Oracle is 'too optimistic on profitability of the cloud business' according to this analysis

Oracle’s shares haven’t recovered from its disappointing fourth quarter miss in June.

That’s historically Oracle’s biggest and most important quarter, when salespeople push to close deals to make their annual quotas.

And a new research note from Citi probably isn’t going to help that much. (Citi is neutral on Oracle, not bearish.)

Citi’s Walter Pritchard analysed Oracle’s all-important new cloud business and decided, “We think management is too optimistic on profitability of the cloud business.”

Investors were scared off by Oracle’s last earnings report because revenues from new software licenses, Oracle’s bread-and-butter business, were down 10%.

Management explained that the company is going through the same sales transition as all the other big enterprise software companies. It is shifting to selling cloud services on a subscription model instead of selling one-time software licenses plus multi-year maintenance contracts.

Oracle should make about three times more money from each cloud customer over the life of a contract, executive chairman Larry Ellison explained.

So Citi made some conservative assumptions and ran the numbers to see when we can expect Oracle to rake in more bucks from cloud than they do from licenses.

Upshot: It will take 8 to 10 years to hit a break-even point.

Citi compared the price Oracle charges for cloud services to the price it charges for software.

They assumed that Oracle salespeople discount software prices by about 30%. (No one in enterprise software pays full list prices. It’s a lot like buying a car.)

If there’s a bright side its this: Citi believes that Oracle’s cloud version of its star product, its database, will break even a lot faster, in 2 to 5 years.

But this all depends on how wildly Oracle is offering discounts on its cloud services to get customers to try them. Citi has heard that salespeople are giving away the first year free and sometimes the first two years.

Oracle declined comment.

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