Oracle Looks for Inside Track on Outsourcing

It looks to augment the business with application servers and databases. Analysts are skeptical.

Author:: Ronna Abramson
Publish date:: Apr 2, 2002 7:17 AM EST

For more than three years,

Oracle

has been trumpeting outsourcingapplications as a way to diversify away from its core database business.

But now that the world's second-largest software maker is taking moreconcrete steps to develop outsourcing, analysts are expressing doubtsabout whether it is as lucrative as Oracle suggests. Despite all the recenthype, virtually no analyst has yet included outsourcing revenue in hisfinancial model.

The latest step taken by Oracle to build that outsourcing business will comeTuesday when the Redwood Shores, Calif., company announces it isextending beyond applications to databases and application servers.

That move comes on top of recent changes in Oracle's salesforce to push more outsourcing deals, including dedicating 18 North American sales consultants to the effort, and spending about $60 million to expand its data infrastructure.

Oracle CFO Jeff Henley has said Oracle can build outsourcing into a $1billion business in the next five years, assuming one-quarter of itsexisting customers sign up. The sales pitch is that customers can lowertheir costs by outsourcing. Oracle's more than 200 customers have loweredIT costs by up to 46%, according to the company.

But at least one analyst, David Hilal of Friedman Billings Ramsey, hascalled the $1 billion a "lofty goal" for a company whose revenues havedeclined four straight quarters. Outsourcing currently generates less than$50 million in annual revenue -- a drop in the bucket given Oracle's totalrevenue totaled $2.2 billion in the most recently completed quarter.

Analysts say while the cost savings may prove attractive to small andmedium-sized businesses, Oracle faces a tough road ahead convincing largecompanies to outsource their software. After Oracle touted the new businessat a recent analyst day in New York, Deutsche Banc Alex. Brown analysts JimMoore and Matthew Kelly said in a research note that success could behampered by risk-averse CIOs fearful of handing over critical corporatedata and applications to a third party -- a sticking point for applicationservice provider failures in the past. Moore or Kelly own Oracle shares.

Lisa Arthur, Oracle's vice president of outsourcing marketing,disputed that point, saying outsourcing appeals to small and largecompanies alike. "The larger the company, the larger the IT budget, themore ability they have to make an impact to that budget," she said. Inaddition, she said Oracle offers several outsourcing options, includingallowing companies to house the hardware and hire Oracle to manage,administer and maintain its software remotely.

Merrill Lynch analyst Chris Shilakes agreed it could take companiessome time to digest and become comfortable with the new businessproposition. Shilakes, who has a neutral rating on Oracle, did not changehis estimates after hearing the company's pitch in New York. He said Oracleis fully valued for his estimates for long-term earnings growth of 10% to 15%.His firm hasn't done any business with Oracle.

So how long will it take for outsourcing to have an impact onOracle's income statement? "We think meaningful traction is two yearsaway," Hilal of Friedman Billings Ramsey said in a recent interview. Hilalsuggested Oracle is using outsourcing to accelerate customer upgrades anddifferentiate its products from competitors like

PeopleSoft

(PSFT)

Siebel Systems

(SEBL)

and

SAP

(SAP) - Get Report

Indeed, none of those players have begun outsourcing their software.

Microsoft

(MSFT) - Get Report

, through its .Net initiative, has made a push to eventuallydeliver software as a service.

Another point of uncertainty, however, is what effect outsourcing willhave on Oracle's margins, which the company has managed to hold steady evenas revenue and earnings slide. "You will have to invest upfront to beable to do this," said Eric Upin, an analyst with Robertson Stephens. "Sothere could be some margin implications."

Upin, who rates Oracle a market perform, said he has declined toinclude revenue for outsourcing in his models for Oracle because "we'restill a little dubious near term." His firm hasn't done any bankingbusiness with the company.

Oracle's Arthur countered that outsourcing is a "very scalable model"and said that margins can benefit because Oracle is able to addresscustomer problems much faster, which also improves customer satisfaction.

Despite the uncertainty, Upin acknowledged that getting intooutsourcing makes sense. "The benefit of the ASP hosting modelis you have long-term contracts. You almost have a utility business model,which is great for visibility and predictability. And investors will pay apremium for that," said Upin. "It's a smart move for them to continue totry to diversify the business and pursue other growth areas."

But, Upin added, "it also looks like they're off to a small start."