Trade Idea – An $ORCL Prophesy

by Dan December 3, 2015 12:16 pm • Commentary

In 2008, Oracle (ORCL) CEO Larry Ellison famously poked a little fun at the term Cloud Computing, (listen here, trust me its worth it) asking the question “WHAT THE HELL IS CLOUD COMPUTING?” Ellison, now the Chairman/CTO has changed his tune a bit, as the company is locked in a death-match with (CRM) to be the largest provider of cloud based software.

While (AMZN), Adobe (ADBE), CRM, Google (GOOGL) and Microsoft (MSFT) have seen their stock prices rise dramatically in 2015 (up 118%, 27%, 37%, 46% and 18% respectively) on rapidly growing “cloud” sales, it’s important to remember that the offerings of AMZN’s AWS, GOOGL and a good bit of MSFT’s Azure & Intelligent Cloud, are generally made up of Platform as a Service (PaaS) and Infrastructure as a Sevice (IaaS), which are very different from ADBE, CRM & ORCL’s offerings, and ultimately will have very different profitability than their Software as a Service (Saas) offerings.

Investors don’t seem to be too discerning at the moment. Except in the case of ORCL. The stock is down 14% on the year.  When the company reported fiscal Q1 results on Sept 16th the company missed on cloud sales (SaaS and PaaS) and guided down for the current quarter, but offered a ray of light in the back half of fiscal 2016. From Nomura’s research note on Sept 17th:

Cloud Revenues Miss and F2Q’16 Guidance Below Expectations 

-Reported cloud SaaS and PaaS revenue of $452mn, up 38% yoy in cc and 33% yoy in reported currency, was below the consensus expectation of $457mn. The company guided to 36-40% (cc) yoy growth in Cloud SaaS and PaaS in F2Q’16, which is also below Street expectations. Management noted annual recurring revenue (ARR, or new bookings) results of $191mn for its SaaS/PaaS business in F1Q’16, which represents 165% growth yoy.

SaaS and PaaS Revenue Growth Acceleration Expected in F2H’16 

As more customers go live and complete their promotional periods, we will see acceleration in the SaaS/PaaS billings and revenue metrics. Oracle confidently expects this coincidence of billings (or completion of promotional periods) to occur in F2H’16. FY16 revenue guidance suggests this acceleration in growth in F2H’16 and consequently, a rapid improvement in SaaS/PaaS margins.

Implied Earnings Move: ORCL is scheduled to report fiscal Q2 results on December 15th after the close.  The options market is implying a $1.90 move between now and December 18th expiration, or about 5% in either direction.  Given the stock’s recent 10% rally from its 52 week lows in late September, the stock’s 5.25% average move over the last 4 quarters, the 10 year average of just below 5%, and the fact that Dec expiration not only catches earnings but also the FOMC’s highly anticipated rate decision, the implied move looks fair at the very least, and quite possibly cheap.

Valuation: the stock trades about 14.5x expected fiscal 2016 earnings, which are expected to decline about 5% on 2% sales decline, its first since 2009.

How to Stimulate Growth?  Organic growth has been hard to come by, and they are obviously stumbling a bit with their cloud transition.  But ORCL is a roll up for all intents and purposes, and I suspect ORCL is going to be forced to make a large acquisition and soon to help stimulate growth. Which is has long been their plan.  Dating back to their $10 billion purchase of PeopleSoft in 2005, the company has made a bunch of smaller, but still very large purchases (Siebel for $6 billion in 2006,  Hyperion for $3.3 billion in 2007, BEA Systems for $8.5 billion in 2008, Sun Micro for $7.4 billion in 2010, RightNow for $1.5 billion in 2011, Taleo for $1.9 billion in 2012, Acme Packet for $2.1 billion in 2013, and Micros for $5.3 billion in 2014).  You get the point, any and all sales growth in the last decade has come from acquisitions.

So Who’s Next? With nearly a third of their $165 billion market cap in cash the company could make a large transformative deal, but their debt load has more than doubled since 2013 and investors could soon become worried about leverage ratios if future deals are expensive and don’t deliver.  CRM is probably way too big, but maybe Service Now (NOW) or Workday (WDAY) both with an expected $1.3 billion in sales next year, with expected sales growth of about 35%, both with market caps around $15 billion. A deal would likely be at $20 billion for either.

What’s the Trade? My sense is that this could be an important report.  If the company were able to beat and raise, and offer a level of confidence in their cloud transition that they did when on last December’s FQ2 call, then I suspect the stock would likely gain 10%, as it did the day following that report.  If the company were to miss the already lowered FQ2 guidance, and then once again guide down the current quarter, then I suspect that the stock outperforms the implied move on the downside, I suspect a re-test of the double bottom low from August and September would be in the cards, down about 10% from here:

[caption id="attachment_58944" align="aligncenter" width="600"]ORCL 1yr chart from Bloomberg ORCL 1yr chart from Bloomberg[/caption]

A 10% move in either direction would test the late June breakdown level fo $42 on the upside, and the double bottom low just mentioned on the downside.

With that in mind, both the Dec at the money calls and puts (38.5 strike) look dollar cheap right now with the stock at $38.40, each option offered at slightly less than a dollar. This depends on your directional view obviously. We’re going to keep our eye on ORCL and offer some specific trade ideas closer to the event itself.