image Proposed stock symbol: SORE

Customer line: “I’m a SORE customer…”

Rejected names: Sunacle?  Too close to Unocal.  Orasun?  Sounds like a cloying dental product.  Orsun?  You could easily swap Ellison for Hearst in the remake of Citizen Kane…

Ok, so this isn’t a merger of equals.  It is the end of Sun.  Only Oracle survives.  But this deal surprised me.  I figured if Oracle wanted Sun, their well-oiled M&A machine would have swooped in a while ago rather than waiting for IBM to set things in motion, though there are rumors that Oracle made a joint bid with HP last year.  They certainly could have gotten a better price.  Did IBM get pulled in to play the second bidder?  The extra dime Oracle is sharing is not exactly the sign of a bidding war.

Quick thoughts:

  • MySQL – you’d never know Sun owned it from the Oracle press release.  Interesting market definition problem for the antitrust authorities evaluating this transaction.  With MySQL’s European heritage, maybe we’ll get some more novel legal theory from the EU.
  • Solaris – Oracle has been treating it as a legacy platform in recent years and it is hard to see Oracle being any more successful with Solaris vis-a-vis Linux than Sun. After all, Oracle’s Linux relationship is unbreakable…  But the acquisition means Solaris can reestablish itself as Oracle’s choice for high-end deployments.  Not clear whether Solaris remains a go-to platform beyond the database.
  • Sun’s Hardware Business – this definitely gets flipped to HP, Fujitsu, an Asian up-and-comer or someone else.  Sun doesn’t have the share and Oracle has too much invested with partners to go to the vertically integrated model (not even IBM can sustain the vertically integrated model and they invented it).  Oracle must already have a plan here (is there another shoe to drop with HP in the next few days?).  The hard part is how to minimize the atrophy during the long road to closing the deal.
  • SPARC – Oracle wants nothing to do with this.  Maybe Fujitsu will take it.
  • StorageTek – hope someone does the math on how much value got destroyed with this acquisition.  Sun bought this company just as disk became cheaper than tape.
  • OpenOffice – this deal could be a big boost for OpenOffice, as Oracle can’t resist an opportunity to tilt at Microsoft, especially with Microsoft driving more and more integration between the Office suite and the back-end applications that are Oracle’s bread and butter.  Oracle can provide OpenOffice a value proposition beyond price.
  • IBM – they got a good look at Sun, but in the end I suspect they’re going to regret not doing this deal.  They regretted giving Microsoft control of the software crown jewels for the PC; they may face similar situation now on the server.  Oracle can have a lot of fun making IBM choose between  open systems sanctimony and controlling their own destiny.  That of course assumes there is more relevant innovation to be had around Java.  IBM should have figured out how to get through regulatory approvals or how to cut the company up into piece parts to get what they wanted.
  • Integration Risk – this is a very different deal than the other big acquisitions Oracle has done. Sun customers are skittish as is and there is minimal maintenance gravy train here.  Whereas Sun offered IBM access to a bunch of net-new customers, I suspect Oracle is already in all of Sun’s accounts.  Serious layoffs ahead at Sun regardless of how it plays out for Oracle.
  • Consumer/Embedded Java – not exactly high on Oracle’s priority list.  Maybe it finally gets liberated in gesture of openness/misdirection by Oracle.  Maybe they can sell it to Google.  It fits nicely with the Android (lack of) business model.
  • Open Source – will be interesting to see if any of the projects Sun open-sourced get fork and/or critical mass.  Some argue Sun has already lost control of MySQL.
  • Timing – I need to go back and look at the sequence, but Oracle has been pretty good since their acquisition parade began at timing deals in such a way that they help their year-on-year comparisons.  Never forget Oracle is managed financially these days.  This might explain why they didn’t pull the trigger on Sun earlier.

What did I miss?

MySQL or My Bad?

I was wondering a few months ago how Sun’s MySQL acquisition would impact their relationship with Oracle:

How has the MySQL acquisition by Sun impacted the relationship with Sun’s biggest historical partner, Oracle?  I may be misjudging Oracle’s leadership, history and culture, but my guess is they view databases as their birthright and treat any real or proposed encroachment, even from a company with as poor an acquisitions record as Sun, as a serious matter.

