The Surprising Acquisition Of NetSuite Is A Smart Move By Oracle Corporation

  • Oracle has surprised the market by announcing the mega acquisition of the cloud company NetSuite.
  • The Software-as-a-service (SaaS) application software market is expected to continue to grow at an extremely fast pace.
  • The average target price of top analysts is at $44.11, an upside of 7.4% from its August 10 close price.

On July 28, Oracle (NYSE:ORCL) surprised investors by announcing that it has entered into a definitive agreement to acquire Netsuite (NYSE:N), the very first cloud company. In fact, analysts expected Oracle to continue to buy small and mid sized cloud companies, but NetSuite is a mega acquisition valued at about $9.3 billion.

In the announcement, Oracle CEO Mark Hurd said:

"Oracle and NetSuite cloud applications are complementary, and will coexist in the marketplace forever. We intend to invest heavily in both products – engineering and distribution."

According to Oracle, it expects the acquisition to be immediately accretive to earnings on a non-GAAP basis in the first full fiscal year after closing.

The transaction is valued at $109 per share in cash, or approximately $9.3 billion, a premium of 19% to NetSuite's closing stock price of $91.57 on the day before the announcement.

As I see it, the acquisition of cloud business application software company NetSuite is a smart move by Oracle, and it is not paying an excessive price for the deal. The acquisition fits well into Oracle's strategy of promoting its cloud products at the expense of on-premise products. NetSuite has developed a single system for running a business in the cloud for 18 years, and the deal will give Oracle a better access to the mid-market fast-growing commercial software-as-a-service (SaaS) sector, and strengthen its line of SaaS applications.

What's more, Oracle Chairman Larry Ellison personally owns almost fifty percent of NetSuite, and NetSuite runs on Oracle databases. NetSuite has more than 30,000 customers in about 100 countries, most of them small and mid-sized business customers. As such, some possibility may arise in selling Oracle products to NetSuite customers and more so in the sale of NetSuite products across Oracle's extensive worldwide customer base.

Oracle has earlier made much smaller acquisitions of cloud-computing software companies. In 2012, it acquired Right-Now for $1.5 billion and Taleo for $1.9 billion. In February 2013, Oracle bought Elogqua for about $935 million. Also, in February 2013, the company purchased Responsys in a deal valued at about $1.6 billion. All these companies have expanded Oracle's SaaS solutions. However, the NetSuite acquisition, in my view, will contribute much more to Oracle' cloud growth prospects due to its broad customers base.

The SaaS application software market is expected to continue to grow at an extremely fast pace. According to the information technology research company IDC, the market for software-as-a-service is projected to increase at a compound annual growth rate (CAGR) of 34.5% till 2019. According to the IT research company Gartner's press release from July 20, the SaaS application software total market size in 2016 stands at $144 billion, and is expected to grow at a CAGR of 37% till 2020. What's more, the platform as a service (PaaS) application infrastructure software total market size in 2016 stands at $177 billion, and is expected to grow at a CAGR of 10% till 2020.

According to Oracle, in its fiscal 2016 fourth quarter, SaaS and PaaS revenue growth accelerated to 68% in constant currency, significantly higher than the company's guidance. SaaS and PaaS gross margins continued to improve throughout the year, exiting FY16 at 56%. Bookings in the fourth quarter were also very strong. As a result, Oracle raised its guidance for the first quarter of fiscal 2017 SaaS and PaaS revenue growth to be between 75% and 80%.

2016-08-11 07_28_43-ORCL 10-8-16 - Microsoft Word 1

Source: company's reports

Valuation

Since the beginning of the year, ORCL stock is up 12.5% while the S&P 500 Index has increased 6.4%, and the Nasdaq Composite Index has gained 3.9%. However, since the beginning of 2012, the ORCL stock has gained only 60.2%. In this period, the S&P 500 Index has increased 73%, and the Nasdaq Composite Index has risen 99.8%. According to TipRanks, the average target price of top analysts is at $44.11, an upside of 7.4% from its August 10 close price, which appears reasonable, in my opinion.

2016-08-11 07_29_22-ORCL 10-8-16 - Microsoft Word 2

Chart: TradeStation Group, Inc.

Oracle's valuation metrics are pretty good. The trailing P/E is at 19.82, and the forward P/E is low at 13.64. The quick ratio is very high at 3.73, the eighth highest among all 67 S&P 500 tech companies. Furthermore, the price to free cash flow is at 17.15, and the Enterprise Value/EBITDA ratio is low at 10.65.

The ten S&P 500 tech companies with the highest quick ratio

2016-08-11 07_29_38-ORCL 10-8-16 - Microsoft Word 3

Source: Portfolio123

Oracle has a strong balance sheet, and it is generating high free cash flows. The company had $56.1 billion in cash and equivalents at the end of the last quarter and $40.1 billion in total debt.

Oracle started to pay a dividend in April 2009. The forward annual dividend yield is at 1.46%, and the payout ratio is only 28.4%. The annual rate of dividend growth over the past three years was very high at 28.6%, and 20.6% over the past five years.

Conclusion

Oracle has surprised the market by announcing its mega acquisition of the cloud company NetSuite. Oracle has earlier made much smaller acquisitions of cloud-computing software companies. However, the NetSuite acquisition in my view, will contribute much more to Oracle' cloud growth prospects due to its broad customers base. According to IT research companies, the SaaS application software market is expected to continue to grow at an extremely fast pace.

Oracle's valuation is good; the forward P/E is low at 13.64, and the Enterprise Value/EBITDA ratio is also low at 10.65. Moreover, the company has strong balance sheet, it generates high free cash flow, and returns substantial capital to its shareholders through stock buybacks and increasing dividend payments. The average target price of top analysts is at $44.11, an upside of 7.4% from its August 10 close price, which appears reasonable, in my opinion.

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  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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