Financial Statement Analysis - Oracle Systems Corporation - Case Study Example

Financial Statement Analysis Customer Insert His/Her Name Customer Insert Grades Course Customer Insert Tutors Name April 17, 2012. The Company Founded in 1979, Oracle Systems Corporation operates in Application Software industry. Its main objective is to industrialize an inventive Database as well as Middleware Software comprising of softwares like Database Management, Content Management, Application Server, Data Integration, and Development Tools among others. Its products are categorized into various lines of business; applications, tools, databases, middleware, Server and Storage Systems which are portable across personal computers and all main computing platforms Oracle, 2012). They also offer services like consulting, financing, premier support, cloud services, training and customer support (Bruner and Micaelian, 2008: Finance.yahoo.com, 2012). Under leadership of Ellison, the co-founder, the firm’s sales from the year 1980 to 1989 were not less than double the amount of previous sales. In year 1990 the firm made $971 million as sales, during this period it was the fastest developing software firm internationally and dominant in its area of specialty (Bruner and Micaelian, 2008). Currently, the firm sales have been increasing year after year from $23,252 million in 2009 to $35,622 million in 2011 (Finance.yahoo.com, 2012). In 1985 to 1990 the firm was aggressive and used four main business strategies. (1) Aggressive sale of its products; the firm distributed products through sales force, which allowed it to have close administrations and control over the sales force. Sales force representatives were allocated ambitious goals every three months. (2) Maintaining product and technology leadership; technology leadership brought benefits to the firm as they started to use SQL2 Language, which was later adopted by IBM. (3) Diversification; the firm expanded to other fields like system integration, and consulting services and as its products expanded these services also expanded. (4) Expanding globally through subsidiaries and exclusive distributions to more nations (Bruner and Micaelian, 2008). Currently, the firm has achieved its strategy of cloud computing, IT simplification, storage strategies and business analytics (Oracle, 2012). These strategies have enabled the firm to increase sales in year 2011 and they will enable it to have sustainable profits in the future. The firm’s Return on Equity (ROE) will only revert back to cost of capital if Oracle holds more cash. This holding affects ROE since the denominator will take in cash balance while the numerator will take in income earned from such cash. Because cash normally generates around riskless rates, ROE will thus drop as a result of cash presence. The industry The industry has grown at a very high rate with many software developers coming up. This has been brought about by increasing production of the personal computers as well as competition amongst the hardware vendors. However, software vendors have become important players in computing sector. Customers normally buy hardware based on availability of software, which makes many hardware vendors integrate forward to software development, thus reducing costs of productions. Competitors in this industry include; hardware vendors who integrated forward DEC and IBM, and database vendors like Oracle, Infomix, Ingres, and Gupta Technologies among others Finance.yahoo.com, 2012). Oracle’s direct competitors include Microsoft Corporation, IBM and SAP AG (Bruner and Micaelian, 2008). Accounting On March 20, 1990, the firm presented quarterly earnings basically unchanged from similar quarter previous year. The firm attributed zero growth earnings to disallowable by the auditors of around $15 million in the sales. The firm sold many software contracts on trial basis raising questions on when revenue should be recognized. The auditors judged that a number of such sales would for no reason be realized. The action triggered rumours on decreasing product quality, rising accounts receivable and sales representatives exiting the firm. As a result, the firm’s stock price fell by 31% from $28.38 per share. The firm’s R&D costs are debited in the income statement and matched to revenue of that particular period as was the case in late 1980s and 1990s. However, these costs create economic assets which are reported in balance sheet as non-current assets, thus R&D of this type should be reported as assets in the balance sheet. Financial Analysis Liquidity Oracle’s liquidity as measured by current ratio and quick ratio show an increase in liquidity position from 1989 to 1990, 2010 to 2011 and a decrease from 2009 to 2010. The quick ratio decline as compared to current ratio decline from 2009 to 2010 shows