Valuation: Slightly Overvalued

Investment Thesis:

Since the beginning of the pandemic there have been many companies that have prevailed, sending their share prices soaring. As a result of the pandemic, and the work-from-home model, many SAAS companies were able to thrive and perform better financially.
- However, this was not the result for Oracle as their revenues were stagnant, and they did not seem to grow any of their main revenue streams.
This underperformance shows that Oracle did not take advantage of the opportunity given to them by COVID and are likely to miss the post-covid work-from-home business boost that many other SAAS companies will capitalize on.
- It is these missed opportunities that make me second guess an investment into Oracle, and I am sure that other investors feel the same way too.
As a result of their poor performance in this key moment, and their DCF valuation implying that Oracle is massively overvalued, I am bearish on Oracle for the time being.
- Through my valuations (which can be seen below) I have come to a price target on Oracle of $75.20, which represents a share price decrease of 4.5%.
Oracle has big potential in the future, especially with their IAAS business model, which is why I am waiting until the price reaches the $75.20 level to consider buying into Oracle.

Company Overview:

Oracle provides products and services that address enterprise information technology. These products and services include applications and infrastructure offerings through flexible IT deployment models, including on-premises, cloud, and hybrid models. Oracle offers and recommends these models to their corporate clients in order to meet their individual needs. These clients include businesses, educational institutions, government agencies, etc.

Oracle Cloud Software-as-a-service (SAAS) and Infrastructure-as-a-service (IAAS) provide an integrates stack of applications and infrastructure services to their customers via a cloud-based deployment model. Oracle’s Cloud services integrate the hardware and software on behalf of their customer, and provide constantly is managing, upgrading, and supporting through the cloud. Their cloud services are quick to deploy, easily maintainable through cloud upgrades, connectable/interchangeable between IT environments, and cost-effective via low up-front costs and reliable usage.

Oracle has split their business into 3 segments in their SEC filings, which include:

Cloud and License Business
Hardware Business
Services Business

Investment Information:

Macroeconomic Outlook:

SAAS:

In March of 2020, governments, businesses, and educational institutions recognized the severity of COVID-19. As a result of this, many of us were forced into lockdowns, and the ways in which we lived were changed for the meantime and remain changed to this date. One of the biggest changes that we were forced to adapt to is to work and study from home, in order to limit the spread of COVID-19. Here we are in June of 2021, over a year later, still working and studying from home (for the most part).

Many businesses were able to thrive in this “stay-at-home environment” such as Amazon, who saw revenues increase by over 37% between 2019 and 2020. However, Amazon (and ecommerce) is not the only business (industry) that has thrived due to the pandemic. Many SAAS companies were able to perform well over the pandemic and are expected to continue to grow after the pandemic due to the work-at-home environments created by the pandemic and expected to sustain even after the pandemic.

The COVID-19 pandemic has helped to prove to corporations that employees can work from home and do so in an efficient manner. As a result of society passing this work-from-home “test” more businesses are providing the option for their employees to work from home more often (or fully) even after the pandemic is over. Furthermore, we know that employees will be onboard with this change as 83% of workers have stated that they would prefer a “hybrid” work model post-pandemic, in which they can work from home 25%+ of the time.

SAAS businesses can thrive/profit off of this fact/expectation as SAAS solutions are easy to implement, are affordable, and can help to manage thee work-from-home environment. As a result of this, many research institutes have forecasted that the SAAS industry can grow at a CAGR of 11.2% over the next 5 years, and are expecting growth of 34.29% in this industry between 2021-2022.

Although, we have not seen this type of growth with Oracle, this industry trend is favourable and provides Oracle with an opportunity to capitalize on this growing space.

Sources:

Remote Work Evolves Into Hybrid Work And Productivity Rises, The Data Shows (forbes.com)

SaaS in 2021: Growth Trends & Statistics – BMC Software | Blogs

IAAS:

According to industry research the infrastructure-as-a-service industry is set to grow at a CAGR of 23.2% over the next 7 years. This is expected to happen due to the growing awareness of cloud services, growth in internet penetration in emerging economies, and the increasing demand for effective computing services.

Oracle is one company among many that are set to capitalize on this growing market/industry over the next 7 years and beyond. This gives Oracle a great opportunity to break their stagnancy and grow consistently over the course of the next decade.

