Don't Jump on Oracle's Hype Train

 Oracle (ORCL) delivered solid first-quarter results behind continued strength in its SaaS business, but we continue to take issue with the firm’s strategy for the remainder of its cloud business. Management’s second-quarter guidance was moderately worse than we had anticipated, though management expects foreign exchange rates to remain a top-line tailwind in the near term. While we believe Oracle’s wide moat remains intact, we maintain our negative moat trend rating as the company continues to face secular headwinds in its legacy on-premises business. We remain confident that Oracle’s SaaS business can carry the water as Oracle works through these challenges, but we are maintaining our $46 fair value estimate and continue to view shares as overvalued.

Adjusted first-quarter revenue rose 7% versus the prior-year period to $9.2 billion, driven by 62% growth in the firm’s SaaS business. We are encouraged that the firm is seeing strength across its biggest cloud application properties including ERP, which reached an annualized revenue run rate of $1.3 billion in the quarter. Still, the firm continues to benefit from the addition of NetSuite, though Oracle will begin lapping tougher comparable periods in the back half of the year. The firm continues to manage its on-premises business well despite material long-term headwinds, as license revenue fell 6% (roughly in line with our expectations), while maintenance revenue expanded roughly 3%.

Adjusted operating margin continues to trend in the right direction, expanding more than 150 basis points to 41.1% in the quarter, driven primarily by sustained improvement in SaaS gross margin, which reached 66.5% in the quarter. Still, investors should note that faster growth in the firm’s IaaS/PaaS business would flatten the firm’s margin trajectory, as the company continues to work through higher costs spread across fewer customers in that business.

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