Oracle needs to read Cisco cautionary tale
By Robert Cyran
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Empires built through acquisitions can run into problems as they sprawl. That‚Äôs doubly so in technology, where obsolescence is a risk. Oracle has used profits from its database stronghold to expand. Its acquisitions have worked well so far – indeed that‚Äôs one reason why German arch-rival SAP has become more active in acquisitions, such as Saturday‚Äôs purchase of SuccessFactors for $3.4 billion – but Cisco Systems‚Äô sad experience suggests Oracle boss Larry Ellison needs to stay on his toes.
The $160 billion Oracle tends to buy relatively slow-growing firms that sell software and lucrative maintenance contracts, cut costs, and then let profits roll in. In October, Ellison‚Äôs company bought cloud computing firm RightNow Technologies for $1.5 billion. Oracle‚Äôs revenue has grown at a 20 percent annual clip over the past five years.
Yet Cisco‚Äôs recent rethink shows the hangover that can follow acquisitiveness. The networking company, led by John Chambers, bought firms in loosely related markets. But managers lost focus with distractions like consumer electronics. Investors became skeptical that profits were durable, reducing the valuation multiple they attached to the company‚Äôs forecast earnings from 18 times in 2006 to just over 10 times today. After several profit warnings, Chambers earlier this year reset strategy to focus on defending the networking business.
Oracle continues to invest – expenditure on research and development is rising faster than sales – and the company‚Äôs operating margins, at more than 40 percent, remain high. That‚Äôs evidence the firm is working to maintain the edge that it still has. Oracle‚Äôs sales of licenses, an indicator for new business, are still rising, although acquisitions flatter this figure. And customers tend to be locked into maintenance contracts with fees that rise each year. So this 40 percent chunk of Oracle‚Äôs business could grow even if it gets fewer new customers.
There‚Äôs little sign of decline as yet. Even so, Oracle is getting more aggressive with its acquisitions. Ellison bought Sun Microsystems, a big hardware maker, for $7.4 billion in 2009. And he paid a whopping seven times revenue for RightNow. Meanwhile, investors have squeezed the premium out of the company‚Äôs price-to-earnings multiple, which at around 13 times forward earnings is now in line with the broader market.
Those trends could be viewed as early danger signs. Ellison will want to avoid Cisco‚Äôs missteps, but Oracle‚Äôs moment in the sun won‚Äôt last forever.