June 10, 2011 4:24 pm

Oracle: signs of eye wrinkles?

The 30-something’s next earnings report will be key

For tech companies, as for people, middle age is defined by behaviour, not years. Business software leader Oracle is well over 30 – an age at which many firms are in forced retirement – but frisky. Over the last five years, it has zipped around in a sports car, growing revenue and free cash flow at an average annual rate of around 20 per cent. Big-cap rivals IBM, Hewlett-Packard, and Microsoft have been tooling around in minivans by comparison.

Oracle’s vigour has two sources. In the 1980s and 90s, chief executive Larry Ellison was prescient about where business software was headed. In the last decade he recognised early that the industry must consolidate, and led the charge with big acqusitons.

Why, then, have Oracle’s shares underperformed the market and its frumpy peers since early May? Some investors see wrinkles around the eyes. The next earnings report, in two weeks, will be the first without comparisons helped by the acquisition of Sun Microsystems, and it is not clear how the roll-up strategy proceeds from here. Oracle’s success as a buyer stems in large part from refusal to overpay, and valuations of mid-cap tech companies, especially in software, have jumped. Oracle has three options: focus on organic growth and smaller deals; start paying up; or look farther from its core business for cheap targets (as it did in buying hardware maker Sun).

Moving still further from software means lower margins. Paying rich premiums lowers return on capital. The first option, then, promises the best financial results. The problem is selling it to tech investors, who fixate on topline growth. Wall Street will not hesitate to slap Oracle, now trading at a reasonable 13 times prospective earnings, with a lower valuation if sales growth falls to single digits. It is hard to grow old with dignity.

E-mail the Lex team in confidence at lex@ft.com

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