopleSoft in 2004, and he created value for customers and shareholders in doing so. When it was about innovation, which arguably it always has been, he drove to attain the best database technology in the market, far and away, with breakthroughs such as row level locking, RAC, and now in-memory and multitenant capabilities. It is said that technology companies have their term limits, but we recognize Oracle’s staying power and attribute much of it to Mr. Ellison’s winning spirit. From an investor perspective, we would be pleased to align with the company’s largest shareholder, holding 27% of outstanding equity.
Oracle Corporation (ORCL)6 5 September 2017
Figure 8: Many Tech Companies Have Term Limits… Figure 9: …Oracle Has Showed Staying Power Indexed to peak market cap, first to peak brought to front Indexed to peak market cap, last to peak brought to front
IBM Oracle CA Novell DEC Wang Labs Wang Labs DEC Novell CA IBM Oracle
1973 1978 1983 1988 1993 1998 2003 2008 2013 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: Thomson Reuters Datastream, Credit Suisse Research. Source: Thomson Reuters Datastream, Credit Suisse Research.
Figure 10: ORCL and MSFT Stand Out in This Age Indexed to peak share of global tech market cap
Peaked before 1990: Peaked between 1990-2000: Peaked after 2000: Wang Labs, Xerox, IBM, DEC, Unisys, Novell, BMC & Microsoft & Tandem computing, Data General & Prime Computer Associates, Oracle
1975 1980 1985 1990 1995 2000 2005 2010 2015
Source: Thomson Reuters Datastream, Credit Suisse Research.
Leading Database Oracle’s database is that good: it is the company’s crown jewel with leading market share, and it still accounts for a vast majority of operating profit. The most mission critical data in the world lives in Oracle databases. Even Oracle rival SAP, the leading enterprise application software company in the world, is installed more on Oracle’s database than its own, which has been available in earnest for the past seven years (first product shipped in 2010). The company has consistently innovated and remains ahead of the competition when it comes to product quality, in our view. Bears will suggest Oracle is losing share in database, and we agree this is marginally accurate at the lower end of the market, where the product probably shouldn’t be used in the first place (the analogy of driving a Ferrari to go around the block). We see cloud-native options in the market like Amazon’s Aurora as almost entirely incremental and not competitive with Oracle’s core use cases. We believe in the durability of this business and upside potential from aggregation by selling Platform as a Service. We size Oracle’s opportunity to convert its existing installed base to PaaS at an incremental $27 billion in revenue and $3.61 in EPS. See the section of this report titled Durable Database Business.
Oracle Corporation (ORCL)7 5 September 2017
Data Gravity While many sensational headlines focus on public clouds taking over the world, we appreciate not only that Oracle’s largest enterprise customers are moving more slowly than everyone else, but that data gravity is on Oracle’s side. Take the recently announced deal whereby AT&T will migrate over 10,000 of its Oracle databases to the cloud. We believe several hundred of those databases are in excess of 5TB in size and constitute ~80% of AT&T data. While we would expect AT&T to have access to the fastest networks available, most customers are not AT&T. Figure 11 shows the difficulty of moving data across the Internet. This dynamic is driving growth in Edge computing, where many are now realizing that perhaps not everything goes to the cloud, especially workloads that require near instantaneous decisions be made on large amounts of data.
Figure 11: Upload Time to the Cloud for Various Amounts of Data at Various Speeds from Google; The More Purple the Color, the More Strongly Google Recommends a Physical vs. Online File Transfer
1 Mbps 100 Gbps
1 GB 3 hours 18 minutes 2 minutes 11 seconds 1 second 0.1 seconds
30 hours 3 hours 18 seconds 2 minutes 11 seconds 1 second
12 days 30 hours 3 hours 18 minutes 2 minutes 11 seconds
124 days 12 days 30 hours 3 hours 18 minutes 2 minutes
10 TB 3 years 124 days 12 days 30 hours 3 hours 18 minutes
34 years 3 years 124 days 12 days 30 hours 3 hours
340 years 34 years 3 years 124 days 12 days 30 hours
3,404 years 340 years 34 years 3 years 124 days 12 days
100 PB 34,048 years 3,404 years 340 years 34 years 3 years 124 days
Source: Google, Credit Suisse Research.
Finally, it is not just data gravity working to Oracle’s advantage but the sheer amount of PL/SQL code that lives in Oracle databases, which would be insurmountable to re- platform.
Time-Tested Strategy While many see the cloud as an entirely new challenge for Oracle, we see the company’s strategy as very consistent. Oracle has always solved for maximizing share of customer wallet. The industry consolidation strategy was an example of this, as was the move into engineered systems. Along with cloud, the common theme is consolidation of adjacent markets. This is no different than the era of Exadata or the wave of 90+ companies Oracle has acquired since 2015. It also follows Oracle’s core database strategy in selling innovative options and features that drive down the customer’s total cost, making hardware more efficient, reducing labor, and optimizing TCO. This has been Oracle’s playbook for years; Cloud is just the next chapter.
Oracle Corporation (ORCL)8 5 September 2017
Figure 12: Oracle Outperformed S&P500 with Wallet Share Maximizing Strategy Stock Performance Indexed to S&P 500 (2004 – 2011)
350 ORCL S&P 500 The 'Exa' Years
300 ) %
( The Years of Consolidation
e
c 250 n a m r
o 200 f r e p
k 150 c o t S 100
50
0 4 5 6 7 8 9 0 1 5 6 7 8 9 0 1 4 5 6 7 8 9 0 4 5 6 7 8 9 0 0 0 0 0 0 0 1 0 0 0 0 0 0 1 1 0 0 0 0 0 1 1 0 0 0 0 0 0 1 ------r r r r r r r c c c c c c c n n n n n n n n p p p p p p p a a a a a a a e e e e e e e u u u u u u u u e e e e e e e J J J J J J J J M M M M M M M D D D D D D D S S S S S S S
Source: Thomson Reuters, Credit Suisse Research.
Margins to Benefit from Cloud Transition Oracle has delivered in excess of 40% non-GAAP operating margins for the past 12 years, reaching as high as 47% in fiscal 2013 and 2014 and completing the most recent year at 43%. The more recent dip reflects the impact of cloud transition on the financial model, and traditional metrics should continue to improve in F2018 and beyond. Aside from the many benefits of cloud that are woven throughout this report, we point out the upside potential from incremental scale and efficiency in sales and marketing. Especially on the technology side of Oracle’s business, there had always been a need in the on-premise world to re-sell the customer a new enterprise license agreement (Oracle ULA, or Unlimited License Agreement) every three, four, or five years. With DBaaS, as customers require additional capacity, we envision S&M efficiencies in the cloud that we expect will contribute to operating margins.
Figure 13: Operating Margins Have Been Stabilizing Despite the Cloud Transition Key Operating Metrics
Revenue %Sales & marketing/revenue Operating margin
47.3% $38.4bn 46.2% 47.3% 45.5% 50% 42.6% 42.7% 38,305 $38.0bn 38,253 40% 37,899 $37.6bn 30% 37,221 37,253 20.7% 20.9% $37.2bn 20% 19.5% 18.8% 19.1% 19.3% 37,056 $36.8bn 10%
$36.4bn 0% 2012 2013 2014 2015 2016 2017
Source: Company data, Credit Suisse Research.
Oracle Corporation (ORCL)9 5 September 2017
Back to Traditional Metrics—We See an Inflection Somewhat plaguing the stock from 2014 to 2017 has been the shift to cloud and confusion created by having too many different metrics. Some of the more successful cloud transitions, like Adobe, set long-term guidance and educated the investor base on what to expect. We believe Oracle could have done a better job at this, but hindsight is 20/20. It appears to us there had been debate within the company on how far and how fast to drive a transition, and we believe it was that hesitation that caused the stock to languish. The good news is that we believe the model is finally coming out the other side of this transition and the leading indicators are becoming much simpler. We will look to EPS, free cash flow, and ecosystem revenue growth to gauge the company’s success, and we believe the story and financials become a lot cleaner at this point. The good news is that after several years of taking a near-term hit to these traditional metrics, the payback is the cumulative build in recurring revenue from the cloud.
Figure 14: ORCL Estimate Revisions Have Been Figure 15: ADBE Estimate Revisions Have Been Negative Positive
48,000 Larry Ellison announced Oracle 11,000 Public Cloud in late 2011 10,000 FY19 46,000 9,000 Adobe announced their 44,000 cloud intentions in FY18 8,000 November 2011 42,000 FY19 7,000 FY17
40,000 6,000 FY18 FY16 5,000 FY15 38,000 FY12 FY15 FY13 FY14 FY14 FY16 FY17 4,000 FY11 FY12 FY13 36,000 FY10 3,000 34,000 2,000 2010 2011 2012 2013 2014 2015 2016 2017 2007 2009 2011 2013 2015 2017
Source: Thomson Reuters, Credit Suisse Research. Source: Thomson Reuters, Credit Suisse Research.
Looking at LTM FCF for the last 16 quarters, we see that FCF trends have stabilized.
Figure 16: FCF Is Stabilizing and About to Return to Figure 17: Recurring Revenue Mix Increasing Driven Growth by the Cloud Transition Trailing Twelve Months (TTM) Free Cash Flow Recurring revenues now account for 72% of the total revenues
TTM FCF yoy % Recurring revenue % Non-recurring revenue $16bn 20% 100%
10% 32% 28% $12bn 39% 36% 80% 46% 43% 40% 0% $8bn 60% -10% 40% 68% 72% $4bn 61% 64% -20% 54% 57% 60% 20% $0bn -30% F F F F F F F F F F F F 1 3 1 3 1 3 1 3 1 3 1 3
Q Q Q Q Q Q Q Q Q Q Q Q 0% 1 1 1 1 1 1 1 1 1 1 1 1
2 2 3 3 4 4 5 5 6 6 7 7 2011 2012 2013 2014 2015 2016 2017
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 10 5 September 2017
Increasing Recurring Revenue Mix While this may seem somewhat intuitive, this is one of the benefits of transitioning to the cloud: a more predictable financial model. We believe this justifies a premium to a business that is otherwise dependent on large lumpy license deals. Oracle still has and will have that exposure, but the mix is clearly shifting more favorably.
Down Market Opportunity The opportunity for Oracle has been squarely focused on the large enterprise segment of the market since the company’s inception. The midmarket has always seemed obvious yet elusive, as Oracle has a poor track record in capturing it. The bad news is that it has never been successful selling the small and medium enterprise, but the good news is that it remains an opportunity and the story has only gotten better. Firstly, cloud is a democratizing force that theoretically enables adoption regardless of scale. Secondly, with recent acquisitions Netsuite and Textura, there is more experience to lead with than in the past. Lastly, Oracle has evolved its distribution model to better scale down, including everything from investing in new regional sales hubs to programs like the Accelerated Buying Experience, which streamlines the contracts and purchasing process. We note that according to the U.S. Census Bureau, roughly half of employment in the U.S. is at companies with 1,000 or fewer employees, a market segment in which Oracle hasn’t had much traction historically.
Figure 18: Plenty of Opportunities for Oracle in the SMB Market… US Census Bureau Details of Employment % of Total Cumulative % of Firm Size Firms Establishments Employment Employment Total Employment 1 to 4 2,832,845 2,835,890 5,974,204 5% 5% 5 to 9 1,019,909 1,030,539 6,722,195 6% 11% 10 to 19 605,354 636,898 8,251,287 7% 18% 20 to 49 379,912 464,227 11,679,693 10% 27% 50 to 99 117,232 206,319 8,189,227 7% 34% 100 to 249 64,955 210,733 9,982,196 8% 43% 250 to 499 19,586 138,585 6,726,563 6% 48% 500 to 999 9,664 122,584 6,457,373 5% 54% 1,000 to 2,499 5,923 151,187 8,435,352 7% 61% 2,500 to 4,999 2,285 129,326 6,791,162 6% 67% 5,000 to 9,999 1,291 121,939 6,794,173 6% 72% 10,000+ 1,370 673,099 33,099,485 28% 100%
Source: Census Bureau, Credit Suisse Research.
Adaptive Intelligent Applications All applications are becoming more intelligent, and largely speaking, enterprise apps are lagging what is found in the consumer realm. We are firm believers in the opportunity to narrow the gap between consumer and corporate app experiences, with the future pointing to more easy-to-consume, data-driven applications. Oracle, first and foremost a data company, is well positioned to deliver on this. Announced at OpenWorld one year ago was this new category of decision science and data-driven cloud apps. We see this as differentiated and helping to drive market share gains.
Oracle Corporation (ORCL) 11 5 September 2017
Figure 19: Adaptive Intelligent Apps from Oracle—A Competitive Differentiator
Source: Company data, Credit Suisse estimates.
Customers Love to Hate Oracle Oracle has historically been a company that customers love to hate. As investors, we’ve always appreciated this and felt it was a good sign. The sentiment reflects product strength and pricing leverage, specifically in relational database. With margins in the software industry far greater than just about all others, it is important to be able to command price by justifying value, which is something Oracle has historically been able to achieve. We have heard countless stories from the field of customers looking to wean themselves off of Oracle to only find themselves increasing their spend with Oracle to in turn save elsewhere within the IT budget (hardware, labor, etc.).
Cloud Transition Could Be Material Positive to Revenues/EPS If Oracle is successful in defending its large installed base of customers and migrating them to the cloud, this could result in meaningful upside to revenues/EPS. At the end of FY17, Oracle had $19 billion in on-premise support revenue across its business. We estimate 65-70% of this mix derives from the database and middleware business, with the remaining from applications. Oracle began the transition to applications earlier, given the annualized SaaS business is now worth $4+ billion. The database transition is still early, and Oracle has disclosed its DbaaS business being at a $100m+ annual run rate for a few quarters now. Oracle expects the cloud business to be worth 3x maintenance revenues, given better TCO on the cloud products. Assuming Oracle can execute, patient investors will be rewarded for being on the right side of this massive transition that lies ahead. We analyze and size the opportunities for SaaS and PaaS in the Cloud ERP and Durable Database sections of this report, respectively.
Oracle Corporation (ORCL) 12 5 September 2017
Figure 20: SoundBytes—On-premise Business Is Stabilizing, While Cloud Continues to Grow
Brad Zelnick Software SoundBytes (212) 325 6118 [email protected] Oracle: On-Premise Business
“On premise business isn’t falling off the way it was few years ago, that’s a positive…. A lot of clients were doing practically nothing on prem, trying to figure out their cloud strategy. Now Oracle is pitching flexibility, structuring deals where the customer can go back and forth [cloud/on prem], it’s taking heat off a lot of clients”
“We’re seeing prodigious jumps in cloud, but also seeing support and license maintained”
“On support - slightly more leeway on annual support on reducing uplifts, in the past they were impenetrable – I’d say more recently they’ve given some flexibility there, but not much, perhaps reducing 3-4% uplift to 1-2%”
“We’re selling a lot more on prem stuff, but the biggest explosion is cloud deployments.”
“Oracle is maintaining more of its support steam than we would have predicted, and customers like the flexibility of being able to move back & forth into the cloud.”
Source: Company data, Credit Suisse estimates. Investment Risks Database Share Erosion Oracle database has been a Swiss Army knife in the IT toolkit for decades and often times utilized for requirements beyond core OLTP, for which it is so strong. Understanding this risk requires appreciation of the historical adoption pattern. The enterprise would always have a portion of workloads for which Oracle was the only solution, with basically no alternatives.
