Oracle just reported slightly better than expected Q4 FY19 results with revenues of $11.1B for the quarter and $39.5B for the year, up 3% in constant currency. A closer look at Oracle's change in the reporting of cloud revenues offers some clues about its longer-term cloud transition strategy.
So how did the "Red Stack" do this quarter? Oracle finished relatively strong overall with a 4% increase in YoY Q4 revenues compared to FY18. Compared to its competition's lightning growth rates (e.g. Microsoft – 13% and Salesforce – 26%), this growth may seem tepid at first glance. However, readers should keep in mind that Oracle has an enormous boat to alter the direction to move the needle on its massive customer base of over 430,000 organizations.
I am regularly hard on Oracle as there is no denying it was more than a little late to the cloud game. And it's no understatement to point out the massive lead that the Big 3 have and will maintain in the IaaS space. But the cloud is much bigger than merely IaaS and Oracle does have plenty to offer in other maturing areas such as PaaS and SaaS.
Summary quarter results by product segment are noted below:
The bright spots in Oracle's revenue growth center on its high-flying cloud application services, including Oracle Fusion ERP, HCM, and NetSuite. For the fiscal year 2019, these cloud application suites showed a stellar 32% growth rate, which Oracle elevates and attempts to show a healthy cloud business.
Our clients adopting Oracle cloud solutions are overwhelmingly doing so in the cloud applications space, further supporting these substantial growth numbers. However, rare is the deal we are asked to review for Oracle’s public cloud IaaS offering. When these transactions do emerge, it is generally under the guise of a lift-and-shift strategy and Oracle has highly discounted the service for the initial term to spur adoption.
It is apparent that Oracle is de-emphasizing sales of its commodity hardware offerings at the same time it is aggressively pushing higher-margin cloud business. The net results of this strategy finally seem to be paying off as Oracle reported non-GAAP operating margins of 47%, a five-year high water mark! The outstanding level of profitability for Oracle will likely be the source of funding for the ongoing cloud investments required to build out its cloud infrastructure at a global scale. Oracle deploys net new cloud infrastructure on a Just In Time (JIT) model where cloud bookings and consumption drive demand.
One more tidbit that bears noting…Oracle's cloud infrastructure is built on its high-performance Exadata series of hardware. This is proven, high-end hardware, proprietary to Oracle via the Sun acquisition years ago, and further fine-tuned over the past decade. This provides Oracle with another cost advantage over its rivals in that it does not have to expend capital on hardware R&D nearly as much as its competition, maintain low cloud infrastructure costs by buying its own product, and improve profit margins by selling less of a lower-margin product line.
While there are the notable strengths referenced above concerning Oracle's cloud business, all is not clear. Oracle stopped reporting cloud revenue numbers by segment last Q4 FY2018. This prevents us from seeing exactly where growth or lack thereof is occurring at a granular level. Why did Oracle make this change?
It is tempting to take the easy analyst position, or more frequently that of a Wall Street analyst, to say that Oracle must be masking weakness or they would not have reduced the transparency in its numbers. There is likely some truth to this position, but the situation is more nuanced than it appears at first glance.
On the one hand, as we have already observed, Oracle started in the cloud race quite late. As a result, its IaaS business is nascent, and the further reporting of stagnant/slow growth in this segment would likely invite pressure from the financial analyst community.
On the other hand, Oracle's application cloud business has gross margins of 86%, and its legacy license support revenues are well north of 90% gross margins. The play here may by combining the reporting of both cloud and perpetual revenue streams, Oracle sets a new baseline by which it can be measured, at a new blended gross margin. This allows Oracle to demonstrate growth materially as its cloud business grows, regardless of the cloud layer (IaaS, PaaS, SaaS).
Combining revenue streams in this manner is akin to Apple recently cutting off data disclosures of iPhone unit shipments in an attempt to shift the narrative to the velocity of the Apple Services business and the further monetization of each retained customer.
There is real merit to this approach and the underlying story of the company. Oracle’s customers must look at this level of operation by Oracle to understand how Oracle’s cloud offerings may fit into their IT strategy. There are pros and cons to Oracle’s market approach, and potential cloud customers need to understand the product landscape, applicable use cases, license options, and contract models.
Oracle seems to have found a way to slowly increase revenues while both investing and building on its maturing cloud offerings. By weaving together new license models, deployment options, and a dizzying array of cloud applications offerings, Oracle provides a tempting narrative offering a path to the cloud in a vertically integrated manner to existing Red Stack customers.
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