Oracle's earnings have largely been driven by lower tax rates over the last two years and recent disappointments on the legal front may indicate tough times ahead.
That's the gist of a research note from Cowen & Co. analyst Peter Goldmacher. Goldmacher reiterated a neutral rating on Oracle and has argued that the company is under pressure from customers tired of maintenance fees and looking to the cloud as well as technology shifts such as big data.
Goldmacher argues that the effects of competition and technology shifts become more clear when you back out taxes and legal fights. Goldmacher said in a research note:
Organic/constant currency license growth on a four-year compound annual growth rate (CAGR) is 2.3% (Tech is 1.4%/Apps are 4.4%). In the face of lackluster license growth and increasing competitive pressure in every line of business, the biggest driver of EPS upside for the last two years has been lower taxes. Exiting FY12, Oracle grew EPS 11%, but if we normalize earnings to exclude an ever declining tax rate, EPS growth was actually only 7%. For FY13, consensus expectations are for 8% EPS growth, with the Street modeling a ~23.5% tax rate, 50 basis points below FY12's full year tax rate of 24%. Oracle's declining tax rate appears to be from an increasing percentage of the company's profits being generated overseas, despite the fact that there's been no significant change in the geographic distribution of sales.
On the legal front, unfavorable verdicts in the HP lawsuit over Itanium (HP is reportedly seeking $4 billion in damages) and the Google suit over Java patents represent strategic setbacks.
The first point about taxes is worth noting since Oracle's earnings growth can be tricky to track. Aside from taxes, Oracle has been built by acquisition so organic growth has been difficult to note for years. In addition, Oracle, like most U.S. tech companies, has benefited from a weaker U.S. dollar in recent years.
As for the legal items, the Itanium suit is a problem for Oracle, which will likely appeal the setback. HP has indicated in recent quarters that high-end system sales have been crushed over the Itanium uncertainty. The Java loss vs. Google was also notable and could have given Oracle some return for its acquisition of Sun Microsystems. In addition, Oracle damages in its TomorrowNow lawsuit vs. SAP have been reduced dramatically.
But for Oracle the only real legal victory it needs is one over Rimini Street and third party support. That trial will kick off in the first quarter of 2013. Should Rimini Street win---and the company is very confident it will---third party maintenance companies could proliferate. Goldmacher noted that the legality of third party support isn't an issue, but the methodology used to provide it is. Once the third party maintenance blueprint is set, Oracle and SAP will have real issues.
In other words, Oracle (and SAP's) maintenance cash cows will take a hit. Goldmacher noted:
We believe Oracle's multi decade dominance in Enterprise Computing is waning. While we believe Oracle could repurpose its $4.4 billion R&D budget to write new, more relevant code, we perceive the real issue to revolve around its pricing model. Page 1 of every Cloud and Big Data business is better/more contemporary technology at a lower price. This has been a major impediment to license growth for Oracle and we believe the situation is getting worse. The last remaining bright spot for the business is Maintenance; 45% of total sales and 85% of net profits.