Sources:

$200+ Bn Infrastructure as a Service (IaaS) Market Outlook 2020-2027 - ResearchAndMarkets.com | Business Wire

Financial Information:

Stock Repurchase Program: As of May 31^st, 2020, Oracle has $16.6B remaining for the share buyback program (as authorized by their board of directors). This stock repurchase program does not have any specific expiry date, so there will be no way of estimating when they will buy back these shares, however, we know that it is in their budget. For the sake of this analysis, we will assume that Oracle purchases all $16.6B of shares within the next 3 years. At current prices, they will be buying back 210,820,422 shares over the 3-year span, which would equate to a share price inflation of 7.3% (or 2.38% yearly). This is good for current investors as their shares would be worth 7.3% more if this were to happen, however it is also good because it sends a bullish signal to potential/future investors which could help the share price even more.
Acquisitions: Oracle has an active acquisition program that they deem important to their strategy going forward. Historically, we have seen Oracle invest $Billions into their numerous acquisitions in order to expand and fuel growth. Recently, their pace of acquiring companies has slowed down, however, they have stated that they are open to acquisitions if they become available and make sense for the business. When the news breaks about an acquisition, usually there are more eyes on the company’s stock(s) and they tend to soar if the deal makes sense and is considered a “good deal”.
Amortization Expense: One of Oracles biggest expenses in the fiscal year 2020 was their amortization of intangible assets. This expense accounted for roughly $1.59B and is expected to decrease by 48% YoY until 2026 where it is expected to remain at $35M. This sudden and large decrease in expenses will help Oracle to have better margins, which may be able to attract more investor interest.
Stock Based Compensation: Oracle spent $1.59B in order to fulfill their stock-based compensation program for their employees. Although this is a good thing for the company, as stock-based compensation generally increases employee efficiency, the negative effects of this are burdened on the shareholders. Continuing off with the 3-year stock buyback example, we can expect Oracle to distribute roughly $4.77B worth of shares to their employees. By doing this, Oracle will be distributing 60,579,121 shares into the market, diluting the existing shares by roughly 2.1% over the 3 years (0.7%/year). Based off of the 3-year examples, the effects of the share buyback should offset the dilution of these shares and increase the value of existing shares by 5.2% over the 3 year timeframe (1.7% share inflation/year).
Restructuring Expenses: In 2019, Oracle restructured portions of their business, and by doing so they incurred some additional costs. These costs were reflected in the 2019 financial reports and have since decreased by 44% and are expected to decrease further in the future. This large expense ($443M in 2019), will be negligible in the upcoming years, which will help reduce Oracle’s expense and increase their profitability.
Overall Financial Performance/Growth: The fiscal year 2020 was not one to write home about for Oracle. Each of their 3 revenue sources (as mentioned in the company overview) did not grow YoY, but rather decreased by a small amount. This is somewhat worrying for Oracle, however they noted that COVID-19 had adverse effects on their business. However, most tech businesses thrived due to the pandemic. This may scare some potential investors away, as they may see more bleeding to come.
Tax Rate: In their 10-K filing with the SEC, Oracle realized an effective tax rate of 16% for the fiscal year 2020, this is a large increase from their effective tax rate of 9.7% in 2019. This is due to reduced tax benefits due to the Tax Act and will remain at this higher rate in the future. This will have negative effects on the overall profitability of Oracle and has been accounted for in the DCF models.
Debt: In 2020, Oracle issued $20B of senior notes for corporate purposes. This has increased Oracle’s long-term debt by roughly 34%, and now their long-term debt amounts to $69.23B. Additionally, as a result of this increase in long term debt, Oracle’s long-term debt to equity ratio is now 7.14 (long term debt/equity). Any long-term debt to equity ratio above 0.5 is considered high, which implies a risk of defaulting and/or bankruptcy. Oracle, having such a high debt to equity ratio is quite concerning and will scare off some potential investors. However, Oracle has a cash position of $43B which helps to reduce the risk of defaults and shows that Oracle has the necessary capital to cover their obligations.

Competition:

As you can see in my comparable analyses (linked as an image below), there are 4 main competitors that operate in a similar manner to Oracle. These companies include Microsoft ($MSFT), Alphabet Inc. ($GOOG), Intel Corp. ($INTC), and SAP SE ($SAP). These companies were mentioned to be some of Oracles biggest competitors in their most recent SEC 10-K filing, this is because the IT landscape is very competitive, and their services compete directly with the services provided by each of their competitors listed above.

