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Oracle's

(ORCL) - Get Oracle Corporation Report

solid showing this week supplied more proof that along-awaited, albeit modest, recovery in software has finally arrived.Oracle's results also have some market watchers abuzz over a broadercomeback for application software.

As the world's second-largest software maker, Oracle's results areoften viewed as a harbinger of the broader software sector, and conventional wisdom is that application software will be the sector's leader in 2004.

Oracle sells both applications software -- the software programs used to track employees, corporate finances and sales and marketing -- as well as databases, considered infrastructure, a segment that also includes operating systems and storage. Both Oracle's applications and database businesses posted stronger-than-expected gains in Oracle's fiscal second quarter, although the 27% year-over-year increase in new application sales outpaced an 11% increase in database sales.

As with Oracle's example, "we think applications will do better

overall next year than infrastructure will," said Rich Parower,co-manager of Seligman Global Technology Fund. The reason: Companies still bought infrastructure software such as storage during the downturn, while they held off buying applications, which are more expensive discretionary purchases, he explained. As a result, "the wish lists are pretty big" for applications.

The vast majority of observers agree, if only because applicationsoftware makers such as

Siebel Systems

(SEBL)

, German behemoth

SAP

(SAP) - Get SAP SE Report

and

PeopleSoft

(PSFT)

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suffered more during the downturn than infrastructurecompanies such as

BEA Systems

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,

Veritas

(VRTS) - Get Virtus Investment Partners, Inc. Report

and

MercuryInteractive

(MERQ)

.

UBS analyst Heather Bellini found applications vendors sufferedpeak-to-trough license revenue declines ranging from 54% for PeopleSoft -- the subject of a hostile takeover by rival Oracle -- to 77% forcustomer-relationship management software maker

E.piphany

(EPNY)

. Theinfrastructure players fared better, with the peak-to-trough declinesranging from only 22% for storage software maker Veritas to 37% forbusiness analytics vendor

Informatica

(INFA)

.

Consequently, the business of application software makers should bounce back more as IT spending picks up. Bellini likes PeopleSoft and Oracle, having raised her ratings on each to buy from neutral on Dec. 3. (UBS has done investment banking with Oracle.)

In a note Tuesday, Friedman Billings Ramsey & Co. analyst David Hilal said Oracle's strong results speak to the improving demand forapplications. "We think this trend will continue into 2004 and thatOracle's results provide an important data point that could spark a sector rotation into software stocks," Hilal said.

Treading Carefully

To some degree, such expectations may already be reflected in thecompanies' stocks. Shares of Siebel, PeopleSoft and SAP have all rallied steadily in recent months, for example, while the performance of infrastructure software plays has been uneven.

As a result of its recent rally, Siebel now trades at almost 49 times forward earnings, while SAP trades at 34 times, still slightly higher than the industry benchmark of 30. PeopleSoft's forward price-to-earnings ratio is 24.

Valuation was partly behind Hilal's decision to maintain his marketperform rating on Oracle, and why he has a buy rating on PeopleSoft,despite some controversy surrounding PeopleSoft's guidance and pro forma accounting. Hilal also maintained Oracle's rating because its latest quarterly results, while solid, came against easy comparisons from a year ago.

"We want to see a little bit of consistency, and we want to see anattractive valuation," Hilal said of Oracle. (His firm hasn't done anybanking with Oracle or PeopleSoft.)

In addition, there are a few other reasons why investors should be careful reading too much into Oracle's latest application numbers:

Sales that slipped from Oracle's disappointingly weak first quartercould have boosted its second-quarter results.

The firm's results benefited from currency exchange rates. Withouta currency impact, new database sales grew only 2% year over year, while applications increased 18%.

Oracle is under special pressure to make its applications businessshine as the competition to outdo rival and takeover target PeopleSoft hasreached a feverish pitch. But new application sales in its latest quarterwere still lower than they were in the same period of fiscal year 2002,when IT budgets were very tight.

Finally, applications still only make up a small portion ofOracle's overall business, accounting for about one-quarter of totalrevenue.

That last factor is reason enough for Parower to steer clear of Oracle. Oracle's applications business isn't big enough to move the bar for the $10 billion company, whose core database business is suffering slower growth because of stiffer competition from

IBM

(IBM) - Get International Business Machines Corporation Report

and

Microsoft

(MSFT) - Get Microsoft Corporation Report

.

Investors interested in software application stocks should considerSAP, which Bernstein analyst Charlie Di Bona believes will gain marketshare. (Bernstein doesn't do investment banking business but its parent,Alliance Capital, holds shares of Microsoft and BEA.)

Nevertheless, a minority of observers believes infrastructure will outpace applications in the coming year.

Just because companies went on application spending sprees before the downturn doesn't mean they will again now that the economy has recovered, said Rob Tholemeier, an enterprise software analyst with New York-based DRW Research. He believes demand remains saturated and boldly predicts the applications market will shrink to half its current size within 24 months. (Tholemeier owns shares of Oracle.)

Excluding Y2K and the euro conversion, past computing cycles werecharacterized by buildouts of computer hardware and telecom followed by short, intense software infrastructure investment and then more moderate applications spending, Di Bona argued.

That pattern is about to repeat itself as software enters aninfrastructure cycle driven by integration and Web services, which connect different software programs together, Di Bona said.

The beneficiaries of such infrastructure investment include bellwetherMicrosoft, with its .NET framework aiming to integrate systems, and BEASystems, with its move from application servers to a more integratedplatform that includes integration and application development tools, DiBona said. He has outperform ratings on both companies and underperformratings on applications vendors PeopleSoft and Siebel Systems.