Image Source: Oracle Corporation – September 2019 Financial Analyst Meeting Presentation
By Callum Turcan
Oracle Corporation (ORCL) is one of our favorite dividend growth ideas that also earns high marks as it concerns ESG (environmental, social, and governance) investing standards. We use our proprietary ESG scoring matrix, which scores firms on a 1-100 scale (100 being the best), to gauge their adherence to ESG practices. Oracle scores a nice 96 ESG rating with a strong showing across all three categories. We include shares of ORCL as an idea in both the Dividend Growth Newsletter and our ESG Newsletter portfolios. The high end of our fair value estimate range sits at $101 per share of Oracle, comfortably above where shares are trading at as of this writing. Shares of ORCL yield ~1.5% as of this writing.
Growing its cloud computing operations as part of its pivot away from its legacy IT offerings represents a major part of Oracle’s turnaround story over the past decade. Its efforts here have started to play out quite favorably in recent fiscal quarters, as witnessed through the strong financial performance Oracle put up during its second quarter of fiscal 2022 (period ended November 30, 2021) when its GAAP revenues were up 6% year-over-year. Furthermore, management offered some promising near-term guidance during Oracle’s fiscal second quarter earnings call, noting that “we expect cloud revenue will accelerate further and exit the fiscal year in the mid-20s, potentially higher,” which speaks quite favorably towards the company’s longer term growth outlook as well.
Cerner Deal
Shares of ORCL initially surged higher after its fiscal second quarter earnings update was published on December 9, before rumors of a major potential acquisition materialized, rumors that in this case turned out to be true. On December 20, Oracle announced that it was buying Cerner Corporation (CERN) for $95 per share through an all-cash deal with an equity value of ~$28.3 billion. Cerner offers electronic health records (‘EHRs’) services, analytical services for healthcare providers, and back-office services for the healthcare sector. Healthcare is a huge business that is still in the early stages of transitioning towards modern IT practices, and Oracle views the Cerner acquisition as one that will help push its cloud computing offerings into a new vertical.
However, we caution that Oracle exited November 2021 with a net debt load of ~$55.6 billion (inclusive of short-term debt). Though it had $22.8 billion in cash, cash equivalents, and current marketable securities on the books at the end of this period, which provides Oracle with ample liquidity, the company does not have the financial firepower to make the Cerner acquisition without also making some big changes to its capital allocation priorities.
From fiscal 2019-2021 (its fiscal year ends in May), Oracle generated ~$12.7 billion in annual free cash flow on average and exited fiscal 2021 with run-rate dividend obligations of roughly $3.1 billion. Oracle generates ample “excess” free cash flow (free cash flows less dividend obligations) which has enabled it to spend handsomely buying back its stock. From fiscal 2019-2021, Oracle spent $76.3 billion, in total, repurchasing its stock, though some of those repurchases were funded by the firm issuing debt as well. Looking ahead, Oracle will need to slow down or suspend its share buyback program to maintain its balance sheet strength as it gets ready to acquire Cerner.
The deal, as envisioned, is expected to close in calendar year 2022 once the necessary regulatory approvals have been received and after a majority of Cerner shareholders have tendered their stock. Oracle intends to retain an investment grade credit rating going forward. At the end of the September 2021, Cerner had a net debt load of $1.1 billion (inclusive of short-term debt), though that figure does not include the $0.5 billion in ‘long-term investments’ Cerner had on the books at the end of this period which includes some cash-like assets (such as government and corporate bonds).
Cerner’s net debt load is relatively small for a firm like Oracle, though Oracle will still need to tap debt markets to fund a large chunk of the cash portion of its pending acquisition. On the flip side, Cerner generated $0.9 billion in free cash flow in 2020 (when defining capital expenditures as ‘capital purchases’ and ‘capitalized software development costs’) and its annual free cash flow averaged ~$0.7 billion from 2018-2020. Adding those free cash flows to Oracle’s financial performance should help improve the tech giant’s cash flow profile over the long haul.
Within the press release announcing the deal, Oracle noted that the Cerner acquisition is “accretive to Oracle’s earnings on a non-GAAP basis in the first full fiscal year after closing and will contribute substantially more to earnings in the second fiscal year and thereafter.” Furthermore, “Cerner will be a huge additional revenue growth engine for Oracle for years to come as Oracle expands Cerner’s business into many more countries throughout the world.” In our view, this deal is primarily about giving Oracle’s cloud computing offerings a foothold in the healthcare space.
Oracle noted how integrating its operations with Cerner’s would help healthcare providers cut down on the time spent on paperwork and similar activities while improving patient outcomes. Additionally, Oracle highlighted how many of Cerner’s operations already run on Oracle Database, which will make integrating Oracle’s various cloud computing applications with Cerner’s operations an easier task. In particularly, Oracle’s digital voice assistant offering was highlighted several times in the press release as representing an effective way healthcare providers will be able to streamline their operations when accessing the EHRs of relevant patients. Security remains a key focus as well, and Oracle intends to make sure EHRs are only being accessed by the appropriate parties.
Concluding Thoughts
Adding Cerner’s operations to Oracle’s portfolio should support the tech giant’s longer term growth trajectory. Pushing into the healthcare sector, which was equal to almost 20% of US GDP in 2020 according to the Centers for Medicare & Medicaid Services (‘CMS’), will open up a massive growth opportunity for Oracle to capitalize on. Farther out, Oracle appears to see ample international upside on the healthcare IT services front as well.
However, we are somewhat worried that Oracle is stretching its balance sheet to make the deal happen. Shares of ORCL took a hit when news of the acquisition broke; however, shares of Oracle are still up ~37% over the past year as of this writing. We continue to be huge fans of Oracle as its growth outlook continues to improve, though management will need to provide greater insight on the kinds of synergies the tie-up will unlock in the coming months. Oracle should remain committed to its dividend obligations going forward given its stellar free cash flow generating abilities.
For more information on our ESG Newsletter service, please check out this link here. To read more about our thoughts on Oracle, please check out our article covering the company’s latest earnings update (article link here).
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Callum Turcan does not own shares in any of the securities mentioned above. Apple Inc (AAPL), Cisco Systems Inc (CSCO) and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Alphabet Inc (GOOG) Class C shares, Meta Platforms Inc (FB), Korn Ferry (KFY), PayPal Holdings Inc (PYPL) and Visa Inc (V) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) and Qualcomm Inc (QCOM) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Meta Platforms, Oracle Corporation, and Taiwan Semiconductor Manufacturing Company Limited (TSM) are all included in Valuentum’s simulated ESG Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.