Oracle and SaaS: Inevitable

After reporting a solid third quarter that beat estimates and declaring its first dividend, on Monday Oracle (NASDAQ:ORCL) decided to go on a shopping spree. It started the quarter by acquiring Relsys International, which provides drug safety and risk management software. There are also speculations about Oracle acquiring Red Hat, but the enterprise software giant continues to avoid acquisitions in the SaaS space. Let’s explore why.

First, we’ll take a close look at its recent acquisitions. Last month, Oracle bought mValent Inc., a small manufacturer of software that helps to configure other software. This acquisition is expected to enhance Oracle’s enterprise management solution for end-to-end application configuration management. The Relsys acquisition, on the other hand, is supposed to strengthen Oracle’s position in the pharmaceutical industry. It created a Health Sciences business unit last year. Both acquisitions are for undisclosed amounts, but mValent is estimated to be less than $10 million.

In my last post, I said Oracle would shop SaaS in 2009. Unlike last year, when Larry Ellison categorically said that it is not interested in the SaaS model due to the high sales and implementation costs, this year it has started focusing on the sector. On March 9, Oracle released Oracle Sourcing On Demand, a SaaS solution designed to make supply chain management more efficient and cost-effective. Weeks later, SAP announced the latest version of its BusinessObjects Global Trade Services Application designed to automate regulatory compliance across the supply chain. During the earnings call, Oracle also referred to its success rate against competitor Salesforce.com.

So unlike last year, Oracle definitely seems keen on SaaS; it just seems to be a matter of price and time. And even Research firm Wedge Partners lists SaaS companies on Oracle’s shopping list. The article goes on to say that Wedge Partners believes Oracle made a bid for SuccessFactors but that the company wanted more than what Oracle offered.

On the financial front, Q3 revenues were up 2% to $5.5 billion, beating analyst estimates of $5.42 billion. Net income was down 1% to $1.3 billion or $0.26 per share due to the impact of the stronger dollar. Non-GAAP EPS increased 16% on the other hand to $0.35, beating analyst estimates of $0.32 per share. Non-GAAP operating margin grew by 510 basis points to 46.4% in US dollars, the highest in the company’s history.

At the currency rate of Q3 last year, revenues would have been up 11% and EPS would have been up 18% to $0.31 rather than up 3% to $0.26. Oracle repurchased 86.0 million shares for about $1.4 billion and ended the quarter with $11.3 billion in cash and investments. It generated a record $8.0 billion in free cash flow over the year, up 14%. It has announced that it will pay a quarterly dividend of $0.05, the first in the company’s history.

By segment, software revenues were up 5% to $4.4 billion with new software license revenues down 6% to $1.5 billion. Software license updates and product support revenues were up 11% to $2.9 billion. Services revenues were down 8% to $1.0 billion. Technology new license revenues were down 4% to $1.1 billion. Applications new license revenues were $396.0 million, down 12%.

The BEA acquisition has been integrated successfully with Oracle’s Fusion Middleware and BEA products accounted for $140.0 million of new license revenues in the quarter.

Despite performing well in the quarter in the face of the recession, Oracle issued weak guidance for Q4 as it expects the strong dollar to continue to have a negative impact. It expects total revenue to range from +2% to -3% in constant currency and -10% to -14% at current exchange rates. Non-GAAP EPS is expected to be $0.49 to $0.53 in constant currency, up from $0.47 last year and between $0.42 and $0.46 at current rates. GAAP EPS is expected to be $0.41 to $0.45 at constant currency and $0.34 to $0.38 at current rates. The company expects new software license revenues to range from -5% to -15% in constant currency and -17% to -27% at current rates. The stock is currently trading around $18 with a market cap of about $90 billion. It hit a 52-week low of $14.14 on March 6.

Oracle has both the cash and the currency to do a SaaS roll-up. 2009, with low valuations, would be an interesting time to get going on the process, an inevitable direction that Ellison needs to steer in.