Figure 21: Leading Databases Have Declined in Figure 22: …as the Market Has Become More Popularity… Fragmented
100% 24% Concentration index of database popularity 22% 80% Other 20% 60% MSFT SQL Server 18%
40% 16% MySQL 14% 20% Oracle 12% 0% 2 3 4 5 6 3 4 5 6 7 3 4 5 6 7 3 4 5 6 7 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------10% v v v v v y y y y y b b b b b g g g g g a a a a a o o o o o e e e e e u u u u u 2012 2013 2014 2015 2016 F F F F F N N N N N A A A A A M M M M M
Source: db-engines.com, Credit Suisse Research. Source: db-engines.com, Credit Suisse Research.
Oracle Corporation (ORCL) 13 5 September 2017
In large enterprises, the typical adoption pattern had been to engage in an enterprise license deal whereby the customer is incentivized to use Oracle for not only the must-have workloads, but for others for which technologically it could have done with a lesser alternative (SQL Server, MySQL, etc.) But standardization made sense as the incremental cost to deploy was basically zero, and having one standard skillset for development, deployment, maintenance, etc. saved money. Today there are more lower-end alternatives than ever before, and the value of standardization is less compelling. A developer can very quickly watch an online training video and be off and running with the next greatest NoSQL cloud service. For this reason, we believe Oracle will likely lose unit share of the market, though we are comfortable in its ongoing ability to monetize the high end. An example of this is the recent AT&T deal for PaaS, discussed in the Durable Database Business section of this report.
Product Strength, Services? …Not So Sure… Oracle is one of the most respected software product companies in the world, as demonstrated by its sheer mass and longevity. It was built on selling licenses and related support and maintenance. We are not completely convinced that Oracle has proven itself to provide service levels akin to leading companies like Amazon or salesforce.com. As an example, we have been customers of AWS for several years and compare it with the experience of Oracle’s public cloud service. Suffice to say, we’ve never received anything like this from Amazon, but in fairness this is a managed service vs. pure infrastructure. See Figure 23.
Oracle Corporation (ORCL) 14 5 September 2017
Figure 23: Oracle Is Known as a Great Product Company
Source: Oracle Corporation, Credit Suisse estimates.
License Revenue Volatility We believe license revenue is of less relevance going forward but acknowledge it can still result in some volatility in quarterly results. We expect this risk decreases as the mix shifts to more recurring revenue. In hindsight, we argue license revenue was not the pure leading indicator investors believed it to be even before cloud has become such a meaningful contributor to the mix. With a significant portion of license revenue derived from renewable enterprise agreements, we are not sure it was a reliable indicator of true new business for many years. We will look at Cloud ARR, total revenue, ecosystem revenues, deferred revenues, and cash flow.
Oracle Corporation (ORCL) 15 5 September 2017
Figure 24: Cloud Transition Has Caused a Pause in Revenue Growth and FCF in the Near Term FCF and Non-GAAP Revenue Growth
$15bn Free Cash Flow Revenue Growth (y/y) 4% 14,341 3% $14bn 13,574 3% 2% 2% 12,945 $13bn 1% 12,372 12,105 0% 0% $12bn 0% -1%
-2% $11bn -3% -3% $10bn -4% 2013 2014 2015 2016 2017
Source: Company data, Credit Suisse estimates.
Public Cloud Competition More so than ever, we believe Oracle is playing from behind, negative selling against players it cannot conceivably catch up with in the public cloud. It is clear that Oracle will have a place in a multicloud world as exemplified by the recent AT&T and Bank of America deals, though we do not expect Oracle to be a real player outside of Oracle-related workloads. Conceptually, it has many advantages in its own realm, specifically a tremendous installed base and ability to deliver differentiated services and features related to its own IP. In the chart below, we look at data from Cloudscene that analyze cloud on-ramp data for eight public cloud service providers, including Amazon Web Services, Microsoft Azure, Google Cloud, and Oracle Cloud, among others. The data center industry is seeing a rise in enterprise customers demanding private, direct connections via colocation data centers. Cloud on-ramps measure the number of connections each public cloud provider has with colocation data centers. AWS understandably holds the top spot with 33% of all connections, while Oracle Cloud holds the bottom spot. We think this illustrates the difference in Oracle’s cloud presence, as proxy for ambition, versus the leaders.
Figure 25: Oracle Ranks Last Among Public Cloud Figure 26: Oracle Capex Is Trailing AWS and MSFT, Peers in # of On-Ramps the Leading Public Cloud Vendors Estimated mix of Global Cloud On-Ramps by Public Cloud Vendors Capex Spend by Public Cloud Vendors
Rackspace, 3% Oracle Cloud, 3% ORCL MSFT AWS Alibaba Cloud, 4% $10.0bn VMware vCloud 4% Amazon Web 6% Services $8.0bn 33% Microsoft Azure Global Cloud $6.0bn 15% On-Ramp Mix by Vendor $4.0bn
16% $2.0bn 20% IBM Softlayer Google Cloud $0.0bn 2011 2012 2013 2014 2015 2016 Platform
Source: Cloudscene, Credit Suisse Research Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 16 5 September 2017
Oracle’s IaaS strategy appears to be an evolution of Oracle On Demand, which was a hosting solution, evolved. For some customers/architecture, it will make sense: more isolation, bare metal analog, with reliability and fault tolerance as priorities. It appears to be a great platform for anything within the Oracle stack. We believe Oracle’s capex relative to Amazon and Microsoft speaks to its ambitions in the IaaS market, regardless of management commentary suggesting technological efficiency.
The greatest driver of IT demand appears to be from workloads that don’t require five 9’s availability with transactional consistency. Think social media, digital marketing, even data science and discovery applications. We believe much of this, however, is incremental opportunity rather than cannibalizing Oracle’s core.
Non-Strategic Partner According to company EVP Douglas Kehring, Oracle had traditionally had an antagonistic relationship with its customers: The way I look at it is we really moved from being an antagonistic type of relationship with the customer to being a strategic partnership type of arrangement because when I say antagonistic, the notion is as we went through and once you'd selected the technology, all of a sudden we're at odds with each other. The whole contracting practice was about trying to get the best terms possible for each of our companies as we thought about the sale of this multimillion dollar type of license. - EVP Douglas Kehring, OpenWorld Analyst Day, September 22, 2016 We are not entirely convinced Oracle has been able to pivot its customer perception that easily. IBM and SAP, for example, have more generally been viewed as strategic partners within very large enterprises. Oracle has generally been viewed as having draconian business practices, and we believe there is a risk customers look to diversify away from Oracle in places where they can.
Architectural Shift As customers journey into the cloud, many are reassessing old decisions and going back to market to look at alternatives. In some cases, the benefits of cloud are so compelling that customers are accelerating depreciation on prior investments to get there. At the same time, we believe Oracle’s value proposition in the cloud to be compelling, and in some cases (database, ERP) uniquely positioned in the market. Lastly, if one believes there’s a future in edge computing, which we personally subscribe to, then perhaps the cloud really is just water vapor as founder Larry Ellison once so famously suggested.
Lawrence J. Ellison With the deepest of respect, we recognize Mr. Ellison is 72 years old and we hope he will live another 72 years. It is also our understanding that he remains well engaged in the business, is the largest single shareholder, and continues to drive strategy as he always has. That all said, we view Ellison as the heart and soul of Oracle and believe there is some degree of key man risk that should not be overlooked.
Oracle Corporation (ORCL) 17 5 September 2017
Markets Oracle is a market heavyweight across the data management spectrum. Figure 27 features a table of revenue, growth, and market share across all the IDC secondary markets in which Oracle competes. We calculate that Oracle’s Total Addressable Market will be $244 billion in 2020. In our calculations of TAM below, we have included only those markets in which Oracle has 5% market share or greater.
Figure 27: Oracle Is a Leading Vendor in the Database Market and Has Decent Presence in Application as Well
Secondary Metric 2012A 2013A 2014A 2015A 2016A Market 2016- Market 2020E CAGR*
Structured Data Management Company Revenue ($) $13,497 $14,224 $14,607 $13,928 $14,015 Software Growth (%) 5.4% 2.7% -4.6% 0.6% 8.3% Market Share (%) 36% 36% 35% 33% 31% Enterprise Resource Company Revenue ($) $4,578 $4,612 $4,726 $4,702 $4,771 Management (ERM) Applications Growth (%) 0.7% 2.5% -0.5% 1.5% 6.6% Market Share (%) 10% 10% 9% 9% 9% Customer Relationship Company Revenue ($) $2,698 $2,772 $2,927 $2,758 $3,093 Management (CRM) Growth (%) 2.7% 5.6% -5.8% 12.2% 9.1% Applications Market Share (%) 12% 11% 11% 9% 9% Company Revenue ($) $2,370 $2,415 $2,422 $2,271 $2,185 Application Platforms Growth (%) 1.9% 0.3% -6.2% -3.8% 6.8% Market Share (%) 21% 20% 19% 18% 17% Operations and Manufacturing Company Revenue ($) $1,298 $1,294 $1,340 $1,198 $1,216 Applications Growth (%) -0.3% 3.6% -10.6% 1.5% 6.6% Market Share (%) 3.2% 3.1% 3.0% 2.7% 2.6% Supply Chain Management Company Revenue ($) $998 $1,095 $1,139 $1,148 $1,169 (SCM) Applications Growth (%) 9.7% 4.0% 0.8% 1.8% 5.9% Market Share (%) 13% 13% 13% 14% 13% Data Access, Analysis, and Company Revenue ($) $1,041 $1,065 $1,087 $1,063 $1,039 Delivery Growth (%) 2.2% 2.1% -2.3% -2.2% 7.8% Market Share (%) 7.3% 7.0% 6.8% 6.5% 6.0% Company Revenue ($) $836 $794 $798 $763 $744 Content Applications Growth (%) -5.0% 0.4% -4.3% -2.5% 8.6% Market Share (%) 2.6% 2.3% 2.2% 2.1% 1.9% Integration and Orchestration Company Revenue ($) $593 $607 $608 $572 $564 Middleware Growth (%) 2.4% 0.2% -6.0% -1.4% 7.9% Market Share (%) 7.2% 7.1% 6.8% 6.6% 6.2% Company Revenue ($) $470 $502 $513 $486 $472 Security Software Growth (%) 6.7% 2.2% -5.2% -3.0% 7.1% Market Share (%) 2.3% 2.4% 2.3% 2.1% 1.8% Company Revenue ($) $563 $487 $465 $403 $404 System Software Growth (%) -14% -4% -13% 0% -1.0% Market Share (%) 1.5% 1.2% 1.1% 1.1% 1.2% Company Revenue ($) $159 $158 $158 $154 $155 Engineering Applications Growth (%) -0.6% -0.2% -2.2% 0.8% 5.3% Market Share (%) 1.0% 0.9% 0.9% 0.9% 0.9% Company Revenue ($) $89 $112 $121 $126 $153 System Management Software Growth (%) 26% 8% 4% 21% 7.3% Market Share (%) 0.5% 0.6% 0.6% 0.6% 0.7% Application Development Company Revenue ($) $90 $77 $74 $67 $64 Software Growth (%) -14% -4% -10% -4% 3.4% Market Share (%) 1.5% 1.3% 1.2% 1.1% 1.0% Company Revenue ($) $21 $21 $22 $21 $22 Storage Software Growth (%) 2.3% 2.1% -3.0% 1.1% 4.8% Market Share (%) 0.1% 0.1% 0.1% 0.1% 0.1% Company Revenue ($) $16 $16 $16 $15 $15 Quality & Life-Cycle Tools Growth (%) -1.6% -0.7% -4.1% 2.5% 5.1% Market Share (%) 0.4% 0.3% 0.3% 0.3% 0.3% Company Revenue ($) $29,318 $30,252 $31,023 $29,674 $30,081 Total Company Growth (%) 3.2% 2.6% -4.3% 1.4% 7.7% Market Share (%) 8.7% 8.5% 8.3% 7.9% 7.6% *revenue weighted TAM $147,804 $156,921 $166,837 $169,616 $181,924 Total Market Growth 6.2% 6.3% 1.7% 7.3% 7.6% *Only markets with >5% share included *>5% TAM Total TAM: $338,577 $357,838 $373,933 $374,137 $393,826 Markets with >5% Share 44% 44% 45% 45% 46% 6.6% *entire TAM
Source: IDC, Credit Suisse estimates.
Oracle Corporation (ORCL) 18 5 September 2017
Below are charts detailing Oracle’s TAM by market size and revenue composition. Oracle clearly weights structured data management software more heavily in its revenue composition than proportionally to market size.
Figure 28: Structured Data Management/ERM/CRM—The Largest Addressable Figure 29: Oracle Now Generates More than 82% of Markets for Oracle Its Revenues from Database/CRM/ERM Offerings
SCM Integration and Integration and Applications Orchestration Orchestration Structured Data Middleware Data Access, Management 2% Middleware 4% Analysis, and Software 5% Data Access, 4% Delivery 10% Analysis, and 8% 25% Delivery SCM 5% 2016 Revenue Applications Application 2020 TAM 12% Share by Market 7% Platforms Structured Data Application Share by 53% Management Platforms Market Software CRM Applications 19% 17% 30% CRM Applications ERM Applications ERM Applications
Source: IDC, Credit Suisse estimates. Source: IDC, Credit Suisse estimates.
Oracle is the largest player in the structured data management market, with a 31% share of the $44 billion market in 2016. Within this market, Oracle derives most of its revenue from relational database management systems, with almost $17 billion in revenue representing 42% market share.
Figure 30: Oracle Is Leader of the Structured Data Figure 31: Oracle Dominates the RDBMS Market Management Market with 42% Market Share
Others Others Amazon Web Services 18% Teradata 7% InterSystems Oracle 2% CA Technologies 31% SAP 3% SAS 1% 1% 7% 1% Teradata Structured Data Oracle 2% Relational Database 42% Informatica 2% Management Software: $44,618m Management Systems 3% Amazon Web Services (RDBMS): $31,120m 14% IBM 7% SAP
14% 20% 23%
IBM Microsoft Microsoft
Source: IDC, Credit Suisse estimates. Source: IDC, Credit Suisse estimates.
However, it is worth noting that many of the largest players in this space have experienced flat or negative growth in recent years, and market share is slowly declining. Oracle has declined at a three-year CAGR of -0.5%, though IBM’s decline was a more precipitous at -4.48%. The fastest growth comes from Amazon Web Services, with a three-year CAGR of 190% since entering the space in 2013.
Oracle Corporation (ORCL) 19 5 September 2017
Figure 32: ORCL RDBMS Revenue Was Flat over the Figure 33: Oracle Technically Lost Market Share Past Three Years Within the RDBMS Market 200% 100%
150% Other 80%
100% IBM 60% MSFT 50% 40% 0%
20% ORCL -50% l t l s a f e u E S P l M t s e s o c A t P a B i e W s D j I a r d S H o r
A 0% u g a r r O F c o i r e 2012 2013 2014 2015 2016 P T M
Source: IDC, Credit Suisse estimates. Source: IDC, Credit Suisse estimates.
Oracle is also the second largest player in both ERM and CRM markets, but there is a fairly sizeable gap between it and the leader in both spaces.
Figure 34: Oracle Is the Second Largest in ERM… Figure 35: … And In The CRM Market As Well
SAP Salesforce.com
16% 18%
Oracle 46% Others Enterprise Resource 9% 47% Customer Oracle Management (ERM) Others Relationship 10% Applications: Management (CRM) $50,327m Applications: 9% $32,253m 7% Intuit SAP 4% 4% 3% 3% 2% 3% 3% 2% 3% 3% 2% 2% Microsoft 2% 2% Genesys Telecommunications Laboratories DATEV ADP Cisco Adobe IBM IBM Workday Infor Sage Google Verint Systems NICE SYSTEMS
Source: IDC, Credit Suisse estimates. Source: IDC, Credit Suisse estimates.