The answer is becoming clearer:

  • Oracle has entered the hardware appliance business, partnering with HP
  • Sun’s stock is trading near a 13-year low
  • Sun’s CEO got a 44% pay raise

(Ok, the last one isn’t so clear).

The next question is what is the end game for Sun?  Do they circle the drain like Silicon Graphics (yes, they are still in business) or do they get consumed by the likes of Fujitsu or perhaps a rising dynamo from the developing world?  Leave your predictions as comments and maybe we’ll start a pool.

Oracle BEArs Down

With a $6.66 billion (numerologists take note) unsolicited, all-cash bid for BEA Systems, Oracle further cements their role as the new Computer Associates, i.e. the ecosystem scavenger.  BEA seems to have accepted they’re in the endgame, quibbling only about valuation and not their independence.  Quick thoughts:

  1. The acquisition suggests Oracle’s Fusion middleware may not be quite the juggernaut the company has claimed it to be.  Oracle seems to have dropped any pretense of rationalizing their acquisitions, and are content to milk the maintenance revenue, cross-sell whatever they can and make parallel albeit shallow R&D investments in each codebase.  But the side effect of maintaining all those silos is they are making the integration mess even worse.  Now that is a business opportunity for Oracle middleware, but customers are not going to appreciate the Oracle cross-sell requiring higher cost and integration complexity.
  2. Another big acquisition means more churn for Oracle’s financials, further postponing judgment day on the financial outcome of their acquisition binge.  No doubt this transaction will be timed like other deals to start adding to Oracle’s year-to-year comparisons just as other deals have contributed a full four quarters of apparent growth.  The question is about their organic growth.
  3. I doubt any other bidders emerge.  Speculation has centered on HP and SAP.  HP is plausibly interested but I don’t see them getting into a bidding war for the likes of BEA.  SAP still believes in architectural coherence so hard to see them getting into the fray.  Maybe there is another bidder with a similar financially-driven roll-up strategy to Oracle (e.g. Infor) or a private equity company trying to find something to do with all their cash.
  4. There are a couple key things to understand about BEA.  It derives most of its revenue from a very small number of customers (around 100) so they don’t provide any scale in terms of customers or technology.  The majority of their revenue is from consulting services, not software (shades of IBM’s acquisition strategy).  And the legacy Tuxedo business is stronger of late than the newer WebLogic and AquaLogic products.
  5. Given BEA hasn’t actually filed financials with the SEC for multiple quarters (due to stock option backdating), I am sure Oracle will insist upon some serious due diligence.

The Much Misunderstood Larry Ellison

samurai1 It is not often I rally to Larry Ellison’s defense.  In fact, it has never happened, unless you count that incident involving two underage interns, the failed MiG fighter acquisition and ten thousand cubic yards of Jello, but the legal settlement thereof bars further elaboration.

Larry recently made a statement which people are assuming is just a typical, cynical, self-serving, Machiavellian exercise in spin and depositioning as befits a disciple of Sun Tzu and Miyamoto Musashi (bonus points for the commenter who can connect the advice of either of those strategic gurus with dumpster diving).

But what if he actually spoke the truth?  Past performance admittedly might lead you to overlook such a possibility, but Larry’s comment came during Oracle’s quarterly earnings call with financial analysts last month.  It slipped out in the midst of the ritual competitive bashing, in this case of SAP’s new midmarket offering, that Oracle uses to distinguish its conference calls from those of other publicly traded companies:

“So while we think it’s an interesting market — the small market — because it’s large, we just haven’t figured out a way to make a substantial profit in that market. We think it’s hard to make money. Our strategy: add more value, go upstream, sell industry-specific software to our existing customers, and we’ll watch and see how SAP does going after small companies. Especially with in Software as a Service which we think is very interesting, but so far no one has figured out how to make any money at it.

