Stock Of The Week: All Aboard Oracle

Stock Of The Week
All Aboard Oracle
John Dobosz 04.18.07, 4:55 PM ET

Sam Subramanian, editor of AlphaProfit Sector Investors' Newsletter, recommends buying shares of Redwood City, Calif.-based application software company Oracle.

Founded by CEO Larry Ellison in 1977, Oracle develops, distributes and services database, middleware and application software for businesses. For the past several years, it has been on an acquisition spree, purchasing big enterprise software players like PeopleSoft and Siebel Systems.

Subramanian likes Oracle on several fronts. First off, he's impressed by the strategy of growing through acquisitions and how it is beginning to pay off.

"Oracle's strategy is to acquire companies with the intent of delivering a broader software suite," says Subramanian. It has spent more than $20 billion on software acquisitions since 2003, and announced that it is buying business performance measurement software maker Hyperion Solutions for $3.3 billion.

"This strategy is paying off as customers consolidate their IT spending with key suppliers," he says. "Oracle is gaining market share in applications and middleware."

As far as fundamentals, Oracle recently reported 25 cents a share in third-quarter earnings, beating analysts' 22 cents a share estimate. Revenue rose 27%, to $4.4 billion, with sales from new licenses also increasing 27%, to $1.4 billion.

"Out-performance was driven more by market share gains than a pick up in enterprise spending," says Subramanian. "Strength in sales of applications and middleware was notable."

For the fourth quarter, Oracle expects new software license revenue to rise between 5% and 15%, and per-share earnings to increase to 34 cents. Subramanian sees possible upside surprises on the horizon.

"Guidance for fourth-quarter earnings appears relatively conservative," he says. "The pipeline for new contracts is strong. Deals that failed to make the third-quarter deadline are expected to close during the fourth. Longer term, the Hyperion acquisition should also provide earnings upside."

In addition, earnings per share should also stand to benefit from share buybacks. Recently, Oracle's board added $4 billion to its stock buyback commitment.

Shares of Oracle closed Friday at $18.63, or 18.8 times expected 2007 earnings. The company's price-to-earnings growth (PEG) ratio is a fairly lean 1.2. Subramanian looks for the P/E multiple to expand as long as execution remains consistent and profit margins expand.

"In terms of major products, Oracle is working on Fusion, a software suite that will combine the best features of Oracle's and its acquired companies' products," he says. "Down the road, Fusion could well provide customers a compelling value proposition paving the way for strong earnings per share gains."

Subramanian notes that risks include the potential for delays in integrating acquisitions and in the launch of Fusion, as well as market share loss in the database and applications market due to competition

For investors looking for a broader play on software, Subramanian recommends Fidelity Select Software & Computer Services and iShares Goldman Sachs Software.