Oracle Corporation (ORCL) 20 5 September 2017
The Cloud ERP Opportunity Oracle is hyper focused on what it sees as a massive opportunity in Cloud ERP. We tend to agree and believe Oracle is well suited to capture it. Again, this is a significant, CLTV-accretive aggregation play whereby Oracle can not only drive growth by migrating its large installed base, but also by capturing significant new customer logos. Unlike the relational database market of which Oracle commands 50% share, the broader enterprise application software market is far more fragmented, where Oracle’s share ranges from 8% to 10% in the largest three categories of ERP, HCM, and CRM. The CRM market is furthest along in cloud adoption, given the early leadership and success of salesforce.com. It is tempting though optimistic to use the evolution of CRM as a guide for what could play out in the ERP market. Not only did salesforce.com expand the market by addressing adjacent requirements in the cloud (hardware, labor, etc.), but it also redefined CRM beyond salesforce automation and into service and marketing as well. This has been a brilliant aggregation strategy, redefining the CRM market.
Figure 36: CRM—Second Largest Application Figure 37: ORCL Is the Number Two Player in Large Category Market CRM Market (2012 – 2016) 2016 CRM Market Share
$40bn Salesforce.com 32,912 29,900 18% $30bn 27,698 25,028 22,805 47% Customer Oracle Others Relationship 10% $20bn Management (CRM) Applications: $32,253m 7% SAP $10bn 4% 3% 3% 2% 2% 2% 2% Genesys Telecommunications $0bn Laboratories Cisco Adobe 2012 2013 2014 2015 2016 IBM Google Verint Systems NICE SYSTEMS
Source: IDC, Credit Suisse Research. Source: IDC, Credit Suisse Research.
The CRM Market is further along in terms of cloud adoption. We believe cloud adoption has expanded the market, as can be seen by the constant upward bias to estimates of the 2016 Market, with the actual market size overachieving even recent estimates.
Figure 38: 54% CRM Offerings Are on Public Figure 39: … TAM Estimates Revised Up Multiple Cloud… Times 2016 CRM Market Mix by Deployment 2016 Actual CRM Market versus prior 2016 Forecasts
$40bn 32,084 32,912 29,093 $30bn 27,234 27,848
On-Premise/Other $20bn software, 46% 2016 CRM Market Public Cloud , by Deployment 54% $10bn
$0bn 2012 Forecast 2013 Forecast 2014 Forecast 2015 Forecast 2016 Actual
Source: IDC, Credit Suisse Research. Source: IDC, Credit Suisse Research.
Oracle Corporation (ORCL) 21 5 September 2017
The next largest application software market in the cloud is the HCM category, which is largely driven by Workday but includes many other players as well. Workday has led with core HCM, followed with payroll, and is a full suite provider with products in other categories within the broader HCM umbrella, such as learning, talent management, etc. This market is a bit more fragmented than CRM, and the cloud portion is also more distributed among players. Given earlier learnings from salesforce.com in CRM, established HCM vendors were quicker to develop credible HCM strategies to compete with Workday. Figure 41: ORCL Is the Number Three Player in the Figure 40: HCM—$13bn Market with Healthy Growth HCM Market HCM Market (2012 – 2016) 2016 HCM Market Share
SAP $16bn
12,892 14% 11,745 $12bn 11,174 ADP 10,178 Others 40% 9,301 12% Human Capital Management: $12,892m $8bn
10% Oracle
$4bn 7% 1% 2% 2% 6% 3% 3% Infor Workday SkillSoft IBM $0bn Kronos 2012 2013 2014 2015 2016 Cornerstone OnDemand Ultimate Software Source: IDC, Credit Suisse Research. Source: IDC, Credit Suisse Research.
We define the ERP market as IDC’s ERM market, excluding HCM, which we consider separately. The ERP Market is the largest application software category at $43 billion in 2016, and in fact larger than the relational database market, in which Oracle is dominant with 50% share. Arguably the most complex, it has been behind HCM and CRM in transitioning to the cloud. Most cloud ERP customers today are at the lower end of the market (i.e., Intuit, Sage, NetSuite) and/or vertically focused with limited functionality, like Rootstock Software or Acumatica.
Figure 42: Financial Applications Represent Half of Figure 43: Oracle Is a Leader in Cloud ERP Ahead of the ERP Market Workday and Others
Enterprise Asset Project and Management Portfolio 4% Management 10% Enterprise Performance Management Applications 9% 2016 Enterprise Resource Management Financial Order Applications (ex-HCM): Applications Management $43 billion 51% 6%
Procurement 10%
Payroll Accounting 10%
Source: IDC, Credit Suisse estimates. Source: Gartner, Credit Suisse Research.
Oracle Corporation (ORCL) 22 5 September 2017
Workday was perhaps earliest and quite vocal about offering its Financial Management application in the cloud, but has definitely experienced slower traction than many originally expected. The company claims about 350 customers to date after now being in the market for over five years. We believe at least some of the takeaway here is that core financial applications can be very complex to deliver and maintain, particularly in larger enterprises where Workday is concentrated. Oracle offers two cloud ERP solutions, one by way of the NetSuite acquisition, which focuses on small businesses with up to 1,000 employees, and the other by way of Oracle ERP cloud, which caters to large and medium-sized enterprises.
Figure 44: Oracle’s Wins in Financials Far Outnumber Workday New Cloud Financial wins for Oracle versus Workday
1000 New WDAY Financial Customers ORCL SaaS ERP/EPM Customer Wins 868 808 800
564 600 532 380 400 311 334 344 250 164 200 200 94 7 13 17 17 13 18 41 22 21 29 41 29 0 1 2 3 4 1 2 3 4 1 2 3 4 Q Q Q Q Q Q Q Q Q Q Q Q 1 1 1 1 1 1 1 1 1 1 1 1 5 5 5 5 6 6 6 6 7 7 7 7 A A A A A A A A A A A A
Source: Company data, Credit Suisse Research, Credit Suisse Estimates.
Oracle is focused on the opportunity and advantaged in capturing it given its heritage in enterprise ERP and related applications. ERP is complex, just in considering the myriad tax, legal, and regulatory updates and dealing in multiple currencies and locales for the largest global multinational companies in the world. Not to mention the complexity spike of integrating with HCM, Manufacturing, Supply Chain, and other enterprise applications. We assert that unlike HCM and CRM, for which cloud-borne companies have had an advantage, the cloud ERP opportunity will be won by the incumbents, namely Oracle and SAP. To appreciate Oracle’s position, it already has pre-templated support for about 80 countries in its cloud ERP product. This requires significant investment and breadth. Financial Management Applications, which is the largest portion of the ERP market, is where Oracle is leading the way in the cloud. We note that Gartner estimates 17% of the Financial Management market was attributable to cloud products in 2016 and expects that mix to reach 28% in 2020. A testament to the quality of the product, in June 2017, Oracle announced Bank of America had selected its cloud ERP and financial applications for its international general ledger and broker dealer systems. This is part of a broader objective for Bank of America driving to a target of having 80% of its workloads delivered on the cloud within the next few years. In selecting Oracle ERP, the bank specifically cited improvements in cloud security and economics as important drivers of its decision.
Oracle Corporation (ORCL) 23 5 September 2017
Figure 45: SoundBytes—ORCL Is Holding Ground in Competition with WDAY
Brad Zelnick Software SoundBytes (212) 325 6118 [email protected] Oracle: Application Business
“Cloud HCM – we see some competition from WDAY but wouldn’t say it’s been strengthening, if anything it’s the opposite. If anything it’s one of the largest jumps in transactions, Cloud HCM for ORCL is booming, and on prem as well”
“On-prem licensing (Hyperion) has done very well last couple of quarters”
Source: Company data, Credit Suisse estimates.
Meaningful Revenue Upside in Cloud ERP Migration We note Oracle commentary highlighting its success in cloud ERP is a fairly even combination of migrating existing on-premise ERP customers as well as new logo wins.
Figure 46: Oracle Has Been Getting Disproportionately More New Logos in ERP Management's commentaries on the net new customer acquisition
4Q17 "Another good thing for us in the quarter is roughly two-thirds of the new ERP customers never had Oracle ERP before.
3Q17 “50% of our new customers never had Oracle ERP before they bought this quarter”
2Q17 “Over half of the new ERP customers never had an Oracle app before they bought this quarter”
1Q17 “Over 50% of our ERP EPM customers were net new to Oracle. They've never purchased an Oracle app before”
Source: Company data, Credit Suisse Research.
With roughly 5,000 cloud ERP customers and an ASP that Oracle has stated approximates $300,000 and increasing as the company releases and attaches supply chain and manufacturing capabilities, the opportunity appears quite significant. List pricing for Financials is $600 per user/month. Additional applications within the cloud ERP and SCM suites, of which there are over a dozen to choose from, generally price out at an additional $300, $400, or $500 per user/month. It is therefore easy to fathom how the ASP can increase, though it is naturally a function of company size and Oracle’s ability to sell multiple modules. If we consider the rule of thumb whereby cloud ARR is 2-4x that of equivalent on-premise maintenance, the opportunity to continue migrating Oracle’s existing base of ERP customers is meaningful. We value it at an incremental $4.3 billion revenue opportunity, assuming: − 13,000 on-premise ERP customers left − ASP of $500,000 ARR if converted to cloud, which we believe is conservative just assuming alone the remaining on-premise customers are larger on average, not to mention the multiple modules they would likely purchase − 3x conversion of maintenance into cloud ARR
Oracle Corporation (ORCL) 24 5 September 2017
With an 85% gross margin goal for SaaS and negligible incremental operating expense associated with migrating and especially renewing these customers, we estimate this represents roughly $0.66 per share in recurring, annualized incremental EPS.
Figure 47: Notable EPS Upside if ORCL Converts On-prem Customers to SaaS Market Opportunity Analysis on Converting Oracle’s Estimated 13,000 on-premise ERP/EPM Customers ERP Migration 1Q17 3Q17 4Q17 Opportunity On-prem ERP/EPM Customer Base 15,000 14,000 13,000 SaaS ERP/EPM Customer (A) 2,800 3,700 5,000 13,000 ASP ($, B) 300,000 300,000 250,000 500,000 Revenue Run Rate ($m, C=AxB) 840 1,110 1,250 6,500 ORCL SaaS Revenue Run Rate ($mn, D) 2,696 3,736 4,032 ERP/EPM as % of Total SaaS Revenue (%) 31% 30% 31%
Cloud ASP/Maintenance Pricing (E) 3.0x 3.0x 3.0x 3.0x Loss of Maintenance Rev. from Cloud Migration ($mn, F=D/E) 280 370 417 2,167 Incremental Cloud Revenue ($mn, G=D-F) 560 740 833 4,333 Incremental Contribution to Net Income ($mn) 364 481 542 2,818 Incremental Recurring EPS $0.09 $0.11 $0.13 $0.66 Note: We assume 85% operating margin and 23.5% tax rate
Source: Company data, Credit Suisse Estimates, Credit Suisse Research.
The greater opportunity is obviously in capturing incremental market share by way of net new customer acquisition. We note that even without doing so, there are healthy share gains to capture in converting the installed base alone. But consistent with commentary for greater than half of Cloud ERP customers being net new, market validation of the strength of Oracle’s offering, and our thesis around incumbents winning ERP in the cloud, we think this can be very meaningful. In context, traditional enterprise application vendors, even the leaders in SAP and CRM, have been unable to garner more than 20% share of the market. (Salesforce is the leader in CRM with 18% share of the 2016 CRM market, according to IDC.)
Figure 48: Significant Opportunity from Gaining Share in Fragmented Market Potential ERP Opportunity from Share Gains
Opportunity from Share Gain in Cloud ERP
ORCL Share in ERP Today (A) 8% Potential Steady State Market Share (B) 20% Size of Market in 2020 ($mn, C) 54,250 Incremental Revenue Opportunity ($mn, D=(B-A)xC ) 6,456 Incremental Net Income ($mn) 4,198 Incremental EPS $0.99 Note: We assume 85% operating margin and 23.5% tax rate
Source: Company data, Credit Suisse Estimates, Credit Suisse Research.
But, if we consider Oracle’s 8% share of ERP (IDC’s ERM market definition minus HCM) in a market currently projected to be $54 billion in 2020 by IDC, achieving 20% share would imply $6.5 billion in incremental revenue, and we estimate $0.99 in recurring EPS.
Oracle Corporation (ORCL) 25 5 September 2017
Figure 49: Sensitivity Analysis Indicates Incremental Recurring EPS Could Be as Much as $1.72 Sensitivity analysis of incremental opportunity from share gain in cloud ERP
EPS Sensitivity to the Stable Market Share and Operating Margin of Incremental Revenues
Stable Market Share in ERP $0.99 12.0% 14.0% 16.0% 18.0% 20.0% 22.0% 24.0% 26.0% 28.0% 79.0% $0.30 $0.46 $0.61 $0.76 $0.92 $1.07 $1.23 $1.38 $1.54 80.0% $0.30 $0.46 $0.62 $0.77 $0.93 $1.09 $1.24 $1.40 $1.56 81.0% $0.31 $0.47 $0.63 $0.78 $0.94 $1.10 $1.26 $1.42 $1.57 82.0% $0.31 $0.47 $0.63 $0.79 $0.95 $1.11 $1.27 $1.43 $1.59 Operating 83.0% $0.32 $0.48 $0.64 $0.80 $0.96 $1.13 $1.29 $1.45 $1.61 Margin of 84.0% $0.32 $0.48 $0.65 $0.81 $0.98 $1.14 $1.30 $1.47 $1.63 Incremental 85.0% $0.32 $0.49 $0.66 $0.82 $0.99 $1.15 $1.32 $1.49 $1.65 Revenues 85.5% $0.33 $0.49 $0.66 $0.83 $0.99 $1.16 $1.33 $1.50 $1.66 86.0% $0.33 $0.50 $0.66 $0.83 $1.00 $1.17 $1.34 $1.50 $1.67 86.5% $0.33 $0.50 $0.67 $0.84 $1.01 $1.17 $1.34 $1.51 $1.68 87.0% $0.33 $0.50 $0.67 $0.84 $1.01 $1.18 $1.35 $1.52 $1.69 87.5% $0.33 $0.50 $0.68 $0.85 $1.02 $1.19 $1.36 $1.53 $1.70 88.0% $0.34 $0.51 $0.68 $0.85 $1.02 $1.20 $1.37 $1.54 $1.71 88.5% $0.34 $0.51 $0.68 $0.86 $1.03 $1.20 $1.37 $1.55 $1.72
Source: Company data, Credit Suisse estimates.
Workday does not appear to be a significant competitive threat when considering its limited customer traction and product focus only on financial apps. It would seem to us that SAP S/4HANA Cloud would be best positioned to compete with Oracle, though market commentary is inconsistent. While SAP’s S/4 customer metrics appear similarly impressive to Oracle’s, it represents a mix of on-premise and cloud customers, and the cloud version was announced in February 2015 with little traction, per our research. In fact, Gartner for its Cloud Financials Magic Quadrant (Figure 43) evaluated SAP’s older midmarket product, Business By Design.
Oracle Corporation (ORCL) 26 5 September 2017
Durable Database Business Oracle database is that good. The company has consistently innovated and remains ahead of the competition when it comes to product quality, in our view. It is the crown jewel in Oracle’s portfolio and still accounts for a healthy majority of operating profit today (roughly half of non-hardware revenue, and highest margin within the mix). When the requirements are ACID compliance, transactional consistency, high performance, and scale, Oracle database is the gold standard. Some of the most important data in the world lives in Oracle databases, and we believe Oracle’s position at the high end of the market to be quite durable. When considering the market holistically, it appears Oracle is ceding some share, though we see it appropriate to consider the portion of the market in which Oracle actually competes. Within the overall relational database management systems (RDBMS) market, estimated by Gartner to be $31 billion in 2016, Oracle had 45% share. This was down from 47% in 2015 and 48% in 2014. If one were to look at the top five RDBMS vendors in 2016, that list would include ORCL, MSFT, IBM, SAP, and AMZN based on their market shares in 2016. The top five vendors generate >90% revenues in this market, hence it’s important to look at Oracle’s share within this group. Even within this group, Oracle has lost similar share in the last two years.
