Technology infrastructure is a competitive field. Constantly evolving standards in hardware and software mean that companies must be always producing new products and technologies. Oracle (ORCL ) is one of the largest enterprise software, hardware, and cloud computing companies. Its competitors include giants like Microsoft Corp. (MFST ), International Business Machines Corp. (IBM ), and the newer Salesforce.com (CRM ). The demand for these products and service comes from diverse businesses from the smallest local concern to multinational corporations. Home personal computing, the fast-growing mobile computing market, and the rise of the cloud also drive growth.

Oracle, according to its 10-K annual report, is the world’s largest provider of enterprise software. It also provides computer hardware products and services, which when amalgamated, work in the cloud. Oracle offers its products through a variety of revenue arrangements. These include conventional sales of software and hardware and also subscriptions of software and hardware products and services. Oracle categorizes its three business segments as the following (source: Oracle prospectus):

1. Software and Cloud Businesses: Oracle licenses databases and middleware, application software, and provides access to a broader range of its software through its Oracle Cloud Software-as-a-Service (SaaS) and Oracle Cloud Platform-as-a-Service (PaaS) offerings. SaaS and PaaS collectively are referred to as cloud software subscriptions. These represent a growing percent of total revenues from 72 percent in fiscal year (FY) 2012 to 76 percent in FY 2014. Oracle has built its software on what it bills as a “standards-based, integrated architecture” designed to help customers reduce cost and complexity.
2. Hardware Systems: Oracle provides both hardware systems products and hardware systems support. This business tends to have lower operating margins than the software and cloud business because of the costs related to manufacturing, distributing, and supporting these products. This has been a relatively steady component of the revenues for the company. Hardware comprised 14 percent of Oracle’s revenues in both FY 2014 and FY 2013. This is down from 17 percent in FY 2012.
3. Services: Historically, services represent 10-11 percent of Oracle’s revenues. It tends to have lower margins than the other two businesses. Oracle reports that services revenues can be impacted by a variety of factors such as acquisitions, general economic conditions, governmental budgetary constraints, personnel reductions in customer IT departments, and tighter controls over discretionary spending.

Stock Performance and Outlook for Growth

Oracle trades in the diverse large cap technology group. The stock is further classified in the smaller application software industry group where it competes against giants like Microsoft, IBM, and SAP AG (SAP ). Oracle can trade at a premium to the S&P 500, usually depending on the product cycle, economic conditions, government budget spending and constraints, and projected business spend. Wall Street analysts tend to assign anywhere from a 15-25 percent discounted multiple to it. Oracle has traded at a steep discounted multiple to its peers, sometimes trading at 13.5x while its large cap peers trade at an average of 21.4x, according to Bank of America research. Oracle’s multiple relative to its peers is influenced by a variety of factors, most importantly the competitiveness of its products.

An important factor when considering the growth of the company is revenue recognition which can impact the ability to analyze the growth rate of Oracle’s revenues. New cloud subscription revenues are recognized over the life of the subscription while expenses are recognized in advance of the revenue. In contrast, new software license revenues are recognized immediately in full. This deferred cloud recognition can mask deterioration of revenue so when comparing revenue over time or forecasting expected future revenue, it is worthwhile to look at new software licenses and subscriptions. New subscriptions represented 28 percent of Oracle’s total revenue in FY 2014 and 2013 and 27 percent in FY 2012.

Margins play a key role in analyzing the company’s ability to translate sales into profits. Oracle tends to spend upwards of 14 percent of total revenues on research and development and this is expected to stay around the 12-13 percent level if the company wishes to remain competitive. The long-term expected impact from this research and development spend is to keep operating margins at high and sustainable levels through the development and deployment of competitive products. Operating margins for Oracle versus its industry competitors have been strong (high 40 percent). According to Bank of America research, Oracles operating margins are forecasted to remain around 46 percent.

This is an extremely competitive market with low barriers to entry. Competition from new technologies or new emerging companies who offer broad IT solutions or targeted products and changing functionality will impact Oracle’s ability to meet forecasts and keep or expand its valuation multiple. Revenues are also impacted by seasonality. They are influenced by the compensation structure of the sales team and both revenues and margins are highest in the fiscal fourth quarter and lowest in the first quarter. Revenues and margins are also impacted by new licenses and subscriptions. Investors should keep these factors in mind when comparing quarter over quarter results.

The Bottom Line

Oracle considers itself to be a leader in cloud computing, database, and middleware software web-based applications and infrastructure. This is a rapidly changing area with many technological advances and evolving standards influencing the competitive nature of the products. Oracle’s stock price is a function of how well the company can be the leader in the new technologies while keeping costs low so that margins remain or improve.