Why Oracle’s Acquisition of NetSuite is Surprising

Oracle is one of the biggest technology companies in the world. Founded by the famous Silicon Valley icon Larry Ellison, Oracle is a formidable presence in the enterprise technology sector and is valued at $170 billion by the market.

It has built its software empire through numerous acquisitions. Since 2004, Oracle has spent more than $45 billion buying up other IT companies, which is almost double the amount that IBM has spent since 2001. With the said $45 billion of capital in its armoury, Oracle has snapped up almost 100 companies over the last decade. M&A specialists at this firm are no novice.

Given this context, it should not be a surprise that Oracle has made another acquisition. Just two weeks ago, Oracle announced that it has entered into a definitive agreement to acquire NetSuite, a software-as-a-service (“SaaS”) company well known for its business operations and customer relationship cloud offerings. This acquisition, however, is surprising for a number of reasons.

Software companies are often valued on revenue (Enterprise Value-to-Sales ratio) instead of earnings because their income stream is recurring: customers need to use the software every year to operate their businesses.

While companies like Apple have to sell something every year to make money, software companies can still make money from customers who continue to use the software even if it stops spending money to improve its products.

In Oracle’s purchase of NetSuite, then, what is surprising is the purchase price of $9.1 billion that valued NetSuite at 9x Revenue (not 9x Net Income). Despite the special valuation method used for software companies, 9x Revenue is still an extremely high valuation.

Not only that, Oracle is known to be a savvy acquirer that never overpays for its acquisitions. The table below lists the company’s biggest purchases in the last decade and the respective purchase prices.

On average, Oracle paid 5.4x its targets’ revenue. The only other times that Oracle paid around 9x was for companies that were 10-20% of the size of NetSuite. The fact that Oracle’s biggest acquisition ever also is its most expensive one is definitely noteworthy, if not shocking.

This could mean two things. The first possibility is that NetSuite was just an extremely good company that will be tremendously valuable for Oracle. For instance, NetSuite may have had a phenomenal product that just was not getting enough customer attention due to limited scale of the company’s salesforce. In this case, Oracle’s world-class salesforce could greatly enhance NetSuite’s business by cross-selling NetSuite’s products along with Oracle’s massive product portfolio.

The second possibility, however, is more negative. Cloud software businesses are highly disruptive to the traditional software model. Traditionally, vendors like Oracle relied on elongated and complicated installation & maintenance processes that locked in customers (it was extremely difficult and painful to switch your software provider) and allowed vendors to extract payment to their hearts’ content.

However, SaaS companies entered the scene and offered products that were superbly easy to use and manage. Suddenly, traditional vendors were put under an immense pressure because customers found an easier and cheaper alternative to their products.

In this context, that Oracle’s biggest acquisition ever was uncharacteristically expensive is quite intriguing. In fact, the purchase may not have just been a defensive move, but a do-or-die manoeuvre to protect its dominance over enterprise tech market.

As always, we welcome any comments and discussions on the topic in the comment section below.

*Views expressed here represent those of the author’s alone. This article is not a recommendation to take any type of action in the stock market. ValuePenguin does not have a position in any of the stocks mentioned in the article.