Figure 50: ORCL Has Been Losing Share… Figure 51: Even Within Top Five Vendors… ORCL Market Share in Relational Database Management Systems ORCL Market Share among top 5 Relational Database Management (2014-2016) Systems Vendors
48% ORCL Share in Overall RDBMS 52% ORCL Share in Top 5 RDBMS 52% 48%
51% 47% 47% 51%
46% 50% 45% 49%
45% 49%
44% 48% 2014 2015 2016 2014 2015 2016
Source: Gartner, Credit Suisse Research. Source: Gartner, Credit Suisse Research.
That said, we note that this apparent share loss is largely a result of AWS’s rise as a public cloud vendor and increasing acceptance for many of its products. We need to be cognizant that AWS, while a fantastic success in public cloud, is not competing head-to-head in most cases for Oracle workloads. There is likely some overlap, but we wouldn’t expect Oracle to be a first choice if the requirement is to support a cloud native application that doesn’t require near 100% uptime, low latency, and high performance. This makes sense because Aurora is based on MySQL, which has been around for over 20 yrs, is now coincidentally owned by Oracle by way of the Sun acquisition, and doesn’t really compete with core Oracle DB. Similarly, we wouldn’t expect AWS Aurora, for example, to be well suited for an app that requires carrier grade performance and reliability. While there is always some overlap, both players are attracting different ends of the market and with the explosive growth in public cloud, we see Amazon’s presence as largely though not entirely incremental. Backing out Amazon AWS from the top five, we see that ORCL’s share has roughly stayed flat the last three years, suggesting to us that Oracle’s positioning within large enterprises hasn’t changed much in the last three years.
Oracle Corporation (ORCL) 27 5 September 2017
Now, we look at the broader Database Management System group. Relational Database constitutes ~90% of total revenues within this group. If one were to look at the increase in respective markets from 2012 to 2016, we see that more dollars have been added in the RDBMS group, compared with the faster-growing semi-structured DBMS. This was a key concern for many investors a few years ago, that Oracle databases would become insufficient to handle growing unstructured datasets, and that market would eat into the traditional RDBMS market. In fact, the RDBMS group has added more dollars over time than semi-structured DBMS, which benefits Oracle.
Figure 52: RDBMS Forms ~90% of the Total DBMS Figure 53: The RDBMS Sub-Market Has Added More Market Dollars than Other Database Markets The Overall DBMS Group was $34 billion in 2016 Increase in respective Database Markets (2012 – 2016)
Total Market CAGR 7000 2012-2016 6.1% $34,421m 6000 1,644 $28,507m Add O1ra,7c9l9e of this 5000 85% 2,058.79 Semistructured DBMS 155 2,535.73 4000
-5% 3000 Prerelational-era DBMS 4,746 30,563 2000 25,817 4% 1000 Relational Database Management Systems 0 -477 -1000 Relational Database Management Systems Prerelational-era DBMS Semistructured DBMS 2012 2016
Source: Gartner, Credit Suisse Research. Source: Gartner, Credit Suisse Research.
True, the database market is more fragmented today with NoSQL, Hadoop, and cloud native alternatives, but generally speaking, they are attracting incremental and less critical workloads for which Oracle would be overkill. We expect Oracle will likely lose some lower value units in the market, but more than compensate with innovation, pricing, and aggregation of adjacencies with Database as a Service (DBaaS). Oracle introduced DBaaS four years ago, a fully managed database offering for customers to consume database in the cloud. Many years ago, some of the largest companies in the world internally architected similar as-a-service models for database use. Commonwealth Bank of Australia implemented such a strategy back in 2010, based on Oracle technology, and has been a thought leader in this regard. Through our own research and experience, we are aware of similar models implemented by the largest of telecommunications companies, as far back as 12 years ago. But like many technologies, it is now being democratized for consumption by the masses. The customer value proposition of DBaaS includes the following: ■ Infrastructure modernization and consolidation ■ Automated provisioning ■ Maintenance optimization ■ Lower risk with vendor controlled patching ■ Features not available on-premise (i.e., 12c R2 was first only released in cloud) ■ Performance ■ Total Cost (hardware, labor, power, cooling, etc.)
Oracle Corporation (ORCL) 28 5 September 2017
Figure 54: Oracle Database Is Offered with Flexibility on the Oracle Cloud
Source: Oracle Corporation, Credit Suisse estimates.
This parallels many other cloud value propositions, and we believe it presents a significant aggregation opportunity, to create value for customers as well as Oracle, by consolidating adjacent market opportunities, making Oracle DB easier to consume, and capturing incremental market share.
Figure 55: Database License to Cloud Conversion—We See Material Upside to Revenues Illustration of Conversion of a Database Maintenance to an Equivalent Cloud Subscription
License Total On-Prem License Fees Total Maintenance Fee Fee/Processor ($) ($, L+M, for 3 Processors) ($)
Oracle Database Enterprise Edition 47,500 173,850 31,350
$ Per Total Per Month Annual Cloud Pricing ($) Month/OCPU ($, for 6 OCPUs) Enterprise Package - General 3,000 18,000 216,000 Purpose Compute SaaS/Maintenance Multiple: 6.9x Enterprise Package - Virtual Image - 1,500 9,000 108,000 General Purpose Compute SaaS/Maintenance Multiple: 3.4x Note: Assume a database running on a 6 core machine and a 0.5 core processor licensing factor; 2OCPU = 1 Processor
Source: Company data, Credit Suisse estimates.
If Oracle succeeds in migrating its database business to the cloud, similar to the applications business shifting to the cloud, it implies meaningful upside over time to both revenues and EPS. At the end of FY2017, Oracle disclosed that the on-premise platform and infrastructure business contributed $19 billion in revenue. We estimate that this is comprised of ~$6 billion in license revenues and ~$13 billion in maintenance revenues. Assuming a 3x conversion multiple on the technology maintenance business converting to cloud, that would imply the PaaS is worth ~$40 billion in annual recurring revenue. Using conservative assumptions on margins of 75% and a 23.5% tax rate, this would imply $3.61 in incremental EPS.
Oracle Corporation (ORCL) 29 5 September 2017
Figure 56: SoundBytes—Oracle ULA Is Adapting to the Cloud Model
Brad Zelnick Software SoundBytes (212) 325 6118 [email protected] Oracle: ULA (Unlimited Licensing Agreement)
“They’ve tweaked the ULA (Unlimited Licensing Agreement) a little bit – to now what is called a mega or ultra ULA. Same as the old ULA but allows cloud deployment of those same resources in the ORCL Cloud, which they certify at the end of the term and only have to pay the equivalent of support. But if you run in a competing cloud you can only have those licenses compliant during the term of the ULA “
“Not as many brand new ULAs as there were before, more renewals and amendments”
Source: Company data, Credit Suisse estimates.
Testament to the market’s acceptance is the announced AT&T agreement back in May, whereby AT&T will migrate over 10,000 Oracle databases to the Oracle Cloud over the coming years. This is a long-term, strategic deal for both companies, and it is noted that 75% of AT&T’s data is in a fraction of those databases (several hundred of the 10,000+). Oracle management has stated that we should expect more of these types of deals to follow.
Figure 57: Large Opportunity in PaaS Migration Estimated Cloud Opportunity for Database/Technology Business Potential Opportunity in PaaS migration F2017 Platform/Infrastructure Maintenance Revenues ($mn, A) 13,346 Multiplier on Maintenance to Cloud Conversion (B) 3.0x Implied Annual Cloud Revenues ($mn, C=AxB) 40,038 Loss of Maintenance Revenue from Cloud Migration ($mn, D) 13,346 Incremental Revenues ($mn, E=C-D) 26,692 Incremental Net Income 15,315 Incremental Recurring EPS $3.61 Note: We assume 75% operating margin and 23.5% tax rate
Source: Company data, Credit Suisse estimates, Credit Suisse Research.
Oracle Corporation (ORCL) 30 5 September 2017
Figure 58: SoundBytes—Customers Are More Open Toward Oracle Cloud
Brad Zelnick Software SoundBytes (212) 325 6118 [email protected] Oracle: Cloud Business
“Cloud adoption – AWS, whatever – customers are now open to buying more ORCL technology to support development, testing, disaster recovery, even production. We’re seeing the first real big expansion of production workloads in the cloud from April to now, more than in the past 2.5 years. Definitely more tech vs. app.”
“They’re not discounting cloud as much – they had to originally because the offering [wasn’t very good]. They were getting cloud deals in the past because of audit, discounting, duress”
“ Sales comp plans still slightly favor the cloud deal, but they’ve kind of stabilized, no more 3-4x for the cloud deal. What happens now is standard comp is paid for cloud and .75x or .6x for on premise, and if it includes any time of cloud migration there’s some type of relief there as well. Cloud is the new norm.”
“The ‘Cloud Storm’ is driven by contracts people, finance, or media… the reality is no one can pull the plug and drop into cloud without some real pain. It’s not about saving money in the short term – there’s too much effort and pain, and the cost of running parallel environments. Oracle is messaging flexibility…. clients are starting to realize this is not going to be full blown.”
Source: Company data, Credit Suisse estimates.
Market Fragmentation at the Lower End AT&T’s data distribution, with ~80% of its data contained in ~20% of its databases, epitomizes typical structured data distribution and where Oracle plays in the market. Traditionally, customers will require Oracle for their highest value needs and standardize on the technology for lower value use cases as well. We believe this is both a strength and risk for Oracle, a strength in terms of the leverage it has at the high end of the market and risk as it is seemingly easier today for customers to diversify at the lower end, especially in public clouds, as adoption hurdles are far lower than in the past. Today, a software developer can download open-source software, access a cloud service, watch a YouTube video, and be off and running with a new database. There are more alternatives in the market today with lower barriers to adoption than in the past.
Oracle Corporation (ORCL) 31 5 September 2017
Figure 59: Leading Databases Have Seen Popularity Figure 60: …as the Database Market Has Become Diminish… More Fragmented Popularity of various databases in market Concentration index has been coming down
100% 24% Concentration index of database popularity 22% 80% Other 20% 60% MSFT SQL Server 18%
40% 16% MySQL
20% 14% Oracle 12% 0% 2 3 4 5 6 3 4 5 6 7 3 4 5 6 7 3 4 5 6 7 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------10% v v v v v y y y y y b b b b b g g g g g a a a a a o o o o o e e e e e u u u u u
F F F F F 2012 2013 2014 2015 2016 N N N N N A A A A A M M M M M
Source: db-engines.com, Credit Suisse Research. Source: db-engines.com, Credit Suisse Research.
Oracle’s share of popularity has dropped from 29% as percentage of popularity within all databases, as tracked by db-engines.com as of November 2012, to 21% as of August 2017. This is due to a fragmentation at the low end for databases. From 74 databases in November 2012, the index now counts 319 databases at the end of August 2017. We also create a database popularity measure (similar to the Herfindahl index), which is the sum of the square of the market shares of all players. The more concentrated the market shares are within an industry, the higher the measure. In Figure 61, we see this measure has been declining. This is a consequence of the database market becoming more fragmented as new players take share from incumbents. The data show that Oracle has been losing share from a popularity perspective to other vendors like MySQL. We note that many of these newer vendors like MySQL do not generate much revenue, and hence any popularity loss due to fragmentation at the low end of the market will not impact Oracle. Coincidentally, Oracle owns MySQL by way of the Sun Microsystems acquisition.
Figure 61: MySQL Looks Close to Being as Popular as ORCL for the First Time 1,800 Oracle MySQL Microsoft SQL Server
1,600
1,400
1,200
1,000 3 4 5 6 7 3 4 5 6 7 3 4 5 6 7 2 3 4 5 6 3 3 4 4 5 5 6 6 7 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ------l l l l l r r r r r v v v v v y y y y y n n n n n p p p p u u u u u a a a a a a a a a a o o o o o a a a a a e e e e J J J J J J J J J J M M M M M N N N N N S S S S M M M M M
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 32 5 September 2017
Figure 62: Job Postings for ORCL DBAs Have Figure 63: … and This Trend Has Been Sustained Declined Globally... Since 2006 if We Use the UK as a Proxy
0.12% Percentage of job postings on indeed.com matching 'Oracle DBA' 0.10%
0.08%
0.06%
0.04%
0.02%
0.00% Dec '13 Jun '14 Dec '14 Jun '15 Dec '15 Jun '16 Dec '16
Source: indeed.com, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
By moving to the cloud, we see Oracle driving dollar share in database even with the possibility of lower-end unit share losses. To appreciate this, we contemplate the performance of the business as adjusted for this transition. Initially, many of these deals will only show up in new annual recurring revenue (ARR), but not in actual revenue. Below we show an adjusted view of the business, adding 1.5x new PaaS bookings.
Figure 64: Technology Business Turning a Corner… Figure 65: …and Even Better on an Adjusted Basis 4% 8% Estimated Technology License Growth Adjusted Technology Licenses (adding 1.5x PaaS Bookings) 5% 0.5% 0% 4%
-4% 0% -1% -8% -4% -3% -7.6% -8.6% -5% -12% -8% -8% -13.6% -13.5% -10% -16% -12% -12% -17.2% -16.7% -20% -16% 2Q16A 3Q16A 4Q16A 1Q17A 2Q17A 3Q17A 4Q17A 2Q16A 3Q16A 4Q16A 1Q17A 2Q17A 3Q17A 4Q17A
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
Oracle has also disclosed that the database business (license + support + DBaaS) has been growing the last four quarters. We can look at a proxy for this by looking at growth in total Platform and Infrastructure revenues (new disclosure which ORCL started providing in 4Q17) and then backing out IaaS Revenue. This will give us a better proxy of the database and middleware business. This shows that the database and middleware business (of which we estimate databases forms 75%+) has been growing y/y the last four quarters. We estimate this is largely organic given that the Dyn acquisition should largely fall under the Infrastructure-as-a-Service category (which we back out). This is illustrated in the chart below.
Oracle Corporation (ORCL) 33 5 September 2017
Figure 66: The Technology Business Has Been Growing the Last Four Quarters 8.0% Total Tech Business (License + Support + PaaS Revenues)
4.5% 4.0% 4.0% 1.8% 1.3% -0.2% 0.0%
-2.0% -4.0% -4.6%
-8.0% -6.4% 1Q16A 2Q16A 3Q16A 4Q16A 1Q17A 2Q17A 3Q17A 4Q17A
Source: Company data, Credit Suisse Research
Figure 67: SoundBytes—ORCL Database Remains Solid
Brad Zelnick Software SoundBytes (212) 325 6118 [email protected] Oracle: Database Business
“ODA – Oracle Database Appliance is in focus, a lot of clients who were thinking Exa, but it cost too much, ODA is much cheaper $150-200K/box and clients are adopting it”
“Not seeing migrations from Oracle database to non-Oracle databases. Legacy Oracle clients staying with Oracle. “
“People running massive SAP applications on Oracle are staying with Oracle – after looking at SAP Hana. Not seeing migration to any non-Oracle database”
Source: Company data, Credit Suisse estimates.