Valuation Information:

WACC:

In order to find the WACC I used the information on Tracktak, which is a website that helps give information about DCF models and has their own DCF calculator. Tracktak estimated Oracle has a WACC of 6.46%.

CAGR:

I was also able to find the figure for the CAGR from Tracktak, in which they estimated that Oracle’s CGAR was 15.04%.

Interest Expense Growth Rate:

I was able to fins the interest income growth rate through taking the average compound yearly growth in their interest expense over the past 10 years. By doing this I arrived at a figure of 7.99%.

Tax Rate:

I was able to find Oracles effective tax rate for the fiscal year 2020 through their SEC 10-K filing. In this filing they reported that their effective tax rate for 2020 was 16%.

Investment Valuation and Plan:

Valuation:

In order to value Oracle, I conducted a DCF model, and compared my results to those achieve through TrackTaks DCF to get an average DCF valuation.

Furthermore, I underwent 3 comparable analyses, in which I compared Oracles EV/EBITDA, EV/Revenue, and P/E ratios to that of their competitors. By doing this I got 3 different fair values, which I average in order to get one average comparable valuation.

DCF Model:

I used the information found in the “valuation information” section of this report in order to undergo my DCF analysis. By doing this I arrived at a fair value per share of $54.09, or an implied downside of 31.31%. In order to verify this valuation, I decided to compare it to the DF model achieved by Tracktak.

TrackTak DCF:

I used tracktaks DCFF calculator in order to find Oracle’s fair value. This website automatically populated a DCF model (image linked at the end of this article) and it arrived at a fair value per share of $66.32, or an implied downside of 15.77%. This supports the conclusion in my DCF model that Oracle is overvalued.

Average DCF:

By averaging the 2 results from the aforementioned DCF models I arrived at a fair value of $60.21, which implies a downside of 23.53%. However, many SAAS businesses are overvalued, which speaks about how the market perceives value in these types of companies, so the more important valuation technique for this business would be their comparable analyses.

Comparable Analyses:

EV/EBITDA:

The EV/EBITDA multiple is commonly used when analyzing and valuing businesses. Oracles EV/EBITDA multiple is under their competitor’s average, which hints to share price increase of 7.87%, or a share price of $84.95. This indicates that Oracle is undervalued, and contrasts the results achieved through the DCF models.

EV/Revenue:

The EV/Revenue multiple is more commonly used to value businesses that have a history of acquisitions, and ais used to value businesses when looking to acquire them. By comparing Oracle’s EV/Revenue multiple (6.58) to that of their competitor’s average (6.82), we find that Oracle’s fair value is at $81.59, which would imply a share price increase of 3.62%. This is similar to that of the EV/EBITDA comparable and signals that Oracle is undervalued.

P/E:

The P/E multiple is extremely common in comparable analyses, and thus I used it for this valuation as well. The P/E comparable estimated that Oracle’s fair value was at $103.66/share, which would imply a share price increase of 31.65%. This is the most optimistic comparable result out of the bunch but still signals that oracle is undervalued.

Average Comparable:

I took the average of all of the comparable analyses in order to get one valuation metric for the comparable analyses as a whole. This resulted in an overall fair value per share $90.07, which implies an upside of 14.38%.

Valuation:

By taking the average of my 2 analyses I arrive at a share price estimate of $75.14, which is very close to the average analyst price target of $75.30. As a result of this I would stay away from oracle’s stock until it reaches fair value then I would consider buying and holding for the long term to take advantage of macroeconomic factors.

Catalysts:

Stock Repurchases: If Oracle continues to buy back shares it will be favourable for investors and will lure in potential investors.
Acquisitions: If Oracle continues to acquire companies that make sense and fit into their family of business well, then their share price should benefit from the news of an acquisitions breaking.
Decreasing Expenses: If Oracle can continue to decrease their expenses, especially their amortization expense, then their business will be more profitable and attract possible new investors.

Risks:

Share Offerings: Oracle has a history of offering shares, which cause the existing shares to be diluted. There is no indication that this will stop anytime soon due to their employee stock compensation program and is something for investors to watch out for.
Financial Performance: If Oracle continues to have stagnant earnings releases amidst positive economic outlook it will scare away investors and hurt the share price tremendously.
Debt: If Oracle continues to offer senior notes, and other forms of debt, their levels of long-term debt will start to get out of control. Right now, their long term debt is manageable, however if they continue to offer debt things may get ugly.