Focus on the last line about the bottom line where Larry questions whether people can make money off of SaaS in the SMB market.  The SaaS euphoria has been driven largely as a technical imperative by enthusiastic new market entrants.  The SMB market has been held up as a green field that lets providers sidestep the myriad complexities of the enterprise.  And there is no doubt this is a vast and underserved market that would love to eliminate the hassles of deployment and operations.

But what about the profit opportunity?  Now Oracle is a company run by investment bankers these days, but it is a company that banks serious profits – over $4 billion last year with net margins approaching 25%.  When they look at business opportunities, they are looking for big profit pools.

Larry Dignan at ZDNet jumped in and channeled his namesake:

What Ellison could have said [is that] no one has found a way to make gobs of money in SaaS. is profitable but you could find the $481,000 the company made in its latest fiscal year in Ellison’s couch. Indeed, without maintenance fees SaaS may be less profitable in the long run.

However, Ellison can make these comments precisely because Oracle has its SaaS plan ready–it’s called NetSuite.

I think he was a lot closer with the first paragraph than the speculation in the second paragraph.  Larry does have a personal investment in NetSuite that is raising interesting questions as NetSuite tries to go public, but I believe that is irrelevant.  No matter how you look at it, a subscription-based SMB-focused SaaS model at scale looks like a tough business model.  NetSuite certainly has no solution to the financial challenges as we’ll see below.

Nick Carr also noticed Larry’s comment in a good piece on the shifting sands of enterprise software although he displays less than his usual level of certainty:

How will the competition play out? I wish I knew. There are at least two unknown variables: the speed with which the SaaS model penetrates larger companies, and the ultimate profitability of the SaaS model. There are some indications that the adoption of SaaS is advancing more quickly than expected, but there are also indications that the hype may at the moment be getting out ahead of the technology. As for profitability, about all we can say is that Ellison is probably right: SaaS is unlikely to be as lucrative as the old licensing model that it’s replacing – which happens to be very good news for customers.

Profitless prosperity may be great for customers, but at some point companies and their investors will have to find some profits or the activity will come to an end (unless you’re in the airline business).


That was a really verbose motivation to take a look at’s financials and make a prediction about their stock price direction.  As the SaaS poster child, they offer some interesting lessons in the search for potential profits from SMB SaaS.  My conclusion is that the poster child’s economics are not only not the shining beacon for the industry you’d expect but actually a disappointment.  Lets go to the numbers:

  • Revenue: $613 million over the last four quarters.  Up from $497 million for the last full fiscal year (we’re half way through the latest fiscal year), which in turn was up 60% on the prior year.  No doubt Salesforce has been a great revenue growth story.
  • Earnings: $8.17 million over the last four quarters, up from Dignan’s $481,000 in couch money for the last full fiscal year (but below 2006’s $28 million).  They’re not doing a great job turning that revenue growth into profits, and this is a company that has been around since 1999.
  • Interest income: $22.43 million in the last four quarters, which is nearly three times the company’s overall net profit in the same period.  Hmm…
  • Valuation: Salesforce has a market capitalization of over $6 billion as I write this and trades at a forward P/E of over 500.  That valuation is supported by less than a million dollars per month of profit and no profit if you take out interest income.  Wall Street has some mighty big expectations for future profits.

So where will those profits come from?  The problem is there is a giant sucking sound on the income statement that exerts massive drag on profits: sales and marketing which is a proxy for what it costs to acquire customers.  Bruce Richardson at AMR computed the numbers:

Over the last six quarters, has spent between 49.7% and 51.1% of revenue on sales and marketing.

NetSuite is no better  and could be worse, again from Bruce Richardson:

As NetSuite’s Zach Nelson pointed out in The Wall Street Journal (September 19, 2007), even with free trials, it tak
es two months and three to five product demonstrations to close a sale. He was quoted as saying, “It isn’t easy to figure out how to acquire customers and keep them happy at a low enough cost that you still earn healthy margins.”