12c R2 as a Driver? Many investors have anticipated an uptick in the database business with the R2 release of Oracle’s 12c database and have felt this could be a driver of the stock. Historically, many enterprise practitioners would wait for the “dot 2” release of a new database before implementing it, and many have felt this could be a catalyst. For the first time ever, Oracle made the 12c R2 release only available in the cloud, which occurred in September 2016, and followed with R2 being available on-premise as of March 2017. We never really expected this to be a catalyst since (1) many customers already own rights to it by virtue of being on maintenance and (2) Oracle has smoothed out the release cycle and included more in the “dot 1” release that preceded R2, thus making this into less of an event. We look historically at prior R2 release cycles and correlation with database and middleware license revenue growth.
Oracle Corporation (ORCL) 34 5 September 2017
Figure 68: We Do Not Expect the 12c R2 Release to Be a Catalyst Database release cycle vs. segment license growth
30% Sep 09 - 11g R2 GA Jul 05 - 10g R2 GA Aug 07 - 11g R1 GA Jun 13 - 12c R1 GA Mar 17 - 12c R2 GA Jan 03 - 10g R1 20% GA
May 02 - 9i R2 GA 10%
0% Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16
-10%
-20%
-30%
-40%
Source: Company data, Credit Suisse estimates.
Figure 69: SoundBytes—ORCL Sales Model in Transition
Brad Zelnick Software SoundBytes (212) 325 6118 [email protected] Oracle: Sales Coverage/Audits
“Oracle’s sales coverage model is changing, gotten younger for certain, more of a swarm aspect to it, upper management jumps in as needed to get in the weeds on deal mechanics (i.e the reps today are less capable) – when deals are recognized as real, the regional manager and above swoop in. The coverage models are a little different, not seeing a rep work on a $1M cloud deal anymore, more of a traffic cop bringing in the right people, but then pushed aside when real negotiation happens and then that person is gone by time deal comes together.”
“I think ORCL is still playing catch up a bit in terms of how their sales model is covering this new [cloud] business, confusion from clients and employees on coverage, how people are getting paid. It’s better than a year ago but still not where it needs to be.”
“On customer audits, they used to have 240-250 auditors, they recently let go their entire European LMS (License Management) team, NA team cut in half. They’re now down to 30-40. They’re empowering junior field reps with some of the audit abilities and doing informal audits. They’re empowering the reps with questions/scripts to determine if there’s an issue and then they bring in auditor to send a letter summarizing issue, or have the client run a self audit. They’re pushing this function down to the reps more.”
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 35 5 September 2017
Oracle Database User Survey
Figure 70: Which of the Following Best Describes Figure 71: Which of the Following Best Describes Your Industry? Your Position/Title? 22% 22% 46% 19% ~80% of our ~50% of our responses 15% responses came from came from the level of 4 verticals CIO or Above 6% 6% 4% 2% 2% 2% 2% 22% 17% 11%
2% 2%
IT Director CIO CTO SVP / VP / CEO Other / Executive Principal
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 72: How Many Employees Does Your Figure 73: Which of the Following Databases Do Company Have? You Use Extensively? Please Select All That Apply
65% 19% Oracle is the most extensively 15% deployed database within an ~65% of our responses 12% organization came from organizations 12% 9% with more than 20,000 8% 6% 6% employees 6% 5% 1% 17% 19%
0% 0% 0%
Less than 1,001 to 5,000 to 10,000 to 15,000 to More than 1,000 4,999 9,999 14,999 20,000 20,000
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 74: Which Describes Your Decision Making Figure 75: Are You a User of Oracle Under the Authority in Purchasing Database Technology? Company's Unlimited License Agreement? 81% 50% Most of our survey 81% of our respondents participants are notable were purchasers of Oracle 33% decision makers in puchase under the Unlimited License of database technology Agreement (ULA) 17% 7% 11% 0%
Solely or jointly One of a team Significant Do Not My company is a My company is a My company is not responsible that makes the influence but Participate current purchaser of previous user of a purchaser of final decision do not make Oracle technology Oracle technology Oracle technology the final under the ULA under the ULA under the ULA decision.
Source: Credit Suisse Research. Source: Credit Suisse Research.
Oracle Corporation (ORCL) 36 5 September 2017
Figure 77: How Likely Are You to Continue Figure 76: How Long Have You Been Purchasing Purchasing via Oracle's Unlimited License Oracle Under the Unlimited License Agreement? Agreement (on a Scale of 1 to 5)? 57% 57% of our respondents 39% of our respondents 39% were purchasers of Oracle were very likely to 32% under the Unlimited License purchase Oracle under Agreement (ULA) for 5 25% the Unlimited License 20% years or longer Agreement (ULA) 11% 7% 5% 0% 2% 2%
Less than a 1 to 2 years 3 to 4 years 5 years or Cannot Very 2 3 4 Very Cannot year longer discuss unlikely 1 likely 5 discuss
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 78: What Percentage of Your Oracle Database Workloads Do You Feel Truly Require Figure 79: Do You Have Oracle Database Workloads Oracle's Performance/Scalability/Reliability? Deployed on Public Cloud Infrastructure?
28% 72% of respondents 72% 24% 28% of respondents 22% feel that at least 40% of their Oracle have deployed Oracle database workloads databases in public 15% require Oracle's cloud infrastructure performance 28% 6% 6%
< 40% 40% - 50% 51% - 60% 61% - 70% 71% - 80% >80% Yes No
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 80: Do You Purchase Oracle Deployed on Figure 81: What Percentage of Your Oracle Public Cloud from the Cloud Provider or Do You Database Workloads Are On-premise vs. on the Bring Your Own License (BYOL)? Cloud? 53% 53% of respondents have 90 deployed Oracle databases in public cloud infrastructure by 90% of Oracle databases are bringing their own licenses deployed on-premise today (BYOL) 47%
10
Purchase from the cloud BYOL Oracle database workloads on Oracle database workloads on the provider's marketplace premise cloud
Source: Credit Suisse Research. Source: Credit Suisse Research.
Oracle Corporation (ORCL) 37 5 September 2017
Figure 82: How Do You Expect the Mix of Oracle Databases to Be On-premise vs. the Cloud (Three Figure 83: How Many Different Types of Databases Years)? Were in Your Environment Three Years Ago? 67% 70
70% of Oracle databases are 85% of respondents had <11 expected to be deployed on- different kinds of databases premises in 3 years deployed 3 years ago 30 19% 9% 6%
Oracle database workloads on Oracle database workloads on the 1-5 6-10 11-20 >20 premise cloud
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 85: Which of the Following Types of Figure 84: How Many Different Types of Databases Databases Were Used by Your Company Three Do You Expect to See in Three Years? Years Ago? 24% 63% Relational DBMS was the 18% 17% most prominent type of 89% of respondents expect 13% database 3 years ago to have <11 different kinds 8% 6% of databases deployed 3 5% 4% 26% years from now 4%
7% 4%
1-5 6-10 11-20 >20
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 86: Which of the Following Types of Databases Do You Envision to Be Used in Three Figure 87: Are You Running Oracle DBaaS? Select Years? All That Apply
22% Relational DBMS is still expected 54% to be the most prominent type of 14% database 3 years from now 12% 12% 11% 37% 37% of our respondents have 8% 7% begun testing Oracle Database 5% 4% 4% as a Service (DBaaS) 0%
4% 6%
We've begun We use it for We are running No, we do not testing it disaster recovery production use Oracle workloads on it DBaaS
Source: Credit Suisse Research. Source: Credit Suisse Research.
Oracle Corporation (ORCL) 38 5 September 2017
Figure 89: Considering All of Your Database Figure 88: Are You Using Oracle DBaaS Because Workloads Today, Both Cloud and On-premise, Real Application Clusters (RAC) or Other Oracle What Percentage Would Require Oracle DBaaS Database Options/Functionalities Are Not Available Because of Its Ability to Support Deployment on Competing Cloud Infrastructure (i.e., AWS, Configurations (i.e., RAC) Not Available on Other Azure, GCP)? Clouds?
60% of DBaaS users prefer Oracle 60% 52% infrastructure because RAC/other options are not available on public cloud 40% 32%
12% 4% 0%
Yes No 1 to 20% 21 to 40% 41 to 60% 61 to 80% 81 to 100%
Source: Credit Suisse Research. Source: Credit Suisse Research.
Figure 90: How Likely Are You to Purchase Other Oracle Cloud Infrastructure Components, Such as Middleware as a Service, Because of Your Use of DBaaS That You Wouldn't Otherwise Be Purchasing?
36% 48% of DBaaS users are likely to buy other Oracle cloud infrastructure components 24% 24%
12%
4% 0%
Very likely Likely Neither Unlikely Very Cannot likely nor unlikely discuss unlikely
Source: Credit Suisse Research.
Oracle Corporation (ORCL) 39 5 September 2017
Management and Board Management As one might expect, Oracle has one of the most experienced, largest, and highly incentivized management teams in the industry. Many of Oracle’s executives need no introduction. The average tenure is just under twenty years. Although Oracle actively names fewer executives than some peers, the broader executive suite is very large, with many taking divisional responsibility. Figure 91 features a table showing the key executives.
Figure 91: ORCL Executive Management
Name Compensation Beneficial ownership of shares C-Suite Experience Position Year Prior Experience Age Joined Salary ($) Bonus ($) Stock($) Number of shares Value of shares
Safra Catz 1999 $950,000 NA $39,973,275 461,860 $23,093,000 ■ CEO, Oracle: 2014-Present CEO ■ CFO, Oracle: 2011-2014 54 ■ Donaldson, Lufkin & Jenrette: 1986-1997 ■ BA, JD: University of Pennsylvania Mark Hurd 2010 $950,000 NA $39,973,275 203,891 $10,194,550 ■ CEO, Oracle: 2014-Present CEO ■ President, Oracle: 2010-2014 59 ■ CEO and Chairman, Hewlett-Packard: 2005-2010 ■ BBA: Baylor University Lawrence Ellison 1977 $1 NA $39,973,275 1,166,041,236 $58,302,061,800 ■ Chairman and CTO, Oracle: 2014-Present Chairman and CTO ■ CEO and Founder, Oracle: 1977-Present 71
Dorian Daley 1992 NA NA NA NA NA ■ Oracle Legal: 1992-Present SVP, General Counsel ■ Commercial Litigator, Landels, Ripley, & Diamond: 1986-1991 58 ■ JD: Santa Clara University School of Law, BA: Stanford University
David Donatelli 2014 NA NA NA NA NA ■ Executive Vice President, Hewlett-Packard EVP, Converged Infrastructure ■ President, Storage Division, EMC Corporation ■ BA: Boston College, MBA: Northwestern University Kellog School of Management
Douglas Kehring 2000 NA NA NA NA NA ■ Oracle Corporate Development Group: 2005-Present EVP, Chief of Staff ■ Oracle Venture Fund: 2000-2005 ■ Associate: Donaldson, Lufkin, & Jenrette: 1998-2000 ■ BA: University of Wisconsin, Madison Thomas Kurian 1996 $800,000 NA $34,930,400 9,293,882 $464,694,100 ■ Leading Oracle Fusion Applications: 2008-Present President, Product Development ■ Leading Oracle Fusion Middleware 50 ■ Management Consultant, McKinsey & Company ■ MBA: Stanford School of Business. BA: Princeton University Judith Sim 1991 NA NA NA NA NA ■ Chief Marketing Officer, Oracle: 2005-Present Chief Marketing Officer ■ Various Marketing and Customer-Related Positions, Oracle: 1991-2005 ■ BS: University of California, Davis
Mark Sunday 2006 NA NA NA NA NA ■ CIO, Siebel Systems: 1999-2006 SVP, Chief information Officer ■ Vice President, Information Technology, Motorola: 1989-1999 ■ Engineering Manager, Texas Instruments: 1977-1980 ■ MBA: Southern Methodist University, BSE: University of Michigan Joyce Westerdahl 1990 NA NA NA NA NA ■ Head of Human Resources, Oracle: 2000-2017 EVP, Human Resrouces ■ Joined Oracle in 1990, Held Positions in Line and Corporate HR
Mary Ann Davidson 1988 NA NA NA NA NA ■ Represents Oracle on Board of IT-ISAC Chief Security Officer ■ Served on Defense Science Board ■ Named to Information Systems Security Association Hall of Fame ■ MBA: University of Pennsylvania. BS: University of Virginia
Source: Company data, Credit Suisse estimates.
In comparison to our coverage universe and other large-cap application comps (MFST, CRM, ADBE, INTU), Oracle executives have the most experience both in the C-Suite and broadly across the corporate spectrum overall.
Oracle Corporation (ORCL) 40 5 September 2017
Figure 92: ORCL Management Has More Experience Figure 93: This Trend Holds When Considering than Any Other Company in Our Coverage Universe C-Suite Experience Alone Management Relevant Experience Management C-Suite HDP Per Executive NOW Experience Per Executive CHKP HDP CEO/CFO VP CEO CFO NOW PANW Other Executive SYMC SYMC Relevant Industry PANW FTNT FTNT Other Industry AKAM SPLK Finance SPLK MSFT MSFT RHT RHT AKAM INTU INTU ADBE ADBE VMW VMW CHKP CRM CRM ORCL ORCL
0 5 10 15 20 25 30 35 0 5 10 15 20
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
We were interested to note that Oracle’s executive team has the fewest number of degrees per director among our coverage universe and other large-cap comps.
Figure 94: Average Number of Degrees per Executive Degrees per Executive HDP BA/BS ORCL PANW MBA INTU MS CRM JD ADBE PhD NOW SYMC SPLK FTNT AKAM CHKP MSFT RHT VMW
0 0.5 1 1.5 2
Source: Company data, Credit Suisse estimates.
Board of Directors As with management, the Oracle board is an impressive group of industry veterans, with representatives from academia, computer science, and even the former Secretary of Defense. We consider the depth and breadth of knowledge here to be a valuable asset for the company.
