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Oracle's aggressiveness will pay off
Investors are worried about the company's decision to bid for one company as it digests another. But those worries have simply created a buying opportunity.
By Robert Walberg
This column was updated March 18 at 9:38 a.m. ET.
Webster's defines an oracle as a person giving wise or authoritative pronouncements. Well, investors are reserving judgment on whether Oracle (ORCL, news, msgs) CEO Larry Ellison is such a person. His company recently entered a potential bidding war for Retek (RETK, news, msgs) while still working to integrate PeopleSoft, which was acquired for $10.3 billion.
Just named the ninth-richest man in the world by Forbes magazine, Ellison is no dummy, and investors might be smart to follow him. A risk-taker in his personal as well as professional life, he and his company are betting that the way to prosper in the highly competitive software industry is to end up as one of its biggest players.
So the company won't shy away from acquisitions that build market share or keep others from taking it.
But if theres one legitimate criticism of the companys recent takeover activity, it's that Oracle's management seems reactionary in its decision-making, rather than proactive. To wit: If Retek is so attractive, why did the company wait until longtime rival SAP AG (SAP, news, msgs) initiated an offer before making its own play? Similarly, Oracle could have had PeopleSoft for a much lower price if it had recognized the obvious synergies from a merger months earlier.
Unfortunately, investors wont know how successful Oracle is in integrating PeopleSoft until later this year, though, by most accounts, early signs are encouraging. Analysts and, more importantly, PeopleSoft customers give Oracle credit for doing its homework beforehand and making the transition relatively seamless. Indeed, it looks like the retention rate of PeopleSoft customers will be high, and Wall Street's original projections on how the merger will affect sales and earnings may well prove conservative.
Maybe Oracle can really take on Retek
If true, then maybe investors should cut Oracle some slack when it comes to engaging in a potential bidding war for Retek. Founded in 1986, Minneapolis-based Retek provides software and services to more than 200 very large customers, mostly in the retail industry. (Computer Weekly, a British publication, says customers include Abercrombie & Fitch (ANF, news, msgs), The Gap (GPS, news, msgs), New Look, French retailer FNAC and the U.S. Postal Service.) Oracle cited complementary product lines, cross-selling potential and a desire to protect its leadership position in applications in North America as reasons why the deal makes sense.
Gobbling up Retek is definitely manageable. Oracle is offering $11.25 a share, or $669 million, up from its first offer of $9 a share, or $525 million. The software giant has a market capitalization of $68 billion. Nevertheless, the decision to go after Retek so soon after acquiring PeopleSoft has investors concerned. The biggest fear is that a bidding war over Retek will divert managements attention at a critical juncture in its integration of PeopleSoft.
History suggests that Oracle is indeed playing a dangerous game in the short term, because the integration of a company PeopleSofts size usually brings with it a number of unpleasant surprises. Thats before you factor in management being asked to digest yet another company at the same time.
Since these are largely short-term concerns, however, they may not apply in this case. Along with the apparent deft work of combining their operations with PeopleSoft's, Oracle managers probably could easily integrate Retek because it's small and has little obvious overlap with Oracle.
A lack of clarity
So while its almost a certainty that investors will discount Oracles share price for at least the next three to six months based on the lack of clarity created by its aggressive moves, long-term investors may well want to take advantage of the markets caution and buy Oracle.
Not only are the shares cheap relative to its peers and the market, but, to be frank, Oracles aggressive strategy is dead on. Corporate history suggests that Ellisons Darwinian view of the software industry -- that only the strongest and biggest will survive -- is likely to prove true. Traditionally, as industries mature they're dominated by fewer and fewer players. For Oracle to remain a leader along with Microsoft (MSFT, news, msgs), SAP and IBM (IBM, news, msgs), it needs to stay aggressive. (Microsoft is the publisher of MSN Money.)
In fact, dont be surprised if Oracle announces another acquisition within the next 12 to 18 months. Potential targets include BEA Systems (BEAS, news, msgs) and Hyperion Solutions (HYSL, news, msgs). Hyperion provides business management software, while BEA markets infrastructure software and related services.
The software industry has entered a period of consolidation in which the nimblest, shrewdest players will end up on top in the end. Betting against Ellison in such a game seems foolish.
The numbers
Yet thats just what the market seems to be doing. Oracles stock trades at only 17.2 times projected fiscal 2006 earnings of 77 cents and 14 times estimated free cash flow of 93 cents per share. (The company's fiscal years end in May.) Thats well below industry standards, even though Oracles operating profit margins, return on equity and return on assets are among the best in the group.
Basically, it looks like the market is having a harder time digesting Oracles recent moves than the company is having digesting PeopleSoft. So patient long-term investors are looking at a golden opportunity to own one of the software industrys leading players at a bargain price. Assuming Oracle merely lives up to the Street's expectations over the next year, the stock has upside potential to the $16.50 to $17 area, or 25% to 28% above today's price.
Oracle is scheduled to report fiscal third-quarter earnings next week. Wall Street is looking for the company to deliver earnings per share of 15 cents on sales of $3.1 billion, up from last year's 12 cents and $2.51 billion.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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