Amid a devilish brew of rising rates, high inflation, and recession fears, the tech sector offers few hiding places for investors.
The market is shunning the high-growth, profitless software stocks that drove the sector higher during the pandemic. Consumer-facing e-commerce and hardware stocks are sagging, plagued by weakening demand; social media plays are taking a beating as ad buyers retrench; and supply-chain issues are hitting chip stocks. Almost every tech stock is down for the year, with dozens off more than 50%.
In past columns, I’ve made the case for betting on cloud computing, and I think the story remains compelling. As recent earnings reports from
(GOOGL) made clear, demand for cloud-based computing services is both vast and expanding. The promise of the cloud—improved flexibility and reduced costs—is fundamentally changing the way every company handles computing.
In a research note this past week, Credit Suisse analyst Phil Winslow wrote that corporate spending on the public cloud should top on-premises infrastructure IT outlays by 2024. It’s cloud computing, not just software, that’s eating the world. Winslow argues that Wall Street is underestimating the growth potential for Microsoft Azure. I see Microsoft and Amazon as the best long-term bets on the cloud.
But I also see opportunity in another cloud play that’s still hiding in plain sight. In February 2021, I wrote a bullish cover story about
(ORCL), making the case that the enterprise database and applications company had quietly evolved into an underappreciated cloud story.
The company was driving its customers to adopt cloud-based versions of its software, while also launching Oracle Cloud, a fledgling rival to the public cloud’s Big Three. Oracle’s transition to the cloud was gaining traction, but investors hadn’t caught on. As it turned out, Oracle was a great stock to own in 2021, rallying more than 70% by mid-December, as quarterly results showed steady progress on the cloud strategy.
And then two things happened that blew up the stock. At a macro level, the tech selling spree picked up steam. While the selloff started with pandemic darlings like
Zoom Video Communications
(PTON), it soon spread everywhere, and Oracle wasn’t immune. But the bigger issue was Oracle’s late December announcement of a $28 billion cash deal to buy Cerner, an electronic medical records company serving hospitals and healthcare systems.
Over time, Oracle has made many large acquisitions—PeopleSoft, Siebel, Sun Microsystems—but Cerner is its largest deal ever. Oracle is betting big on healthcare digitization. It’s also a wager that it can shift Cerner’s software to the Oracle Cloud, generating huge savings. While Oracle has said the deal will be an immediate boost to earnings, the transaction raises the worry of integration risk, requires Oracle to take on additional debt, and moderates what had been an extremely aggressive stock buyback plan.
Since peaking right before the Cerner deal was announced, Oracle stock has fallen 38%, shedding some $100 billion in market value.
Deutsche Bank analyst Brad Zelnick says the Cerner acquisition cast some doubt about Oracle’s shift to the cloud, the reason behind the stock’s 2021 rally. The deal offered ammunition to the skeptics who were already worried about Oracle’s cloud commitment.
But this past week, Oracle’s earnings provided fresh evidence that the transition is still under way.
For the fiscal fourth quarter ended May 31, Oracle reported revenue of $11.8 billion, up 10% adjusted for currency, in the company’s best growth quarter since 2011. The figure beat the company’s own guidance and Wall Street’s estimates.
Meanwhile, Oracle’s cloud business grew 22% in the quarter—and Oracle CEO Safra Catz told investors that cloud revenue growth should 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 U.S. user traffic to the Oracle Cloud.)
Oracle shares rallied after the report, and they actually finished higher on the week, a rare success in an otherwise dismal week for stocks.
Zelnick, who maintains a Buy rating and $110 target price on Oracle shares—a potential 70% return—says Oracle’s guidance implies continued high-single-digit revenue growth for the overall business on a currency adjusted basis.
While Zelnick concedes that no company is immune from a deep recession, he thinks other dynamics will carry the day at Oracle in the months ahead, setting the stage for a rebound in the stock. “They are transforming their own business, they are taking out costs from Cerner,” and, he says, “inflation actually is good for Oracle.” There are inflation-index linked increases built into Oracle’s customer contracts, Zelnick explains. Meanwhile, switching costs are so high for Oracle software that customers show little resistance to price hikes.
The selloff in Oracle stock has made it cheap by most measures. At a recent $68, it trades at less than 13 times Zelnick’s forecast for profits of $5.36 a share for the May 2023 fiscal year and less than four times his post-Cerner revenue forecast of just under $50 billion. On both measures that’s less than half Microsoft’s valuation.
If Oracle’s cloud growth vision plays out, the stock should rebound, regardless of whether there’s a recession.
Write to Eric J. Savitz at firstname.lastname@example.org