Oracle Corporation (ORCL) 41 5 September 2017
Figure 95: ORCL Board Members
Name Beneficial ownership of shares Committee memberships C-Suite Experience Position Director IndependentOther Board Prior Experience and Principal occupation Age Since? Director? Affiliations?Number of shares Value of shares Audit CompensatioInndependence Governance
Lawrence Ellison 1977 No 0 1,166,041,236 $58,302,061,800 ■ Chairman and CTO, Oracle: 2014-Present Executive Chairman and CTO ■ CEO and Founder, Oracle: 1977-Present 71
Safra Catz 2001 No 0 461,860 $23,093,000 ■ CEO, Oracle: 2014-Present Chief Executive Officer ■ CFO, Oracle: 2011-2014 54 ■ Donaldson, Lufkin & Jenrette: 1986-1997 ■ BA, JD: University of Pennsylvania Mark Hurd 2010 No 0 203,891 $10,194,550 ■ CEO, Oracle: 2014-Present Chief Executive Officer ■ President, Oracle: 2010-2014 59 ■ CEO and Chairman, Hewlett-Packard: 2005-2010 ■ BBA: Baylor University Jeffrey Henley 1995 No 0 4,934,516 $246,725,800 ■ Vice Chairman, Oracle: 2014-Present Vice-Chairman of the Board ■ Chairman, Oracle: 2004-2014 71 ■ Executive Vice President and CFO, Oracle: 1991-2004 ■ MBA: University of California, Los Angeles, BA: University of California Santa Barbara Jeffrey Berg 1997 Yes 1 547,674 $27,383,700 ■ Chairman, Northside Services: 2015-Present Director Chair ■ Chairman, Resolution: 2013-2015 69 ■ Chairman and CEO, International Creative Management: 1985-2012 ■ BA, MA: University of California, Berkeley Michael Boskin 1994 Yes 1 506,562 $25,328,100 ■ TM Friedman Professor of Economics, Stanford University: 1971-Present Director Chair ■ CEO & President, Boskin & Co 70 ■ Chairman, Council of Economic Advisors: 1989-1993 ■ BA, MA, PhD: University of California, Berkeley Bruce Chizen 2008 Yes 1 337,812 $16,890,600 ■ Independent Consultant Advising Permira Advisors: 2008-Present, and Voyager Capital: 2009-Present Director Chair ■ CEO, Adobe: 2000-2007 61 ■ Executive Vice President, Adobe: 1998-2000 ■ BA: Brooklyn College George Conrades 2008 Yes 1 129,531 $6,476,550 ■ Chairman, Akamai Technologies: 1999-Present Director ■ CEO, Akamai Technologies: 1999-2005 77 ■ Various Positions, IBM: 1961-1992 ■ BA: Ohio Wesleyan University, MBA: University of Chicago Hector Garcia-Molina 2001 Yes 0 300,871 $15,043,550 ■ Leonard Bosack and Sandra Lerner Professor of Computer Science and Electrical Engineering, Stanford University: 1992-Present Director ■ Fellow of the Association for Computing Machinery 62 ■ Professor of Computer Science, Princeton University, 1979-1991 ■ BS: Instituto Tecnologico de Monterrey, MS, PhD: Stanford University Renee James 2015 Yes 2 7,000 $350,000 ■ Operating Executive, Carlyle Group: 2016-Present Director ■ President, Intel: 1988-2016 52 ■ Director, VMWare: 2008-2014 ■ BA, MBA: University of Oregon Leon Panetta 2015 Yes 1 10,781 $539,050 ■ US Secretary of Defense: 2011-2013 Director ■ Direcor, Central Intelligence Agency: 2009-2011 78 ■ Member of the House of Representatives: 1977-1993 ■ BA, JD: Santa Clara University Naomi Seligman 2005 Yes 2 301,926 $15,096,300 ■ Senior Partner Ostriker von Simson, Inc: 1999-Present Director ■ Senior Partner, Research Board, Inc: 1977-1999 78 ■ Senior Partner, Cassius Advisors ■ MBA: London School of Economics, BA: Vassar College Sources: Oracle 2017 Proxy Statement, Company Website, Bloomberg
Source: Company data, Credit Suisse estimates.
The distinguished academic careers of certain directors result in lower average C-Suite experience relative to comps than in the executive suite. It is also worth noting that Oracle’s directors have spent more time as CEOs (see the red sections in Figure 97: ORCL Board C-Suite Experience) than the directors of any other company except Check Point and Fortinet, two founder-led security companies with relatively small boards.
Figure 96: ORCL Board Experience Is Still High, but Figure 97: ORCL Board C-Suite Experience Is Low, Closer to Average but Directors Have Spent a Lot of Time as CEOs Board Experience Board C-Suite Experience SYMC Per Director RHT Per Director HDP SYMC CEO/CFO CEO VP CFO INTU NOW Other Executive PANW ORCL Relevant Industry RHT PANW FTNT Other Industry AKAM NOW Finance CRM ADBE INTU VMW HDP MSFT SPLK SPLK FTNT ORCL VMW CRM MSFT CHKP ADBE AKAM CHKP
0 5 10 15 20 25 30 35 40 0 5 10 15 20
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 42 5 September 2017
Also in contrast to the management team, the board has more degrees per member than any other company we analyzed (tied with Symantec).
Figure 98: Oracle Is Tied with Symantec for Highest Average Number of Degrees per Board Member Degrees Per Board Member VMW BA/BS SPLK PANW MBA INTU MS CHKP JD HDP PhD NOW CRM AKAM FTNT ADBE MSFT RHT ORCL SYMC
0 0.5 1 1.5 2
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 43 5 September 2017
Valuation—Initiating with Outperform We initiate our coverage of ORCL with an Outperform rating and a Target Price of $62/share based on our DCF analysis, implying 24% upside potential. We have constructed blue sky and grey sky scenarios in addition to our target scenario. Each assumes a 2.5% terminal growth rate.
Figure 99: We See a TP of $62 in Our Base Case and Figure 100: Our Base Case Implies 24% Upside and a $71/$42 Valuation in the Blue/Grey Sky Scenarios Blue Sky Implies 43% Upside Current Price $50 15.1x FY18E UFCF
Blue Sky
Target Price $62 24% 18.4x FY18E UFCF $71 This scenario assumes continued growth in cloud bookings with the installed base customers transitioning to SaaS/PaaS/IaaS, without assuming share gain in Target Price the ERP market, resulting in UFCF growth of 12% in the medium term ('20-'21) Blue Sky $71 43% 21.3x FY18E UFCF $62 This scenario assumes continued transition to SaaS/PaaS/IaaS from the on-prem offerings along with share gain and up-sell opportunities, which results in UFCF growth of 20%/18% in the medium term ('20/'21) Current Price Grey sky $42 -15% 12.5x FY18E UFCF $50 This scenario implies slowdown of the SaaS transition and continued disruption in the database market from AWS. In this scenario, UFCF growth is flattish Grey Sky in the medium term ('20-'21) $42
Source: Check Point, Credit Suisse estimates. Source: Check Point, Credit Suisse estimates.
Target Scenario Our base case assumes a five-year transition period with FCF growth declining smoothly from an estimated 12% in 2020. This scenario assumes continued growth in cloud bookings with the installed base customers transitioning to SaaS/PaaS/IaaS, with the assumption of modest share gains in the ERP market. We model a 2.5% terminal growth rate from 2027E.
Figure 101: Share Price Sensitivity to Cost of Equity and UFCF Growth Rate Share price sensitivity to cost of equity and UFCF growth rate
Unlevered Free Cash Flow FY4 growth rate 61.86593 0.0% 2.5% 5.0% 7.5% 10.0% 12.5% 15.0% 17.5% 20.0% 9.0% $51 $54 $58 $61 $65 $69 $74 $79 $83 9.5% $49 $52 $55 $59 $63 $66 $71 $75 $80 10.0% $47 $50 $53 $57 $60 $64 $68 $72 $76 10.5% $46 $49 $51 $55 $58 $61 $65 $69 $73 Terminal 11.0% $44 $47 $50 $53 $56 $59 $63 $67 $71 Cost of 11.5% $43 $46 $48 $51 $54 $58 $61 $65 $68 Equity 12.0% $42 $45 $47 $50 $53 $56 $59 $63 $66 12.5% $41 $44 $46 $49 $52 $54 $58 $61 $65 13.0% $40 $43 $45 $48 $50 $53 $56 $59 $63 13.5% $40 $42 $44 $47 $49 $52 $55 $58 $61 14.0% $39 $41 $43 $46 $48 $51 $54 $57 $60 14.5% $38 $40 $42 $45 $47 $50 $53 $56 $59 15.0% $38 $40 $42 $44 $46 $49 $52 $55 $58 15.5% $37 $39 $41 $43 $46 $48 $51 $54 $56
Source: Company data, Credit Suisse estimates.
Blue Sky Scenario For our blue sky scenario, we again model a five-year transition period but assume ORCL gains more meaningful share in the ERP market as well as drives up-sell opportunities. In this case, ORCL can grow FCF by 20%/18% per year in 2020/2021 with the growth rate declining smoothly to the terminal growth rate of 2.5% over time.
Oracle Corporation (ORCL) 44 5 September 2017
Grey Sky Scenario For our grey sky scenario, we also model a five-year transition period but assume that the cloud transition slows down and the share loss in the low-end database market continues. In this case, ORCL could experience flattish FCF growth in 2020/2021 with the growth rate recovering to the terminal growth rate of 2.5% over time.
Figure 102: ORCL DCF—We See a $62 Target Price in the Base Case and $71/$42 Valuation in the Blue/Grey Sky Scenarios
Target Price
HISTORIC FORECAST PERIOD TRANSITIONARY PERIOD TERMINAL TP Value distribution 2014A 2015A 2016A 2017A 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E Perpetuity
Period 1 2 3 4 5 6 7 8 9 10 Current risk-free rate of return 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Beta 1.06 1.06 1.06 1.06 1.06 1.06 1.06 1.06 1.05 1.04 1.03 1.02 1.01 1.00 Equity Risk Premium 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% Cost of equity 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.5% 10.4% 10.4% 10.3% 10.2% FCF Growth Rate -9.4% -3.6% -1.6% 8.2% 4.3% 12.0% 12.0% 10.4% 8.8% 7.3% 5.7% 4.1% 2.5% Discount Factor 1.00 1.11 1.22 1.35 1.50 1.65 1.83 2.01 2.22 2.45
Free cash flow ($M) 15,058.4 13,649.5 13,162.2 12,954.0 14,012 14,611 16,364 18,328 20,237 22,024 23,621 24,960 25,979 26,628 344,035 NPV of Free cash flow ($M) 14,012 13,209 13,374 13,542 13,525 13,322 12,939 12,388 11,690 140,427 Cumulative NPV of FCF ($M) 14,012 27,221 40,595 54,136 67,661 80,984 93,923 106,311 118,001 258,427
Cumulative NPV of FCF ($M) $258,427 Shares outstanding (M) 4,248 NPV/Share of FCF 60.84 (Net Cash) / Share $ 1.03 Total NPV/Share $62 Current price / Share $50 Upside / Downside Potential 24%
Blue Sky
HISTORIC FORECAST PERIOD TRANSITIONARY PERIOD TERMINAL BS Value distribution 2014A 2015A 2016A 2017A 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E Perpetuity
Period 1 2 3 4 5 6 7 8 9 10 Current risk-free rate of return 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Beta 1.06 1.06 1.06 1.06 1.06 1.06 1.06 1.06 1.05 1.04 1.03 1.02 1.01 1.00 Equity Risk Premium 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% Cost of equity 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.5% 10.4% 10.4% 10.3% 10.2% FCF Growth Rate -9.4% -3.6% -1.6% 8.2% 4.3% 20.0% 18.0% 15.4% 12.8% 10.3% 7.7% 5.1% 2.5% Discount Factor 1.00 1.11 1.22 1.35 1.50 1.65 1.83 2.01 2.22 2.45
Free cash flow ($M) 15,058.4 13,649.5 13,162.2 12,954.0 14,012 14,611 16,364 19,309 22,286 25,146 27,724 29,849 31,367 32,151 415,388 NPV of Free cash flow ($M) 14,012 13,209 13,374 14,267 14,895 15,211 15,186 14,815 14,114 169,551 Cumulative NPV of FCF ($M) 14,012 27,221 40,595 54,862 69,757 84,968 100,154 114,969 129,083 298,634
Cumulative NPV of FCF ($M) $298,634 Shares outstanding (M) 4,248 NPV/Share of FCF 70.30 (Net Cash - 10% of Revenues) / Share $ 1.03 Total NPV/Share $71 Current price / Share $50 Upside / Downside Potential 43%
Grey sky
HISTORIC FORECAST PERIOD TRANSITIONARY PERIOD TERMINAL GS Value distribution 2014A 2015A 2016A 2017A 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E Perpetuity
Period 1 2 3 4 5 6 7 8 9 10 Current risk-free rate of return 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Beta 1.06 1.06 1.06 1.06 1.06 1.06 1.06 1.06 1.05 1.04 1.03 1.02 1.01 1.00 Equity Risk Premium 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% Cost of equity 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.6% 10.5% 10.4% 10.4% 10.3% 10.2% FCF Growth Rate -9.4% -3.6% -1.6% 8.2% 4.3% 0.0% 0.0% 0.4% 0.8% 1.3% 1.7% 2.1% 2.5% Discount Factor 1.00 1.11 1.22 1.35 1.50 1.65 1.83 2.01 2.22 2.45
Free cash flow ($M) 15,058.4 13,649.5 13,162.2 12,954.0 14,012 14,611 14,611 14,611 14,672 14,794 14,979 15,228 15,546 15,934 205,870 NPV of Free cash flow ($M) 14,012 13,209 11,941 10,795 9,806 8,949 8,205 7,558 6,995 84,031 Cumulative NPV of FCF ($M) 14,012 27,221 39,162 49,957 59,763 68,711 76,916 84,475 91,470 175,501
Cumulative NPV of FCF ($M) $175,501 Shares outstanding (M) 4,248 NPV/Share of FCF 41.31 (Net Cash - 10% of Revenues) / Share $ 1.03 Total NPV/Share $42 Current price / Share $50 Upside / Downside Potential -15%
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 45 5 September 2017
We also compare Oracle with its peers on a P/E and EV/FCF basis. We include the large-cap names, such as IBM, MSFT, SAP, CSCO, HPE, and AAPL, into Oracle's peer group. We note that ORCL's P/E multiple of 16.3x is relatively in-line with the group average, and its EV/FCF multiple of 15.1x is relatively in-line with the group average as well. Given the progress ORCL has made in its cloud transition and the upside potential that ORCL can realize in the near future, we believe ORCL's valuation is underestimated.
Figure 103: ORCL Trades Relatively In-Line with the Peer Group Comp Table
P/E EV/FCF Price Market Cap ($mn) EV ($mn) CY1 CY2 CY1 CY2 IBM $143 133,295 140,145 10.4x 10.3x 12.4x 11.9x MSFT $75 575,897 529,110 24.0x 21.9x 18.0x 16.5x CSCO $32 161,052 124,277 13.4x 13.0x 10.1x 9.1x AAPL $164 847,097 693,920 17.3x 14.9x 12.7x 11.1x HPE $18 29,334 24,934 12.7x 13.6x NM 13.0x SAP $105 128,590 130,637 21.1x 19.2x 27.9x 23.9x Average 16.5x 15.5x 16.2x 14.3x ORCL $50 213,802 205,633 17.8x 16.3x 16.0x 15.1x ORCL TP $62 262,806 254,637 21.9x 20.0x 19.8x 18.7x
Source: Thomson Reuters, Credit Suisse Research. HOLT® Analysis Priced for Cloud Transition to Fail We also examined ORCL's valuation through the lens of the Credit Suisse HOLT framework. We note a transition from on-premise to cloud-based services has pressured ORCL's returns on capital (CFROI®). In 2016, the company's CFROI was 14%, which was the lowest point in 20 years. ORCL's historical median CFROI was 22%, and the return rate peaked in 2006 at 33.5%.
Figure 104: Transitioning from On-premise to Cloud-Based Services Has Pressured ORCL's Returns on Capital (CFROI) 40 Market implied CFROI: 5-year forward return on 30 capital required to validate 20 current valuation
10
0 1996 2000 2004 2008 2012 2016 2020 CFROI Forecast CFROI Discount rate Historical median Market implied CFROI
Source: Company data, Credit Suisse estimates.
However, we believe the market is not crediting a ramp in traditional metrics, typical of a cloud transition. To put this in perspective, we compare ORCL with ADBE and ADSK, both acknowledged and well understood cloud transition stories. ORCL's market implied return on capital is ~12%, implying a fade from both current and forecast levels. This shows embedded market expectations do not credit ORCL with a recovery in returns on capital, in other words, at current valuations the market is not looking through ORCLs cloud transition. In contrast:
Oracle Corporation (ORCL) 46 5 September 2017
■ ADBE: A cloud-transition proof point, Adobe has rapidly recovered 10p.p. of CFROI from its mid-transition nadir of ~7% in 2014. Underlining the power of a successful transition, returns on capital forecasts driven by IBES consensus estimates for FY1 and FY2 in the mid-20s are higher than ADBE has ever previously achieved. ■ ADSK: If ADBE proves the ability of cloud transitions to increase returns on capital, ADSK proves the market is willing to look through transitions it believes in. ADSK's market-implied CFROI of >18% indicates the embedded market expectations are for a successful execution on its transition messaging.
