Some analysts still don’t get it
Oracle reports its earnings on Thursday, December 14, after the markets close and trying to guess how the company did in its second fiscal quarter has become a parlor game. Seeking Alpha, an investment newsletter, has been making observations ahead to the announcement trying to inform its subscribers about what to expect. They are not alone, financial analysts do this. But the thing that amazes me is how little the financial analysts understand the shift taking place both at Oracle and throughout the industry.
Lots of people seem to be clucking over how much the company has invested—$22+ billion or just under 15 percent of all revenues over the last four years. At the same time Seeking Alpha notes that annual revenues have been flat as a medieval map of the world fir quite a while—stuck at about $38 billion.
The good news, they say, is that cloud revenues have grown at 12.36 percent per quarter while on-premise revenue declined at 1 percent. Meanwhile hardware sales over the last 2 quarters have dropped about 2.5 percent per quarter for the last 2 years. All this despite some world beating computing and storage services. You can find all of the stats here.
Now, it’s expected that the finance guys are always going to want to know about profits and growth and any big time capitalist manager is going to both understand this need and desire to meet expectations. As a technology analyst, I am not either guy and my capitalist instincts are in check whenever I look at a situation where a new industry and product lines are being developed as is the case here.
Consider first what it will take for Oracle to begin making real money on its investment in the cloud. First step in any such situation is to diffuse the new or disruptive innovation to the marketplace. For Cable TV, telephone, and electricity it took decades of stringing wires and opening offices to reach something close to market saturation. Oracle or any cloud provider is piggy-backing on earlier investments in the Internet so scratch that.
But add in some huge investments in data centers around the world that support Oracle’s cloud. Also add the cost of R&D and acquisitions that produce the actual apps that enterprises need and you can easily see how the company spent billions. At the same time, the crowd of users Oracle wants to attract is still in the sales funnel. Oracle’s more than 425,000 customers are primarily on-premise users and they are conscious of the cloud move and many are therefore planning their shifts; they are not investing in a lot more on-premise products as the numbers bear out.
So Oracle is in a classic squeeze having paid out all or a very substantial part of the investment and they’re still waiting for the returns. This understandably makes the finance guys somewhat concerned and although it’s their job to seek profits they don’t show a great deal of sophistication in understanding the major trend that moving to the cloud drives.
Seeking Alpha expects graphs of Oracle’s cloud and on-prem businesses revenues to intersect in 2020. That means continued slow downward trending for the on-premise business and very nice up ticking for the cloud. As a long-term viewer it looks pretty good to me. But I can certainly understand how widows and orphans might not.
Oracle earnings call
Oracle goes into its annual customer conference, Oracle OpenWorld, flying high according to the news from its earnings call on September 15. It’s clear that the company has succeeded in pivoting from on premise to cloud software offerings and while the vendor will continue servicing its on-premise customers, the revenue acceleration from cloud products and services suggest that Oracle will derive an increasing share of its revenues from cloud solutions in the future.
Co-CEO Safra Catz told the earnings call that combined revenue from cloud, SaaS, and PaaS for the quarter was up 82 percent from the prior year and above 80 percent of her guidance to analysts at $816 million. According to the company, organic growth in SaaS and PaaS has now accelerated for seven straight quarters. It was a very good quarter for Oracle.
CTO and founder Larry Ellison said that the growth was primarily from new business and not from converting a large number of Oracle’s customer base to cloud solutions. This is significant because the customer base is seen as a huge reservoir of future business. However, it must be noted that in another part of the presentation Catz said that license revenues were down, a natural consequence of the shift to cloud computing but one that nevertheless must be stated.
While Oracle’s cloud revenue growth was significant and overall revenues were substantial, at $8.7 billion, the company still has some distance to travel to reach the performance of some competitors like Salesforce.com. Salesforce’s annual revenues are roughly on a par with Oracle’s quarterly revenues, but Salesforce captures all of its revenues—north of $2 billion in a quarter—from cloud operations.
Additionally, although Oracle’s cloud revenues are significant, executives are careful to point out that they come from infrastructure services as well as software as a service. Oracle competes with companies like Amazon whose AWS services deliver running computer hardware with operating systems and databases pre-installed so that customers can install and run their software without the effort expended in installing and managing this infrastructure.
