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Will Oracle’s Transition to Cloud Impact Its Margins?

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Apr. 10 2015, Updated 12:06 p.m. ET

Cloud’s contribution towards overall revenues is set to increase

As we saw earlier in this series, Oracle’s (ORCL) growth in cloud offerings—SaaS (software-as-a-service), PaaS (platform-as-a-service), and IaaS (infrastructure-as-a-service)—is impressive.

Currently, although its cloud revenue only accounts for ~5.5%–6% of total revenue, looking at the future growth of its cloud offerings and increasing customer base, cloud offerings’ contribution towards overall revenue will likely increase in the coming years.

To gain diversified exposure to Oracle, you can invest in the PowerShares QQQ Trust (QQQ) and the Technology Select Sector SPDR Fund (XLK). QQQ and XLK invest about 3.08% and 3.41% of their holdings in Oracle, respectively.

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Improved margins and profitability

Currently, Oracle is undergoing a transition from software licensing to the cloud. However, the transition to cloud put some pressure on Oracle’s margins. Cloud-based subscription revenue is recognized over an extended period. In contrast, software revenue boosts the top line immediately.

In the short term, the reduction in the upfront revenue puts pressure on margins. However, in the long term, it results in higher profitability and visibility due to greater efficiency and the recurring nature of the cloud model.

This could be why internet retailers like Amazon (AMZN) and Twitter (TWTR) fetch high valuations. Amazon has low margins. Twitter is a consumer cloud services company. It made a minimal profit. In contrast, traditional enterprise technology companies with high margins are struggling to win over Wall Street. Also, a likely reason why the companies mentioned above garner high valuation could be that market and investors place a premium on the companies that have coherent cloud strategies and the ability to adapt quickly to a rapidly changing market.

Good cloud growth in the future

In 4Q15, Oracle expects SaaS and PaaS to grow 27%–31%. IaaS is expected to grow 29%–33%. In 4Q15, bookings are expected to touch $300 million. Bookings are expected to grow more than 100% on a YoY (year-over-year) basis in fiscal year 2015.

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