Oracle Tests the Limit

Its report may decide whether the stock takes a run at a 52-week high.
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Shares of Oracle (ORCL) - Get Report took a beating in early December when Lehman Brothers published a note forecasting weakness in the company's core database business.

But like that annoying bunny of TV fame, Oracle keeps on ticking and appears headed for a third strong quarter in a row when it reports second-quarter earnings late Monday.

And even the Lehman-inspired dip hasn't done much to hurt the stock's annual performance; it's up about 45% since the beginning of the year, while the

Nasdaq

and Goldman Sachs Software Index have gained just 10% and 11%, respectively. Bitter rival

SAP

(SAP) - Get Report

, meanwhile, has gained just 15% this year.

Indeed, Standard & Poor's analyst Zaineb Bokhari said the recent weakness creates a buying opportunity, and on Thursday she bumped her rating on Oracle to strong buy from buy. "With the shares trading at a 23% discount to peers based on P/E, we view them as compelling," she wrote.

Most other analysts, though, don't see a lot of headroom in the stock at the moment. The consensus target price, according to Thomson First Call, is $19.76, not far above Friday's close of $17.68. The stock had climbed to a 52-week high of $19.75 in late November.

By and large, Wall Street is expecting a strong quarter that will generally be in line with expectations. The consensus estimate calls for a profit of 22 cents a share, excluding the cost of options, on total revenue of $4.15 billion. A year ago, Oracle posted non-GAAP earnings of 19 cents a share on sales of $3.3 billion.

It's worth noting that an in-line performance on the top line would equate to growth of nearly 26%. The comparison is helped, though, by the recent weakness of the dollar, while last year's quarter was hurt by the greenback's strength.

Revenue from software licenses, a key measure of new business, is expected by Wall Street to grow by about 18% to $1.24 billion. Database and middleware licenses (Oracle no longer separates the two categories) will likely grow by 9.5% to $867 million, while applications licenses are expected to increase some 43% to $381 million.

The last number is particularly significant since Oracle spent $13 billion (net cash) to bolster its weak applications business. "The acquisitions are clearly paying off," says Bokhari.

However, a number of analysts say that Oracle is not giving them quite as much information as in the past. Sanford Bernstein's Charles Di Bona called the database segment "a black box," because management is not breaking out the middleware numbers.

Management, he said, is also reluctant to discuss the performance of database add-on options like RAC (real application clusters), "despite their assertions that these products are critical to overall segment results. Without sufficient detail and given recent rumors of weak database sales, it may be difficult for investors to feel comfortable with reported database growth figures even if they are respectable in aggregate," he wrote in a recent note to clients. Sanford Bernstein does not have an investment banking business.

It also gets harder to parse out contributions made by the acquired businesses once they pass their first anniversary. The PeopleSoft acquisition, the earliest and most controversial buy during Oracle's M&A binge, closed in January 2005; Siebel Systems in February 2006. Why does it matter? Organic growth, as opposed to growth derived from acquisitions, is an important indicator of a company's ability to grow.

Passing the anniversary date also means the end of easy comparisons, because the year-ago quarters now contain revenue from both Oracle and the acquired company. Prior to the anniversary, the year-ago quarters were relatively smaller, and it was easy for Oracle to post impressive growth numbers.

Merrill Lynch analyst Kash Rangan adds that PeopleSoft's deal pipeline was drained at the end of 2004 as salespeople scrambled for commissions during the company's final days. It took Oracle about a year to rebuild it, meaning that the comparisons of the last few quarters were easier than they might have been. By the third quarter of the current fiscal year, however, the easy PeopleSoft comparisons will disappear. Merrill Lynch has an investment banking relationship with Oracle.

Even so, it's clear that the acquisitions have swelled Oracle's stream of ongoing maintenance revenue. In the first quarter of fiscal 2006, revenue from applications license updates and product support fees was $466 million; a year later, that had jumped 51% to $703 million.

Although it's not likely, a decrease, or a significant slowing of growth, in maintenance revenue would indicate that customers are defecting.

Looking ahead, Wall Street is looking for third-quarter guidance of 22 cents EPS on revenue of $4.18 billion. If Oracle can get past the tougher comparisons to come, that bunny will probably keep right on ticking.