What Oracle's Cloud Services Push Means For Investors

  • Oracle has committed billions to a new cloud data center based in Texas.
  • Oracle no longer has a choice as cloud has started to hit its numbers hard.
  • Can Oracle succeed where Dell and HP failed?

While Intel (NASDAQ:INTC) has begun buying big companies like Altera for their intellectual property, Oracle (NYSE:ORCL), which spent most of the 2000s buying competing database application providers, is now going the other way, investing directly in cloud services as fast as it can.

Look at Oracle's annual balance sheet you’ll see it clearly, an enormous rise in debt that now exceeds the rise in assets, $41 billion on $111 billion as of the end of its 2015 fiscal year in May, money now being spent in the U.S., in Austin, Texas.

Why Austin, Texas? Mainly because costs are lower there than in Silicon Valley, where Oracle is based. Land costs less, and people do, too. Even the kind of highly-trained people needed to build and maintain a cloud data-center, like the one Oracle is building.

Oracle’s cloud is being built around an acquisition called Stack Engine, a start-up that develops management and automation tools for Docker containers.  Docker is an open source project that treats cloud workloads like shipping containers, allowing them to be moved easily between public and private clouds. Docker is thus the key to Oracle’s cloud vision, in that it can erase the lines separating a corporate data center and a public cloud like Amazon's Amazon Web Services (AWS).

There is a sense of urgency to the Austin work because cloud is finally hitting Oracle’s numbers. Quarterly earnings announced two weeks ago came in at $2.2 billion, 51 cents per share, down 12% from a year ago. Worse, revenue came in at $9 billion, below analyst estimates.

At the same time Oracle also added former Intel president Renee James to its board of directors. Its purchase of Sun Microsystems, a major hardware player for 30 years, has been on the books for five years, five years where Oracle delayed entering cloud in order to protect its client-server assets. Now it’s time for Sun to set and Oracle to return to the computing mainstream, which is now Intel-based cloud.

Still, Oracle is very, very late to this party. What should trouble investors is that it seems to be doing what both Dell and Hewlett-Packard tried to do earlier this decade, and from the same Austin base they used as well. (That’s one reason why trained people are plentiful there, and cheap.) Both Dell and HP pulled back when it became apparent they could not compete on price with Amazon (NASDAQ:AMZN).

Oracle thinks it can succeed because it still owns the heart of the enterprise data market, especially in structured databases, and the switching costs for big enterprises in this area remain prohibitive, assuming that Oracle really follows up and delivers cloud at a competitive cost. The assumption is that these large enterprises will follow Oracle into its cloud, then tell top management their company does indeed have a “cloud strategy.”

The bigger problem for Oracle, however, becomes what happens then? At the end of the day cloud cuts costs, and cuts prices, not just for hardware and services but for the software that runs on top of it. Even if Oracle succeeds in moving enterprises to cloud, what will that mean to its top line? And how can it gain more share using a structured database system many new companies consider obsolete?

If you buy Oracle stock today, you are betting that the computing loads of large enterprises will grow exponentially as they follow Oracle into its cloud, and that this volume will keep their spending high, from which Oracle can extract its usual profit margins.

That’s the argument of a speculator, not of a yield-oriented, safe investor. Oracle has to do what it is doing, but you should be warned of the danger before you follow.

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