Amid a diabolical mix of rising rates, high inflation and fears of recession, the tech sector offers little hiding place for investors.
The market is avoiding high-growth, profitless software stocks that have driven the sector higher during the pandemic. E-commerce and consumer hardware inventories slump, plagued by weaker demand; social media gaming takes a beating as ad buyers retreat; and supply chain issues hit chip stocks. Almost all tech stocks are down for the year, with dozens over 50%.
In previous columns, I’ve made the case for betting on cloud computing, and I think the story remains compelling. As recent earnings reports from
(GOOGL), the demand for cloud-based IT services is both vast and expanding. The promise of the cloud (enhanced flexibility and lower costs) is fundamentally changing the way every business manages IT.
In a research note published last week, Credit Suisse analyst Phil Winslow wrote that enterprise spending on public cloud is expected to exceed on-premises infrastructure IT spending by 2024. That’s cloud computing , not just software, which devours the world. Winslow argues that Wall Street is underestimating Microsoft Azure’s growth potential. I see Microsoft and Amazon as the best long-term cloud bets.
But I also see an opportunity in another cloud game that’s still lurking in plain sight. In February 2021, I wrote a bullish cover story on
(ORCL), arguing that the enterprise database and applications company had quietly moved into an understated cloud story.
The company was pushing customers to adopt cloud versions of its software, while also launching Oracle Cloud, a nascent rival to the public cloud Big Three. Oracle’s move to the cloud was gaining momentum, but investors didn’t catch on. Oracle has proven to be a great stock to own in 2021, rallying over 70% by mid-December, with quarterly results showing steady progress in cloud strategy.
And then two things happened that caused the stock to explode. At the macro level, the tech selling frenzy has accelerated. As the sale kicked off with pandemic darlings like
Focus on video communications
(PTON), it quickly spread everywhere, and Oracle was not immune. But the bigger issue was Oracle’s announcement in late December of a $28 billion cash deal to buy Cerner, an electronic medical records company serving hospitals and health systems.
Over time, Oracle has made many major acquisitions – PeopleSoft, Siebel, Sun Microsystems – but Cerner is its biggest deal ever. Oracle is betting big on digitizing healthcare. It’s also a bet that it can move software from Cerner to Oracle Cloud, generating huge savings. While Oracle said the deal would immediately boost earnings, the transaction raises concerns of integration risk, forces Oracle to incur additional debt and moderates what had been an extremely aggressive share buyback plan.
Since peaking just before the announcement of the Cerner deal, Oracle stock has fallen 38%, losing some $100 billion in market value.
Deutsche Bank analyst Brad Zelnick said the Cerner acquisition cast doubt on Oracle’s move to the cloud, the reason for the stock’s rally in 2021. The deal offered ammunition for skeptics who were already worried about Oracle’s commitment to the cloud.
But last week, Oracle’s earnings provided further evidence that the transition is still underway.
For the fourth fiscal quarter ended May 31, Oracle reported revenue of $11.8 billion, up 10% adjusted for the exchange rate, in the company’s best quarter of growth since 2011. This figure exceeds the company’s own forecasts and Wall Street estimates.
Meanwhile, Oracle’s cloud business grew 22% in the quarter – and Oracle CEO Safra Catz told investors cloud revenue growth is expected to accelerate to 25% to 28% in the August quarter and 30% or more in fiscal 2023. (On Friday, TikTok announced that it will send all of its US user traffic to Oracle Cloud.)
Oracle shares rallied after the report, and they actually ended higher this week, a rare hit in an otherwise dismal week for stocks.
Zelnick, who maintains a buy rating and target price of $110 on Oracle shares – a potential return of 70% – says Oracle’s forecast implies continued single-digit revenue growth for the entire company. business on a currency-adjusted basis.
While Zelnick admits no company is immune to a deep recession, he believes other dynamics will prevail at Oracle in the months ahead, paving the way for a stock rebound. “They’re transforming their own business, they’re taking costs out of Cerner,” and, he says, “inflation is actually good for Oracle.” There are inflation-linked increases built into Oracle’s customer contracts, Zelnick says. Meanwhile, switching costs are so high for Oracle software that customers show little resistance to price increases.
The liquidation of Oracle’s stock made them cheap by most measures. At a recent $68, it trades less than 13 times Zelnick’s forecast for earnings of $5.36 per share for fiscal year May 2023 and less than four times its post-Cerner earnings forecast of just under $50 billion. On both metrics, that’s less than half of Microsoft’s valuation.
If Oracle’s cloud growth vision materializes, the stock should rebound whether or not there is a recession.
Write to Eric J. Savitz at [email protected]