Figure 105: ADBE Is Valued as a SaaS Business, Figure 106: ADSK Is Perceived as a SaaS Business, with Market-Implied CFROI Close to a Historical with Market-Implied CFROI Way Ahead of the High Consensus ADBE's cloud model showed an inflection in 2014 ADSK's capital return is expected to inflect in 2018
40 40
30 30
20 20
10 10
0 0
(10 ) (10 ) 1996 2000 2004 2008 2012 2016 2020 1996 2000 2004 2008 2012 2016 2020 CFROI Forecast CFROI CFROI Forecast CFROI Discount rate Historical median Discount rate Historical median Market implied CFROI Market implied CFROI
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
Looking at the same charts in a slightly different way shows that for both companies, when consensus forecasts initially began to price in near-term transitionary pressures, the market looked through that transition in expectation of a recovery. In both cases, market returns expectations actually increased through the transitionary period.
Figure 107: ADBE Has Been Perceived as a SaaS Figure 108: ADSK Is Now Perceived as a SaaS Company Since 2013, When CFROI Troughed Company, Despite Still Declining/Negative CFROI Market implied CFROI above consensus since 2013 Market implied CFROI stays ahead of the consensus 40 25
20 30 15 20 10
10 5
0 0 Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Source: Company data, Credit Suisse estimates. Source: Company data, Credit Suisse estimates.
Analyzing Oracle through the same lens paints a different picture. Current levels of valuation imply the market is unwilling to look through near-term transitionary pressures to the promise of enhanced future returns. Given we think the cloud opportunity for ORCL is real, we think this analysis shows the market to be overly conservative regarding its transitionary opportunity, and thus offers an opportunity for a rerating as investors become increasingly comfortable with the opportunity.
Oracle Corporation (ORCL) 47 5 September 2017
Figure 109: ORCL's Market-Implied CFROI Is at Historical Low Point
40
35
30
25
20
15
10
5
0 Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
NTM CFROI - Forecast CFROI derived from consensus earnings estimates at that time Market implied CFROI - CFROI level implied by market valuations at that time
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 48 5 September 2017
Figure 110: ORCL Income Statement (non-GAAP) Research Analysts Brad Zelnick - (212) 325 6118 3 #VALUE! #VALUE! #VALUE! #VALUE! #VALUE! #VALUE! #VALUE! #VALUE! #VALUE! #VALUEJ!ob#inV AMLUaEth!ew# V- A(2L1U2E)! 325 9676 ## Oracle (ORCL) Syed Talha Saleem - (212) 538-1428 I n c o m e S t a t e m e n t Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal 2019 by Quarter 2015 2016 Aug-16 Nov-16 Feb-17 May-17 2017 Aug-17E Nov-17E Feb-18E May-18E 2018 Aug-18E Nov-18E Feb-19E May-19E 2019 Non-GAAP Statement Total revenue (non-GAAP) 38,253 37,056 8,613 9,070 9,274 10,942 37,899 9,025 9,495 9,691 11,214 39,425 9,457 9,905 10,126 11,514 41,002 Cloud Revenues 2,105 2,860 986 1,087 1,258 1,411 4,742 1,491 1,612 1,788 1,997 6,888 2,021 2,164 2,361 2,620 9,167 SaaS Revs 1,488 2,008 674 759 934 1,008 3,375 1,124 1,205 1,363 1,479 5,170 1,492 1,588 1,768 1,897 6,745 PaaS/IaaS Revs 617 852 312 328 324 403 1,367 367 408 425 518 1,718 529 577 593 723 2,422 On-Prem Revs 27,391 26,138 5,823 6,125 6,176 7,523 25,647 5,806 6,105 6,141 7,300 25,352 5,772 6,034 6,081 7,067 24,955 New Software Licenses 8,535 7,274 1,030 1,347 1,414 2,626 6,417 924 1,238 1,268 2,300 5,730 810 1,077 1,125 2,025 5,037 Software updates & support 18,856 18,864 4,793 4,778 4,762 4,897 19,230 4,882 4,867 4,873 5,000 19,622 4,962 4,957 4,956 5,042 19,918 Hardware Revenues 5,210 4,670 996 1,014 1,028 1,114 4,152 907 928 935 1,014 3,785 837 854 861 932 3,484 Services 3,547 3,388 808 844 812 894 3,358 821 849 827 903 3,399 827 853 822 894 3,396
COGS (non-GAAP) SaaS 736 1,035 278 310 324 349 1,261 393 422 409 444 1,667 448 476 477 497 1,898 Gross Margin 50.5% 48.5% 58.8% 59.2% 65.3% 65.4% 62.6% 65.0% 65.0% 70.0% 70.0% 67.7% 70.0% 70.0% 73.0% 73.8% 71.9% PaaS/IaaS 365 464 131 155 174 212 672 162 171 183 218 733 217 236 237 271 962 Gross Margin 40.8% 45.5% 58.0% 52.7% 46.3% 47.4% 50.8% 56.0% 58.0% 57.0% 58.0% 57.3% 59.0% 59.0% 60.0% 62.5% 60.3% Software updates & support 1,178 1,121 269 236 264 260 1,029 244 243 244 230 961 223 223 208 232 886 Gross Margin 93.8% 94.1% 94.4% 95.1% 94.5% 94.7% 94.6% 95.0% 95.0% 95.0% 95.4% 95.1% 95.5% 95.5% 95.8% 95.4% 95.5% Hardware 2,276 2,053 388 383 434 437 1,642 339 336 375 374 1,423 300 294 343 330 1,266 Gross Margin 56.3% 56.0% 61.0% 62.2% 57.8% 60.8% 60.5% 62.5% 63.7% 59.8% 63.0% 62.4% 64.0% 65.5% 60.0% 64.5% 63.6% Services 2,898 2,721 687 688 666 714 2,755 698 679 661 722 2,760 707 687 662 719 2,775 Gross Margin 18.3% 19.7% 15.0% 18.5% 18.0% 20.1% 18.0% 15.0% 20.0% 20.0% 20.0% 18.8% 14.5% 19.5% 19.5% 19.5% 18.3% Cost of revenue 7,454 7,394 1,753 1,773 1,862 1,972 7,360 1,835 1,851 1,871 1,988 7,545 1,894 1,916 1,928 2,050 7,788 Gross profit 30,799 29,662 6,860 7,297 7,412 8,970 30,539 7,190 7,644 7,820 9,226 31,879 7,562 7,989 8,198 9,464 33,214 Gross margin 80.5% 80.0% 79.6% 80.5% 79.9% 82.0% 80.6% 79.7% 80.5% 80.7% 82.3% 80.9% 80.0% 80.7% 81.0% 82.2% 81.0%
Opex (non-GAAP) Sales and marketing 7,474 7,665 1,856 1,901 1,929 2,251 7,937 1,913 1,956 1,929 2,204 8,001 1,958 1,981 1,985 2,257 8,180 % of revenue 19.5% 20.7% 21.5% 21.0% 20.8% 20.6% 20.9% 21.2% 20.6% 19.9% 19.7% 20.3% 20.7% 20.0% 19.6% 19.6% 20.0% Research and development 5,001 5,177 1,325 1,322 1,330 1,412 5,389 1,363 1,339 1,318 1,374 5,393 1,371 1,397 1,367 1,433 5,568 % of revenue 13.1% 14.0% 15.4% 14.6% 14.3% 12.9% 14.2% 15.1% 14.1% 13.6% 12.3% 13.7% 14.5% 14.1% 13.5% 12.5% 13.6% General and administrative 930 1,036 277 268 209 291 1,045 280 256 223 258 1,017 246 253 243 265 1,006 % of revenue 2.4% 2.8% 3.2% 2.9% 2.3% 2.7% 2.8% 3.1% 2.7% 2.3% 2.3% 2.6% 2.6% 2.6% 2.4% 2.3% 2.5% Total operating expenses 13,405 13,878 3,458 3,490 3,468 3,954 14,370 3,556 3,551 3,469 3,835 14,411 3,575 3,630 3,595 3,955 14,755 % of revenue Operating income 17,394 15,784 3,402 3,807 3,944 5,016 16,169 3,634 4,093 4,350 5,391 17,468 3,988 4,359 4,603 5,509 18,459 Operating margin 45.5% 42.6% 39.5% 42.0% 42.5% 45.8% 42.7% 40.3% 43.1% 44.9% 48.1% 44.3% 42.2% 44.0% 45.5% 47.8% 45.0% Growth - y/y -3.9% -9.3% -2.0% 2.3% 3.2% 5.2% 2.4% 6.8% 7.5% 10.3% 7.5% 8.0% 9.7% 6.5% 5.8% 2.2% 5.7%
Interest & other income 105 305 148 99 189 168 604 187 187 182 180 736 188 193 191 195 767 Interest expense (1,141) (1,467) (416) (451) (450) (481) (1,798) (444) (442) (432) (424) (1,742) (419) (383) (382) (382) (1,566) Interest and other, net (1,036) (1,162) (268) (352) (261) (313) (1,194) (257) (255) (249) (244) (1,006) (231) (190) (191) (187) (799)
Pretax income 16,358 14,622 3,134 3,455 3,683 4,703 14,975 3,377 3,837 4,101 5,147 16,462 3,757 4,169 4,412 5,322 17,660 Pro forma taxes 3,868 3,386 799 881 795 941 3,416 800 909 972 1,220 3,901 864 959 1,015 1,224 4,062 Effective tax rate 23.6% 23.2% 25.5% 25.5% 21.6% 20.0% 22.8% 23.7% 23.7% 23.7% 23.7% 23.7% 23.0% 23.0% 23.0% 23.0% 23.0% Pro forma net income 12,490 11,236 2,335 2,574 2,888 3,762 11,559 2,577 2,928 3,129 3,927 12,560 2,893 3,210 3,397 4,098 13,598 Pro forma net margin 32.7% 30.3% 27.1% 28.4% 31.1% 34.4% 30.5% 28.5% 30.8% 32.3% 35.0% 31.9% 30.6% 32.4% 33.5% 35.6% 33.2% Pro forma EPS (fully-diluted) $2.77 $2.61 $0.55 $0.61 $0.69 $0.89 $2.74 $0.60 $0.68 $0.73 $0.91 $2.93 $0.67 $0.75 $0.79 $0.95 $3.16 Growth y/y -3.3% -5.9% 4.0% -3.2% 7.1% 9.6% 5.0% 9.3% 11.6% 6.2% 3.0% 6.9% 11.2% 8.9% 8.2% 4.4% 7.8% Growth q/q -31.5% 10.9% 12.0% 28.9% -31.7% 13.3% 6.5% 25.1% -26.3% 11.0% 5.8% 20.6% Diluted shares count 4,503 4,306 4,221 4,195 4,204 4,248 4,217 4,262 4,276 4,290 4,304 4,285 4,304 4,304 4,304 4,304 4,304
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 49 5 September 2017
Figure 111: ORCL Balance Sheet
3 81 82 83 84 85 86 87 88 89 90 91 92 Oracle (ORCL) B a l a n c e S h e e t Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal 2019 by Quarter 2015 2016 Aug-16 Nov-16 Feb-17 May-17 2017 Aug-17E Nov-17E Feb-18E May-18E 2018 Aug-18E Nov-18E Feb-19E May-19E 2019 Current assets Cash and cash equivalents 54,368 56,125 68,396 58,206 59,352 66,078 66,078 65,942 64,433 63,464 66,324 66,324 68,107 67,532 69,037 71,510 71,510 Cash and cash equivalents 21,716 20,152 28,614 18,592 19,748 21,784 21,784 21,648 20,139 19,170 22,030 22,030 23,813 23,238 24,743 27,216 27,216 Short-term marketable securities 32,652 35,973 39,782 39,614 39,604 44,294 44,294 44,294 44,294 44,294 44,294 44,294 44,294 44,294 44,294 44,294 44,294 Trade receivables, net of allowance 5,618 5,385 3,407 3,690 3,721 5,300 5,300 3,543 3,904 4,164 6,134 6,134 4,397 4,567 5,989 7,132 7,132 Inventories 314 212 286 327 391 300 300 250 287 338 291 291 233 274 320 308 308 Other current assets 2,220 2,591 2,362 2,511 2,547 2,837 2,837 2,837 2,837 2,837 2,837 2,837 2,837 2,837 2,837 2,837 2,837 Total current assets 63,183 64,313 74,451 64,734 66,011 74,515 74,515 72,572 71,460 70,803 75,586 75,586 75,574 75,210 78,183 81,787 81,787 Long-term investments Property and equipment, net of depreciation 3,686 4,000 4,108 4,882 5,070 5,315 5,315 5,408 5,526 5,659 5,807 5,807 5,893 5,994 6,099 6,258 6,258 Intangible assets, net 6,406 4,943 5,091 7,968 7,788 7,679 7,679 7,282 6,885 6,488 6,091 6,091 5,736 5,382 5,027 4,672 4,672 Goodwill 34,087 34,590 35,350 42,083 42,504 43,045 43,045 43,045 43,045 43,045 43,045 43,045 43,045 43,045 43,045 43,045 43,045 Deferred tax assets 795 1,291 1,142 895 918 1,143 1,143 1,143 1,143 1,143 1,143 1,143 1,143 1,143 1,143 1,143 1,143 Other assets 2,746 3,043 3,081 3,038 3,091 3,294 3,294 3,294 3,294 3,294 3,294 3,294 3,294 3,294 3,294 3,294 3,294 Total assets 110,903 112,180 123,223 123,600 125,382 134,991 134,991 132,744 131,353 130,432 134,966 134,966 134,686 134,067 136,791 140,199 140,199
Current liabilities Commercial paper and other ST borrowings 1,999 3,750 999 3,838 3,498 9,797 9,797 5,999 4,999 2,499 2,999 2,999 2,000 3,745 6,495 5,995 5,995 Accounts payable 806 504 551 615 481 599 599 542 570 436 572 572 331 238 354 345 345 Accrued compensation 1,839 1,966 1,419 1,486 1,516 1,966 1,966 1,309 1,461 1,260 1,570 1,570 1,135 792 1,215 921 921 Deferred revenue, short term 7,245 7,655 9,462 7,411 7,388 8,233 8,233 10,058 8,047 7,968 8,988 8,988 10,786 8,563 8,422 9,452 9,452 Other current liabilities 2,870 3,333 2,711 2,997 2,907 3,583 3,583 3,583 3,583 3,583 3,583 3,583 3,583 3,583 3,583 3,583 3,583 Total current liabilities 15,291 17,208 15,142 16,347 15,790 24,178 24,178 21,490 18,659 15,746 17,712 17,712 17,835 16,921 20,069 20,297 20,297
Long-term liabilities Notes payable, LT 39,959 40,105 53,057 50,489 50,469 48,112 48,112 47,495 47,495 47,495 46,995 46,995 44,795 43,050 40,300 40,300 40,300 Income taxes payable 4,386 4,908 5,031 5,099 5,162 5,681 5,681 5,450 5,250 5,300 5,450 5,450 5,450 5,450 5,450 5,450 5,450 Other 2,169 2,169 2,161 2,820 2,938 2,774 2,774 2,771 2,703 2,700 2,734 2,734 2,786 2,715 2,712 2,754 2,754 Total liabilities 61,805 64,390 75,391 74,755 74,359 80,745 80,745 77,206 74,107 71,241 72,891 72,891 70,866 68,136 68,531 68,800 68,800
Total shareholders' equity 49,098 47,790 47,832 48,845 51,023 54,246 54,246 55,538 57,245 59,191 62,075 62,075 63,820 65,932 68,260 71,398 71,398 Total liabilities and shareholders' equity 110,903 112,180 123,223 123,600 125,382 134,991 134,991 132,744 131,353 130,432 134,966 134,966 134,686 134,067 136,791 140,199 140,199
Source: Company data, Credit Suisse estimates.