So while Oracle’s cloud revenues are impressive they also are not a direct comparison with pure cloud companies but that’s to be expected given its position and large legacy base. But success is success and Oracle has now established the momentum and a credible claim to being a major player in the new world of cloud computing at a time when much of its installed customer base must be wondering about what comes next and how to reduce the costs associated with running a modern IT department.
Cloud solutions are clearly a part of any long term corporate technology direction and the news shared by Oracle this week will help the company’s cause next week as it makes its annual pitch to customers to further invest in its products and services.
Sliding revenues
Fun pic, no?
Apple’s earnings disappointment thudded into view in the middle of an afternoon of briefings at Oracle’s Modern Marketing Experience conference in Las Vegas. In that context it gave me a lot to think about especially the difference between a one time earnings disappointment and something more serious. (1)
I have a feeling that Apple is only the most visible instance of the wheels beginning to wobble on the truck of tech. The legacy software vendors including Oracle, SAP, and Microsoft each have fundamental challenges ahead as they continue to march to the cloud. Each needs to move its considerable customer base to cloud solutions that have very different economic models and each will have to face the fact that success involves lower revenues as customers adjust to paying for subscriptions. In this scenario, success will look a lot like failure.
The way of the world
This is typical of end of paradigm situations and there isn’t much to help. For instance, textile manufacturing was once the heart of our economy but that’s moved to lower cost countries by and large. We backfilled with higher value products and services and the same is happening now with technology. Ironically though the issues and challenges faced by Apple and those companies moving to the cloud are different from a pure economic perspective.
Apple’s flagship consumer products are reaching barriers caused by market saturation and lower cost competition. The move for Apple is to innovate more consumer goods if it can but that’s a big if. There is likely a limit to how much personal gadgetry we can extract from chips and screens. Google Glass and Apple Watch might be hints of a ceiling though it’s still too early to call a trend.
Commoditization is another factor. Apple is experiencing headwinds in China, its second largest market after the U.S. Also, it sold fewer iPhones globally in the last quarter than expected due in part to stiff competition from Android devices that are lower cost and functionally competitive. Still Apple garners most of the profits from the sale of smartphones, a market whose margins are tightening with competition. We can expect this trend to continue as vendors cut prices while attempting to maintain market share.
Other shoes drop
Apple isn’t alone. Twitter is still losing money though less of it according to the latest numbers (2). The same saturation dynamic is operating for Twitter but at a much lower revenue run rate than Apple. Social media is a winner takes all market so though there aren’t very many competitors the value of a network is in the number of participants, which naturally limits the number of competitors. The dominant advertising model that social media relies on for revenues has been under pressure with other vendors like Google and Facebook having to adjust.
The legacy providers face a different problem that manifests in similar ways. As they become more successful at moving customers to the cloud, their revenues shrink and come in over longer time periods. So their year over year comparisons look worse much like Apple’s predicament even though they may be selling well.
Cloud computing was seen as a great leap forward because it gives customers much lower cost structures and it has kept that promise. But it is also a form of commoditization and I wonder how legacy vendors will replace the revenues they give up as they turn to the cloud. It’s not as though there is a choice, competition is forcing everyone to the cloud so it will take years, I think, for legacy vendors to grow enough to replace revenues they are losing in the shift.
Then, too, demand growth is reverting from an exponential growth curve to one that resembles organic population growth and this means any vendor seeking to grow will need to do it by taking share from others in a zero sum game.
What about CRM?
What happens next for CRM is speculative. The new technologies that Salesforce, Oracle and everybody else are bringing to market foretell a time when the front office employs fewer people as commoditization heats up, but that might not be a problem. The IoT is a hot idea right now with little to show of any real substance but it’s possible that the IoT will be the next bit of infrastructure that will spark exponential growth. As a communications layer it could spawn a lot of jobs as people, relieved of more mundane occupations leverage the information boiling out of the IoT to perform services that only people can do.
In some respects this is a scary time. Apple missing its number can’t be fun and neither can watching a legacy company’s earnings evaporate even as it does most things right. We’re in a transition period and if we keep our wits about us and continue to innovate in a few years we might find ourselves in an era that resembles the late 1980s.
