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Sun Won't Shine on Oracle

The software company's big acquisition of 2010 will soon be a big drag on the stock.
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Oracle (ORCL) completed its acquisition of Sun Microsystems in January 2010 and in the last 15 months the stock has moved up about 16%. But longer term, I think this acquisition will be a drag on Oracle and the stock will lag the S&P 500 for years.

After Oracle acquired the hardware maker there were high fives all around. The Street loved the deal and management hyped up the importance of having a captive hardware company. With Sun, Oracle will be able to close lots of more lucrative software deals because the combined company sells the whole package -- so the talk went. Everything is engineered to work together. The Street loves the deal because Oracle will be able to entrench itself into a customer's business even further. To oust Oracle, you have to get rid of the hardware and the software. No small task.

Today, Sun accounts for about 20% of revenue. But if the hardware business were so fantastic, wouldn't Sun still be on its own as an independent company? An independent hardware company like Hewlett-Packard (HPQ) hasn't done anyone any favors lately. All of a sudden, everyone wants to be IBM (IBM), entrenched hardware and software with services on top.

It's been a bumpy road for Oracle. If you remember back to Q2, the company posted results that were well below Street expectations as market share losses, currency headwinds, weak margins and potential sales pushed out into Q3.  When Oracle reports Q3 (fiscal 2012) on March 20, all eyes will be on margins and market share. In FY11, margins narrowed to 44% from 46% because of the impact of the Sun acquisition, higher R&D spending and greater variable compensation expense with rising sales.

With 32% of sales from Europe, investors will also have to worry about a possible recession there and more competition from German software company SAP, which has recently been taking share from Oracle.

Most analysts have a non-GAAP earnings-per-share-estimate in the $2.35 range with something around $2.60 for FY13. Net of $3 a share in cash and trading at its historical midpoint, Oracle is worth about $32 (only 2 or so points away). To me, Oracle is a show-me stock. It remains to be seen if Sun was a worthy acquisition or if it turns out to be a giant management distraction.

At the time of publication, the author had no positions in any of the securities mentioned.