Figure 112: ORCL Cash Flow Statement 3 81 82 83 84 85 86 87 88 89 90 91 92 c Oracle (ORCL) S t a t e m e n t o f C a s h F l o w s Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal 2019 by Quarter 2014 2015 Aug-16 Nov-16 Feb-17 May-17 2017 Aug-17E Nov-17E Feb-18E May-18E 2018 Aug-18E Nov-18E Feb-19E May-19E 2019
CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) 10,955 9,938 1,832 2,033 2,239 3,231 9,335 2,250 2,667 2,908 3,847 11,672 2,711 3,077 3,293 4,102 13,182 Depreciation 608 712 222 241 259 278 1,000 295 300 302 312 1,210 321 325 330 336 1,312 Amortization of intangibles 2,300 2,149 311 302 397 441 1,451 397 397 397 397 1,588 355 355 355 355 1,419 Deferred taxes (248) (548) 145 (42) 8 (597) (486) ------Stock-based compensation 805 933 319 327 371 333 1,350 330 331 331 332 1,324 330 331 331 332 1,324 Other, net 311 327 39 46 11 27 123 ------Changes to assets and liabilities (40) 673 2,792 (1,854) (715) 516 739 2,683 (2,496) (678) (273) (764) 2,968 (2,941) (1,073) (361) (1,407) Net cash provided by operating activities 14,921 14,336 5,875 1,087 2,699 4,465 14,126 5,955 1,199 3,260 4,615 15,030 6,685 1,147 3,235 4,764 15,831 Growth - y/y 5% -4% 0% 117% -22% 20% 4% 1% 10% 21% 3% 6% 12% -4% -1% 3% 5% % of Total Revenues 39% 37% 68% 12% 29% 41% 37% 66% 13% 34% 41% 38% 71% 12% 32% 41% 39%
CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (580) (1,391) (299) (757) (440) (525) (2,021) (388) (418) (436) (460) (1,702) (407) (426) (435) (495) (1,763) Net cash used in investing activities (7,539) (19,047) (5,203) (9,717) (728) (5,846) (21,494) (388) (418) (436) (460) (1,702) (407) (426) (435) (495) (1,763)
CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of common stock (9,813) (8,087) (2,002) (567) (498) (494) (3,561) (500) (500) (500) (500) (2,000) (500) (500) (500) (500) (2,000) Payment of dividend (2,178) (2,255) (618) (614) (612) (787) (2,631) (788) (790) (793) (796) (3,167) (796) (796) (796) (796) (3,183) Payment of debt - (1,500) (3,750) - (344) - (4,094) (4,415) (1,000) (2,500) - (7,915) (3,199) - - (500) (3,699) Net cash provided by financing activities (4,068) 9,850 7,712 (973) (940) 3,287 9,086 (5,703) (2,290) (3,793) (1,296) (13,082) (4,495) (1,296) (1,296) (1,796) (8,882)
Effect of exchange rate changes (158) (1,192) 78 (418) 125 129 (86) ------
Net change in cash and cash equivalents 3,156 3,947 8,462 (10,021) 1,156 2,035 1,632 (136) (1,509) (969) 2,860 246 1,783 (575) 1,504 2,473 5,186 Beginning balance cash and cash equivalents 14,613 17,769 20,152 28,614 18,593 19,749 20,152 21,784 21,647 20,138 19,170 21,784 22,030 23,813 23,238 24,742 22,030 Ending balance cash and cash equivalents 17,769 21,716 28,614 18,593 19,749 21,784 21,784 21,647 20,138 19,170 22,030 22,030 23,813 23,238 24,742 27,215 27,215 Free Cash Flow 14,341 12,945 5,576 330 2,259 3,940 12,105 5,566 782 2,824 4,156 13,328 6,278 721 2,800 4,269 14,068 Growth - y/y 6% -10% 3% 8% -27% 11% -2% 0% 137% 25% 5% 10% 13% -8% -1% 3% 6% % of Total Revenues 37% 34% 65% 4% 24% 36% 32% 62% 8% 29% 37% 34% 66% 7% 28% 37% 34%
Unlevered FCF 15,058 13,649 5,758 569 2,436 4,190 12,954 5,741 955 2,994 4,322 14,012 6,435 850 2,930 4,396 14,611 Growth - y/y 7% -9% 2% 14% -26% 13% -2% 0% 68% 23% 3% 8% 12% -11% -2% 2% 4% % of Total Revenues 39% 36% 67% 6% 26% 38% 34% 64% 10% 31% 39% 36% 68% 9% 29% 38% 36%
Source: Company data, Credit Suisse estimates.
Oracle Corporation (ORCL) 50 5 September 2017
Credit Suisse PEERs PEERs is a global database that captures unique information about companies within the Credit Suisse coverage universe based on their relationships with other companies – their customers, suppliers and competitors. The database is built from our research analysts’ insight regarding these relationships. Credit Suisse covers over 3,000 companies globally. These companies form the core of the PEERs database, but it also includes relationships on stocks that are not under coverage.
Figure 113: Credit Suisse PEERs Relationship Map
Source: Company data, Credit Suisse estimates
Oracle Corporation (ORCL) 51 5 September 2017
Appendix 1: Credit Suisse HOLT® Overview The HOLT Valuation Framework is based on two fundamental principles: ■ The market pays for economic (cash) performance and not accounting performance. ■ The value of a company is determined by its discounted future cash flows over its life cycle. The HOLT methodology uses a proprietary performance measure known as Cash Flow Return on Investment (CFROI®). HOLT uses CFROI to estimate future cash flows and applies a unique notion of life cycle fade to reflect the position of any individual company on its industrial life cycle.
Figure 114: The HOLT Methodology
Accounting Cash Value . Income Statement . Cash Flow Return on . CFROI . Balance Sheet Investment (CFROI) . Asset Growth . EPS, ROE, ROCE . Economic Performance . Life Cycle Fade . Discount Rate
Source: Credit Suisse HOLT.
Cash Flow Return on Investment (CFROI) Why use CFROI? Accounting statements often present a distorted view of underlying economic performance. To better define a cash measure, HOLT's economic CFROI corrects for the distortions found in traditional accounting-based measures of performance by adjusting for inflation, off-balance sheet assets (e.g., leased property), depreciation, LIFO & FIFO accounting, asset mix, asset holding gains or losses, asset life, acquisition accounting, deferred taxes, pensions, investments, revaluations, special reserves, research and development, and others. As a result, CFROI provides comparability over time, among companies, and across industries and national borders. This proprietary measure focuses on the cash economics of businesses. Once the economics of the company are understood, we can more accurately determine value by taking into account expected future cash flows, asset growth rates, discount rates and life cycles. HOLT's CFROI is calculated in two steps. First, compare the inflation-adjusted (current dollar) cash flows available to all capital owners in the company to the inflation-adjusted (current dollar) gross investment made by those capital owners. Next, translate the ratio of gross cash flow to gross investment to an internal rate of return (IRR) by recognizing the finite economic life of depreciating assets and the residual value of non-depreciating assets such as land and working capital. The process is identical to calculating the yield to maturity for a bond. As a percent per year IRR, CFROI is directly comparable with the return investors expect to receive (i.e., the cost of capital or discount rate).
Oracle Corporation (ORCL) 52 5 September 2017
Figure 115: CFROI Captures Economic Performance
Source: Credit Suisse HOLT.
Figure 116: CFROI Formula in Detail
Source: Credit Suisse HOLT.
Oracle Corporation (ORCL) 53 5 September 2017
Value Creation Companies can create wealth for shareholders by making the right decisions with respect to CFROI and asset growth. Wealth is created when companies: ■ Improve CFROI ■ Grow assets when CFROI is above the discount rate (positive spread) ■ Shrink assets when CFROI is below the discount rate (negative spread)
Figure 117: Managing for Shareholder Value
Source: Credit Suisse HOLT.
Economic Profit The Economic Profit formula underpins the value creation principle. Economic Profit (EP) is the amount of value a firm creates over a specified period, typically annual. It is proportional to the spread between a company’s return on capital and cost of capital. If a firm is meeting its cost of capital, its EP is zero. Growth into projects that earn below the cost of capital destroys shareholder value, and these projects should be rejected. Growth at the cost of capital is value neutral. The HOLT EP is simply the economic spread multiplied by assets if CFROI’ is specified as the return on capital.
Economic Profit = (return on capital – cost of capital) x invested capital HOLT Economic Profit is calculated as = (CFROI® – HOLT discount rate) x inflation adjusted gross investment
HOLT Valuation The HOLT valuation model, at its foundation, is a type of DCF (discounted cash flow) model. Among the model’s distinguishing features, along with the CFROI metric, is the way by which the forecasted stream of net cash receipts (NCRs) is generated and the method by which the firm’s discount rate (DR) is estimated. From a beginning asset base, key variables that drive the forecast NCR stream are variables that actually generate cash flows, namely, economic returns (CFROIs), reinvestment rates (growth), and their expected patterns of change over time due to competition (fade). The competitive life cycle is covered below The discount rate is the rate of return investors demand for making their funds available to the firm. DRs used in our model are real rates, not nominal rates, so they are consistent
Oracle Corporation (ORCL) 54 5 September 2017
with CFROIs. The DRs are also consistent with other aspects of our model, since base DRs are mathematically derived from known market values and from NCR streams consistent within our model. Adjustments (positive or negative) to the base rate are made for company-specific financial and liquidity risk characteristics. The result of discounting the NCRs at the market-derived DR is what is referred to as a warranted value or warranted price. Essentially, this is the valuation that results (or is "warranted"), given the default (or users’ own) assumptions built into the forecast and the resulting present value of the NCRs plus the value of any non-operating investments.
Figure 118: Major Components of the HOLT Valuation Model
Operating Margins Asset Base
n Net Cash Receipts CFROI Asset Turns NPV of Existing Assets = Σ creates + NPV of Future Invests t=1 (1+Disc. Rate) t Growth NPV of Net Cash Receipts Country Base Rate + MV of Non-Op. Assets Fade Total Enterprise Value Revenue Growth – MV of Debt Size Differential Total Equity Value – Minority Interest Leverage Differential Common Equity Value Warranted ÷ Adjusted Shares Price Com Equity / Share
Source: Credit Suisse HOLT.
Oracle Corporation (ORCL) 55 5 September 2017
Figure 119: How to Read a HOLT CFROI Chart
Market Derived Discount Rate Superior performance metric Market-calibrated valuation Competitive Lifecycle & fade
. The HOLT discount rate is forward- . CFROI is a cash-based return on . Forecasted FCF calibrated to current . Empirically derived terminal value looking, derived from observed capital metric that improves market values through observed, recognises competitive life-cycle of market valuation, and accurately comparability of corporate market implied discount rate returns and growth (mean reverting reflects current investors’ risk performance across companies, . Calibrate future CFROI and growth fade concept) appetite geographies and time rates embedded in the current stock . Cumulative probability approximates price the likelihood of achieving future returns given the past return profile
Discount Historical Future performance implied by Future value Turnaround? Forecast Forecast rate returns today’s stock price Growth Fading Mature CFROI Discount Cash flows rate Total Market = FCF CFROI Value (1 + DR)
Reinvestment Solve Capital investment
Historical CFROI
Adjusted historical returns on CFROI Forecast capital based on HOLTs Market derived proprietary framework T+1 and T+2 returns on discount rate capital forecasts based on IBES consensus estimates Country market implied discount rate adjusted for company’s leverage and size
Market implied CFROI
Long-term level of returns on capital required to validate today’s market value
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Source: Credit Suisse HOLT.
Oracle Corporation (ORCL) 56 5 September 2017
Companies Mentioned (Price as of 31-Aug-2017) AT&T (T.N, $37.46) Adobe Systems Inc. (ADBE.OQ, $155.16) Akamai Technologies, Inc. (AKAM.OQ, $47.15) Alibaba (BABA.K, $171.74) Alphabet (GOOGL.OQ, $955.24) Amazon com Inc. (AMZN.OQ, $980.6) Apple (AAPL.O, $164.0) Automatic Data Processing Inc. (ADP.OQ, $106.47) Bank of America Corp. (BAC.N, $23.89) CA Inc. (CA.OQ, $33.18) Check Point Software Technologies Ltd. (CHKP.OQ, $111.87) Cisco Systems (CSCO.DE, €27.13) Cornerstone OnDemand, Inc. (CSOD.OQ, $34.98) Ferrari NV (RACE.N, $114.49) Fortinet, Inc. (FTNT.OQ, $38.2) Hewlett Packard (HPQ.N, $19.08) Hewlett Packard Enterprise (HPE.N, $14.00890722) Hortonworks, Inc. (HDP.OQ, $16.99) Informatics Edu (INFO.SI, S$0.085) International Business Machines Corp. (IBM.N, $143.03) Intuit Inc. (INTU.OQ, $141.45) Kronos Worldwide (KRO.N, $20.93) Microsoft (MSFT.OQ, $74.77) Oracle Corporation (ORCL.N, $50.33, OUTPERFORM, TP $62.0) Palo Alto Networks, Inc. (PANW.N, $132.69) Ramco Systems (RMCS.NS, Rs386.7) Red Hat, Inc. (RHT.N, $107.5) SAP (SAPG.F, €88.398) Sage Group (SGE.L, 692.5p) Salesforce.com (CRM.N, $95.49) ServiceNow, Inc. (NOW.N, $116.19) Splunk, Inc. (SPLK.OQ, $67.09) Symantec Corporation (SYMC.OQ, $29.98) Teradata Corp (TDC.N, $31.92) Ultimate Software (ULTI.OQ, $200.9) VMware Inc. (VMW.N, $108.1) Verint Systems Inc. (VRNT.OQ, $39.7) Workday Inc (WDAY.N, $109.69)
Disclosure Appendix Analyst Certification Brad Zelnick and Jobin Mathew each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.
3-Year Price and Rating History for Oracle Corporation (ORCL.N)
ORCL.N Closing Price Target Price Target Price Closing Price ORCL.N Date (US$) (US$) Rating 55 19-Sep-14 39.80 45.00 O 17-Dec-14 41.16 47.50 50 17-Mar-15 42.87 50.00 45 07-Jul-16 40.53 NC 40 * Asterisk signifies initiation or assumption of coverage. Effective July 3, 2016, NC denotes termination of coverage. 35 30 01- Jan- 2015 01- Jan- 2016 01- Jan- 2017
O U T PERFO RM N O T CO V ERED The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings
Oracle Corporation (ORCL) 57 5 September 2017 are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:
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Target Price and Rating Valuation Methodology and Risks: (12 months) for Oracle Corporation (ORCL.N) Method: Our price target of $62 for Oracle represents a price to earning multiple of 20x over CY2 earnings, and enterprise value to unlevered free cash flow multiple of 18.7x. We believe Oracle stands to benefit from several drivers (1) the potential for further improvements in sales force productivity, (2) adoption of the In-Memory option of Oracle Database 12c, (3) increasing customer traction of Oracle's cloud applications and PaaS, and (4) the market opportunity for Engineered Systems. Given the upside available to our price target, we rate Oracle Outperform. Risk: Over the next twelve months, we believe Oracle faces a number of risks that could impede the stock's continued outperformance relative to the software sector and prevent it from achieving our $62 target price and negatively impact our Outperform rating, including an uncertain macroeconomic environment that could negatively impact the company's applications business and competition with large, established companies such as Microsoft, IBM, and SAP.
Oracle Corporation (ORCL) 58 5 September 2017
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Oracle Corporation (ORCL) 59 5 September 2017
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Oracle Corporation (ORCL) 60