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Oracle will spend the next week preaching about the cloud

Larry Ellison
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Larry Ellison

It's a big week ahead for Oracle.

Starting Sunday, software developers, marketers and salespeople will flood into downtown San Francisco for OpenWorld, Oracle's annual customer conference, which has attracted more than 60,000 attendees in recent years.

But first things first. Oracle announces earnings on Thursday and is expected to report close to $1 billion in quarterly cloud revenue. The earnings call will give Chairman Larry Ellison his first chance to lay out his plans for NetSuite — which also counts Ellison as its biggest shareholder — since Oracle agreed to buy the company in July for $9.3 billion.

The word "cloud" will be everywhere. Like the rest of the computing industry, Oracle has acknowledged that the future of technology is about easy and quick accessibility to data from any device with businesses less inclined to spend money on proprietary hardware and packaged software.

But Oracle has been slow to adopt the subscription business model that follows. The company is still reliant on traditional software licenses, updates and support for the vast majority of its revenue. As Oracle makes the move, it has to deal with pricing pressure that comes from enhanced competition.

"We expect cloud revenue growth will continue to accelerate, though investors will monitor the potential cost to the legacy business, as well as the potential impact to margins during the transition," Nomura Securities analyst Frederick Grieb wrote in a report Thursday. Nomura has a buy rating on the stock and $44 price target.

Oracle shares have gained 4.7 percent in the past year, trailing the 8.5 percent advance for the S&P 500. The stock fell 1.2 percent on Tuesday to $40.18 but was trading slightly higher Wednesday afternoon.

Oracle's gross margin, or the percentage of revenue left after subtracting the cost of goods sold, is strengthening as the cloud business gains traction. Analysts expect its gross margin to hit 79 percent in the quarter ended August and climb to 80 percent by year-end, according to Thomson Reuters. That's up from an average in the mid-70s over the past few years.

"Obviously, cloud margins are going through the roof," Oracle's co-CEO Safra Catz said during the last earnings call in June.

Cloud software vendors Salesforce.com and Workday are growing much faster than Oracle as they don't have any of the legacy business to slow them down. Oracle has actually reported five straight quarters of declining sales and is projected to show meager expansion of 3 percent to $8.7 billion in the fiscal first quarter, according to Thomson Reuters.

"The worst of this cloud transition is behind Oracle and our model indicates the company can finally return to growth," Drexel Hamilton analyst Brian White wrote in a report Tuesday. White recommends buying the shares and has a $51 price target.

Oracle, Salesforce and Workday

Oracle also has a fat cash pile of $56 billion, enabling mega-deals like the purchase of NetSuite, which is expected to close this year. NetSuite's software lets businesses manage their finances, resource planning and customer relationships in the cloud.

Salesforce has been on its own acquisition spree in the software-as-a-service (SaaS) market, buying Quip for about $600 million in August and Demandware for $2.8 billion in June. Of course, Salesforce was in on the bidding for LinkedIn, which ultimately went to Microsoft for over $26 billion.

After NetSuite, there's no reason to think Oracle is through with the wheeling and dealing, according to Jack Andrews, an analyst at DA Davidson.

"We believe this may foreshadow other SaaS acquisitions by ORCL," Andrews wrote in a July 29 report.