A cursory review of NetSuite’s financials in their recent S-1 filing to go public shows they lost $23 million on $67 million in calendar 2006 and while they have a nice revenue hockey stick over the last three years, the profit line is borderline horizontal and well below the x-axis (i.e. in the red).  They also call out explicitly the challenges of SMB customer acquisition:

Our customers are small and medium-sized businesses, which can be challenging to cost-effectively reach, acquire and retain.
We market and sell our application suite to SMBs. To grow our revenue quickly, we must add new customers, sell additional services to existing customers and encourage existing customers to renew their subscriptions. However, selling to and retaining SMBs can be more difficult than selling to and retaining large enterprises because SMB customers:

• are more price sensitive;

• are more difficult to reach with broad marketing campaigns;

• have high churn rates in part because of the nature of their businesses;

• often lack the staffing to benefit fully from our application suite’s rich feature set; and

• often require higher sales, marketing and support expenditures by vendors that sell to them per revenue dollar generated for those vendors.

If we are unable to cost-effectively market and sell our service to our target customers, our ability to grow our revenue quickly and become profitable will be harmed.

The subscription model Salesforce, NetSuite and many other SaaS vendors use is extremely sensitive to the interplay between the cost to acquire a customer (which is an up front cost before you see any revenue), the average revenue per user (which dictates how long it takes to pay back the up front cost, never mind COGS and overhead) and the rate of churn (which tells you how many customers will stick around long enough to pay back the up front cost).  Small deltas in these numbers can make a big, big difference in terms of profitability.  Vonage is a great example of what happens when those numbers don’t add up harmoniously.  And these parameters are interdependent.  Raising prices likely increases churn, for example.

One argument to support Salesforce’s valuation is they are a young company that is investing for growth and just need to get to scale for their business model.  The difference however is they are not like the traditional software company trying to grow into a relatively high, relatively fixed R&D budget where above some threshold additional revenue falls largely to the bottom line.  Salesforce spends relatively little on R&D and their capex on infrastructure is surprisingly low.  The issue is their sales and marketing cost which seems to scale with revenue.

Looking at Salesforce’s future, they face a couple challenges.  Revenue growth will continue to slow.  It has been slowing for five years.  It is always harder to sustain your percentage growth on a bigger base.  And with minimal profit growth, revenue growth seems to be the proxy for the sky-high multiple, and assumes a big profit payoff is coming some time in the future.

They also will face intensifying competition.  Microsoft will soon offer a hosted version of Dynamics CRM, which has only been available as an on-premise offering to date.  The product offers native Office and Outlook integration, deep customization  and broad partner support.  SAP and Oracle are also peripherally in this market, although both have pricing above Salesforce and haven’t really been serious to date about the SMB CRM market.  There also are other startup competitors like NetSuite.  Competition can impact the key variables in a couple ways, all negatively:

  • Acquisition cost – it is likely to cost more, not less for Salesforce to win a customer in the face of more competition.  Today Salesforce spends over $700 to acquire a new user.  Competitors like a Microsoft or an Oracle may have a structural advantage in terms of acquisition costs because they are global players with an instantly recognizable brand who can spread their sales and marketing investments across both on-premise and SaaS deployment options for their software.
  • Average Revenue Per User – competition also tends to reduce prices.  Microsoft’s pricing of $39-59/user/month for the SaaS version out of the gate will undercut Salesforce’s approximately $71/month in average revenue per user. 
  • Churn – when customers have more choices, they’re more likely to go somewhere else.  Today Salesforce needs about ten months to pay off the initial acquisition cost of a subscriber.  When you add in COGS, R&D and corporate overhead, it is more like 18 months.  And unilateral competitive spite gestures on par with cutting off the nose to spite the face probably don’t help on the churn front either (see The Fat Guy‘s blog).

Small perturbations in these parameters can have a huge impact on the attractiveness of the model, and it is easy to see downward pressure on all of them.  It is hard to see how Salesforce can reduce their marketing spend as competition heats up unless they want to stop growing.  So what happens?