that the firm held significant amount of current assets in stock while the increase in both ratios show that the firm held more current assets than current liabilities. This situation implies that Oracle was able to meet short-term obligations on time as the current liabilities are subsequently and sufficiently covered by current assets. In the year ended 2011 the firm was over performing in terms of liquidity compared with its direct competitors, Microsoft and IBM, this implies the Oracle held greater amount of current assets compared to these competitors. However, in 2010 and 2009 the firm underperformed compared with Microsoft meaning that it held more current liabilities than Microsoft as shown by Table 1 and 2. Table 1: Oracle’s ratios Financial Ratios     1990 1989 2011 2010 2009 Liquidity Current ratio 2.01 1.89 2.76 1.84 2.03 Quick ratio 1.83 1.75 2.74 1.82 2.03               Leverage Debt ratio 17.35% 13.59% 27.45% 29.90% 28.14% Debt/Equity 35.24% 27.13% 50.76% 59.77% 53.18% Times interest earned 19.33474 33.83881 18.58292 14.9443 16.57143               Efficiency Inventory turnover 4.17 5.21 29.89 44.51 _ Asset Turnover 1.23 1.27 0.48 0.44 0.49               Profitability Operating Profit margin 19.55% 21.07% 33.78% 33.79% 35.79% Return on Assets (ROA) 14.91% 17.77% 11.62% 9.96% 11.80% Return on Equity (ROE) 30.29% 35.47% 21.49% 19.92% 22.29% Net profit margin 12.12% 14.01% 23.99% 22.87% 24.05% Source: Bruner and Micaelian, 2008: Finance.yahoo.com, 2012. Leverage Oracle financial leverage as measured by debt ratio had increased from 13.59% in 1989 to 17.35% in 1990; this means that financial risk had increased because more debt was acquired by the firm. The leverage increased in 2010 by a margin of 1.76% to 29.90% and decreased in 2011 to 27.45%. Similar trend as debt ratio can be observed with the debt/equity ratio. With debt ratio and debt/equity being less than 50% and 100%, respectively, it means that the firm was not highly geared. The increase in leverage in 2010 and 1990 was as a result of acquisition of bank loan. Time interest earned is more than one, this imply that income earned by the firm was able to cover interest rate charges. Compared with competitors, Oracle was less geared than Microsoft and IBM as measured by debt ratio, implying that it held less debt compared with competitors. In addition, Oracle was more geared than Microsoft as measured by debt/equity, which implies that Oracle had more debt with respect to its equity than Microsoft in all three years and less geared than IBM. Table 2: Direct Competitors Competitors     Microsoft Corporation IBM     2011 2010 2009 2011 2010 2009 Liquidity Current ratio 2.6 2.13 1.82 1.21 1.19 1.36 Quick ratio 2.35 1.9 1.58 0.98 0.98 1.13                 Leverage Debt ratio 1.9 1.86 1.97 5.78 4.92 4.82 Debt/Equity 0.21 0.11 0.09 1.14 0.95 0.97                 Efficiency Inventory turnover 14.75 17.01 14.28 22.5 21.79 20.01 Asset Turnover 0.72 0.76 0.78 0.93 0.9 0.88                 Profitability Operating Profit margin 38.80% 38.60% 34.80% 19.00% 18.20% 17.80% Return on Assets (ROA) 23.77% 22.88% 19.34% 13.79% 13.33% 12.29% Return on Equity (ROE) 44.84% 43.765 38.42% 73.43% 64.94% 74.37% Net profit 33.10% 30.02% 24.93% 14.83% 14.85% 14.02% Source: Morningstar.com, 2012. Efficiency Oracle’s inventories were turned into sales 4.17 and 5.21 times in 1990 and 1989 showing a decline in efficiency of converting stock into sales. It also means that the firm had more idle stock in 1990. In 2011 and 2010, the firm turned stock into sales 29.89 and 44.51 times showing a decline in efficiency of converting stock into sales. It also means that it held more idle stock in 2011. In 1990 and 1989 the firm generated $1.23 and $1.27 of sales, respectively, from every dollar invested in assets. In 2011, 2010 and 2009 the firm generated $0.48, $0.44 and $0.49 of sales, respectively, from every dollar invested in assets. Oracle performed better in terms of efficiency compared with its competitors as measured by inventory turnover. But in terms of asset turnover it under performed implying that Oracle’s sales was lower than competitors. Profitability Oracle’s profitability as measured by Operating Profit Margin, ROA, ROE and Net Profit Margin show a decrease in profitability position from 1989 to 1990, 2009 to 2010 and an increase in 2011. The decrease in profitability indicated that the firm was not able to control cost of production, financing costs and operating costs. While the increase indicated that the firm was able to control such costs. The drop in ROE ratio indicated decline in profitability and inability of the firm to generate returns to equity shareholders and vice versa. The drop in ROA indicated that the firm efficiency in generating returns had dropped and vice versa. Thus, compared to competitors the firm over