The 'U' Word: Do Oracle,
Tech Kin Resemble Utilities?

A word of advice to Oracle Corp. from some analysts and investors: Be careful what you wish for.

In apparent frustration at analysts' preoccupation with a decline in new software sales during the fiscal third quarter ended Feb. 28, Oracle Chief Executive Larry Ellison urged them to pay more attention to the company's revenue from annual software-maintenance fees. That category of revenue was up 16% -- a world of difference from the 4% decline in new-license sales.

To some analysts, it sounded as if Mr. Ellison was promoting his company as … a utility. But, ugh, while utilities do have dependable cash flow -- which investors expect to be dished out as a nice healthy dividend -- don't their stocks also trade at boring multiples because there's limited growth? And what about a dividend?

All in all, Mr. Ellison's comments point to a big issue facing numerous companies in the tech world: Beyond the current technology-spending slump, have some of the biggest ones, including Oracle, evolved into something beyond "growth stocks" -- into something more mature, something deserving a less-sexy market valuation?

Mr. Ellison rejects the notion that Oracle, whose five-year gain of about 150% far outpaces the performance of many peers and the broader technology sector, isn't still a growth stock. He says that more and more data will be stored in the database and sees plenty of growth possible from the stream of revenue known as "software maintenance." But a number of analysts, albeit a minority of them, beg to differ.

"Is it a growth stock? No," says Cheng Lim, an analyst at Fulcrum Global Partners, an independent research firm in New York. "They're not growing right now," says Mr. Lim, who has a "neutral" rating on Oracle, best known for its database-management software.

During the past two years, with the exception of a single quarter, Oracle's new license, or software, sales, as well as total revenue and earnings, have actually declined, he says. To be sure, the slump that started with the bursting of the bubbles in Internet and telecommunications stocks plays a big role. But Mark Murphy, an analyst at First Albany Corp., an investment-bank and research boutique in Albany, N.Y., with no investment-banking ties to Oracle, says Mr. Ellison "came close to tacitly admitting that the days of high growth are behind that company. There are big tech companies that are still growing. But right now Oracle is not in that club."

Mr. Murphy, who also has a "neutral" rating on the stock, argues that Oracle's core database-management software business is mature and under severe attack from Microsoft Corp. and International Business Machines Corp. "The math does not work for Oracle to be a growth company," he says.

Mr. Murphy suggests the stock should trade at closer to 15 to 20 times the analysts' consensus estimate for this year's earnings -- not the current 28. The shares were up 42 cents at $12 in 4 p.m. Nasdaq Stock Market trading ahead of Friday's holiday, down from a 52-week high of $13.36 in early January but still ahead of the tech-heavy Nasdaq Composite Index.

The software-maintenance revenue highlighted by Mr. Ellison has two parts: Customers can pay, on a yearly basis, 15% of the original license amount for the right to future versions of the same software product. They also can pay an additional 7% for the right to call Oracle for product support, that is, help when something goes wrong.

Maintenance revenue represented 43%, or $1 billion, of Oracle's total revenue of $2.31 billion in the quarter ended Feb. 28; the figure has grown at a steady, mostly single-digit rate in recent quarters. The revenue is bigger than the portion from new software sales and other miscellaneous revenue, which represents 33% of the total, or services, 24%.

In the third-quarter earnings conference call, Mr. Ellison suggested that analysts' focus on new software sales is overdone and that the real action is with existing customers. "Who's growing new license revenue? That would be nobody," he says in an interview, with just a bit of hyperbole.

There's no shortage of Wall Street analysts who continue to see it Mr. Ellison's way; estimates for the company's long-term annual earnings growth go as high as 15%. But the more-bearish ones see low-single-digit growth ahead, partly because the technology spending slump shows no signs of abating.

According to a Goldman Sachs survey completed in December, the largest U.S. corporations' chief information officers expect their computer-related equipment purchases to drop 1% this year. That's after a 6% drop last year.

Oracle, like other large successful companies, is grappling with the law of large numbers. Growth comes harder for a company with $9 billion in annual revenue than it does for a nimble small one. And some investors and analysts feel they've already factored the value of software-maintenance revenue into the company's shares.

Oracle, whose market value tops $60 billion, is comparably or richly valued compared with other big software companies on a price-to-earnings basis, and its shares are far pricier than the broader market. Trading at six times estimated 2003 sales, the shares are nearly twice as expensive as those of most rivals, with the exception of Microsoft, whose shares trade at eight times sales.

"If you buy Larry Ellison's argument that we should focus on the maintenance fee, fine, then apply a 10 times" price/earnings multiple, says Jason Brueschke, an analyst at Pacific Growth Equities, an investment bank that doesn't have an investment-banking relationship with Oracle. "Their growth comes from new licenses. … I don't really know who he's trying to fool with that, honestly." Mr. Brueschke, who has an "underweight" rating on the stock, suggests the shares are more fairly valued at $10 apiece.

New software sales always have been the key measure by which Wall Street has judged software companies, because "we're more interested in leading indicators than trailing indicators," explains Rick Sherlund, an analyst at Goldman, who has an "in line" rating on Oracle shares.

Then there's the question of the dividend. "We'll start paying dividends when they stop taxing them," Mr. Ellison says. Meanwhile, he says, the company will continue to buy back shares of its stock to boost shareholder value.

Write to Mylene Mangalindan at mylene.mangalindan@wsj.com

Updated April 21, 2003

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