  • Salesforce will continue to pursue more “enterprise” customers and try to move up market.  Their average seat size per deal has almost doubled in the last five years and a very small number of customers (<100) may account for upwards of 40% of their seats.  The enterprise may prove a more cost effective marketing environment, but it also brings with it many more requirements and competition (in their favor, one of those competitors is Siebel, now owned by Oracle, who have the least satisfied customers I have ever seen).
  • Salesforce will continue to push their platform strategy.  It is a nice story, but it hasn’t contributed any discernable network effects to date that reduce acquisition costs.  But they seem to be doubling down that it might, suggesting a lack of other promising strategies.
  • You will see serious multiple compression for Salesforce (meaning their stock price goes down).  Baring some kind of miraculous breakthrough in terms of a more efficient marketing model for the SMB market, slowing revenue growth without any concurrent growth in profits is going to squeeze the stock.  Going from an insane forward P/E of 500 to an almost-as-insane 250 means the stock halves.  But the reality is when the sentiment flips, the compression is likely to be more extreme.  I think the stock hits the wall in the next 9 months (and the company likely will continue to see good revenue growth in that time).  The frenzy of insider selling suggest this possibility may not lost on management.
  • Salesforce will try to sell out and the challenge for Marc Benioff is the timing.  They simply can’t get to the scale needed to be a viable, standalone, long-term company on their current path with their current scope.  Most of the buyers probably understand that even with sustained revenue growth, in the absence of commensurate profits emerging, the company will likely get cheaper over time.  So who might be a buyer?  Some say Google but Salesforce’s inefficient, unautomated mark
    eting model is anathema to Google’s economic model.  My best guess, to bring this now way-too-long post for the three readers still with us full circle, is none other than Larry Ellison, who was perhaps being both truthful and crafty in his comments far above.  He once said of the old Computer Associates: “every ecosystem needs a scavenger”.  That idea evidently grew on him and he’s made it the strategy at Oracle, spending tens of billions to roll up business applications companies, where they can jack up and harvest maintenance revenues from relatively price-inelastic customers and cross-sell across the installed base.  It is a strategy fundamentally based on leveraging their sales and marketing model.  Buying Salesforce would give Oracle a more powerful CRM franchise than the legacy lineup they have today.  It would give them a stronger SaaS offering in addition to their on-premise offerings, although they would not have the advantages of a single code base for both deployment models unless they packaged up Salesforce to license to others to run.  They could continue to push Salesforce up into the enterprise market or use their existing marketing machine to at least sell into the mid-market.  And if the platform play starts to kick in, Salesforce does run on the Oracle database (unlike, ironically, some of Oracle’s other SaaS offerings…).  Obviously Benioff goes way back with Ellison, who had an early investment in Salesforce.  If Tom Siebel can be welcomed back to the Oracle mothership, so too can Marc Benioff.  Just a matter of the right price.

Disclaimer: I am not a financial analyst, don’t play one on TV but do think the above prediction is far more probable than some of the things that have surprised the best and brightest of the financial analysts of late.  I have no positions in CRM or ORCL.

(Image copyright The Cartoon Network)

A New Approach to Earnings Calls?

I find the things I’d most like to blog about I unfortunately really can’t blog about (you’ll have to wait for my book). So I have to take advantage of industry events in which I don’t have a stake. The Oracle-SAP super heavyweight bout falls into this category except it hasn’t really turned into a bout yet – that would require SAP to fight back

So far, it’s more like Oracle coldcocked SAP in their most recent earnings call and SAP is stumbling around in a daze. SAP announces later this week and we’ll see if they ignore Oracle in their earnings call or counterpunch. In case you missed it, Oracle announced earnings on September 19th and were very “on message” versus SAP, claiming their applications business was growing ten times as fast as SAP’s and SAP’s strategy was flawed in a myriad of ways (including apparently not having enough investment bankers).  They barely mentioned their own results except to compare them with SAP’s.  They’ve been hammering away on this theme since then. There are not many companies that would include a quote like this in their earnings’ release:

“SAP appears to be rethinking their strategy as they lose application market share to Oracle and confront the difficulties of moving their application software to a modern Service Oriented Architecture (SOA),” said CEO, Larry Ellison. “They’ve just announced that they are delaying the next version of SAP applications until 2010. That’s a full two years behind Oracle’s scheduled delivery of our SOA Fusion applications. And now Kagermann is talking about an acquisition strategy to augment SAP’s slowing organic growth. These are major changes in direction for SAP.”