performed in terms of operating profit margin compared with IBM and vice versa for Microsoft. Based on ROE and ROA the firm’s competitors performed better than Oracle. On average, Oracle had lower profitability than competitors. Forecasting According to analysts Oracle’s revenue will grow by 3.70% and 6.50% this year and next year, respectively and in the next five years Oracle will grow by 11.81% per year (Finance.yahoo.com, 2012). Assume the growth in revenue per year will be the average of the two revenue growth figures which is 5.10% [(5.10% =3.70% + 6.50%)/ 2]. Assume that the firm R&D expenses will increase by 10% per year, selling and administrative expenses will increase by 9.0% and other expenses will increase by 5% per annum, this increase will be as a result increase operations and competitions in the industry. Thus, Oracle needs to carry out more research and develop new software we will also assume that the firm will pay 5% of outstanding long-term debt as interest. The balance sheet will use percentage-of-sales method to forecast items in the balance sheet. Those items expected to vary with sales include accounts receivables, inventories, cash, accruals, creditors and non-current assets among others. Cash relationship with sales = Cash/sales x 100% Cash forecast = Cash relationship with sales x sales forecast Non-current liabilities do not have a direct relationship with sales, this applies to common stock as well as other shareholders’ equity thus they will be assumed to be constant. Valuation On April 13, 2012 the Oracle’s stock was selling at $28.50 per share, which was the market value of the firm’s stock according to the market. We are going to use Discounted Cash Flow Valuation analysis to determine the value of Oracle’s stock. Assuming that Oracle will exit from business in 2016, thus we have to determine expected cash flows for the next five years as well as terminal cash flows in year 2016. These calculations are shown on Table 5 and Table 6. Carrying out sensitivity analysis with different discounting rates we are able to determine the value of common stock. In case the firm’s cost of capital (discount rate) is 15% the value of the common stock will be $144,962 million or $28.66 per share. This implies that the stock is undervalued by the market based on April 13, 2012 share price of $28.50. Therefore, at this value the stock can be a good buy. On the other hand, if 20% and 25% discounting rates are used the stock value will be $79,424 Million and 59,316 Million, respectively. This means that the value of the stock will reduce if discount rate increases way beyond 15%. Also it means that the firm’s stock is overvalued by the market and at discount rate of 20% or 25%, the investor should consider selling the stock at the current market price. Because the share price of $28.50 will have to reduce to the stock intrinsic value of $15.70 or $11.73, respectively. In addition, if a discount rate of 12% is used the firm’s common stock value will be very high at $1,647,693 and the stock will have a value of $325.80. This means that the market has undervalued the stock at a price of $28.50 therefore investors should look forward to buy Oracle’s stock as the price will increase in the future. The difference between the market share price of $28.50 and equity values computed using different discounting rates is as result of method used in computing. For instance, market share price uses market forces of demand and supply to determine the price and it also incorporate investors’ reaction as a result of news or information in the market such as dividend payment, new product in the market among others. Equity value on the other hand, is fundamental in that it involves analysis of the firm’s future expectations as well as its financial statements to determine the value of the firm’s equity. Conclusion Using 15% discounting rate, the firm’s stock is undervalued by the market and the investor may consider it as a buy. This value was added by the firm’s management as the firm was profitable as a result of improved efficiency which led to more value addition to the shareholders. The firm is also liquid and not highly geared. Thus it is not exposed to liquidity and financial risks. References Bruner, R. F. and Micaelian, F. (2008). Oracle Systems Corporation. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=909101&http://papers.ssr n.com/sol3/papers.cfm?abstract_id=909101 Finance.yahoo.com. (2012). Oracle Corporation (ORCL): Income statement. Retrieved from http://finance.yahoo.com/q/is?s=ORCL+Income+Statement&annual Morningstar.com. (2012). Microsoft Corporation. Retrieved from http://financials.morningstar.com/ratios/r.html?t=MSFT®ion=USA&culture= en-us#tab- efficiency Oracle. (2012). Products and services. Retrieved from http://www.oracle.com/index.html Read More