This is entertaining in multiple respects:

1.) This kind of brazenness is awfully rare.  Textbook Oracle: declare yourself number two (or in this case spend tens of billions of dollars to be number two) and turn your guns on number one. To come up with anything comparable, I have to go back to the ad earlier this year claiming “Computer Associates Runs SAP”, also coincidently from Oracle.

2.) SAP botched their immediate response and therefore the news cycle. They issued a statement that failed to address the share and growth accusations (which we’ll get to with #4 below) but went after the more philosophical charges leveled by Oracle:

“Larry Ellison’s statements in today’s Oracle earnings press release about SAP’s product and acquisition strategy are a complete misrepresentation,” said Bill Wohl, vice president of product and solutions public relations, SAP. “Since January of 2003, SAP has consistently articulated and delivered on its vision for enterprise SOA following a course of organic growth combined with strategic acquisitions. SAP offers customers market-leading, enterprise SOA applications today while Oracle’s next-generation applications exist only in PowerPoint and won’t be delivered until 2008 or beyond. mySAP ERP 2005 gives customers and partners a world-class ERP platform with planned, regular functionality enhancements without the need for major upgrades through 2010, and has been shipping to customers since June of 2006. By contrast, Oracle’s statements about SAP and their own Fusion progress continue to be inconsistent and misleading. In January, Oracle claimed they were halfway to Fusion and two weeks ago they said they were not even halfway done — Oracle needs to adopt one version of the truth, and be honest with the market on its actual progress.”

Am not. Are too. Am not. Are too.

3.) They’re actually having a fight about who professes to like Service Oriented Architecture more: “No, we’re more SOA than they are…” The reality is neither of them come anywhere close to offering service-oriented applications today and if anything are slowing their march to SOA. Both have yielded to a distinct lack of customer interest in major new releases by pushing their big bang roadmaps further out and focusing on incremental releases. Oracle tells customers not to pay any attention to those Fusion apps and apparently plans to obfuscate the issue with their similarly named Fusion middleware. SAP begs its customers to upgrade to the latest version of SAP and in return they promise not force any more major upgrades any time soon. Given the costs, risks and unknown benefits of these major upgrades, the ERP space is now the paragon of a “good enough” market. But even more mystifying, neither of them really want to see a SOA world come to pass as liquefying all those business processes into individual services undermines their way of life and raison d’être (I apologize for my French).  Having to sell a bundle of services as opposed to the transactional monolith undermines their business models.  The world won’t unravel into an atomistic collection of best of breed services but customers will come at it the other way, chipping off important higher value functions in favor of best of breed solutions.  We’ve seen this inside Microsoft as the move to services has let us pull relatively more important/highly specialized functions like sales commission calculation or managing the Xbox 360 supply chain out of our big, monolithic enterprise applications.

4.) Finally, people are questioning Oracle’s actual growth and share claims.  You can see the influence of the investment bankers who run Oracle. They closed the Siebel acquisition exactly one year and one day after the PeopleSoft deal closed, which means Siebel revenues look to the casual observer like growth for a year. And they’ve reclassified some of Siebel revenue into their middleware line. Oracle’s quarter is a month offset from Siebel’s quarter so it is hard for analysts to do apples-to-apples comparisons. Most of the Wall Street analysts fell for all this and exulted in the apparent success of Oracle’s acquisition strategy, pushing Oracle’s stock is up two bucks.  But as people dig deeper, organic growth looks much lower (CRN, Smart Money, eWeek and Motley Fool all dig into the numbers), possibly even lower than SAP’s.

SAP probably won’t descend into the mud in their earnings call, but who knows, maybe they will follow Oracle’s lead and help liven up earnings calls in this drab, Sarbanes-Oxley world we live in.