Meaghan McGrath, analyst at TBR, says ERP of NetSuite helps Oracle pave the way to cloud dominance and Oracle’s aggressive growth objectives made acquisitions inevitable.
When Oracle founder, executive chairman and CTO Larry Ellison claimed during Oracle’s June 2016 earnings call that Oracle would beat Salesforce to $10 billion in annual SaaS and PaaS revenue, acquisition alarms went off at TBR. As we wrote at the time, “With Salesforce on track to draw $10.5 billion in that segment by CY18, TBR believes Oracle can only reach this milestone first with additional, large acquisitions, on top of its 3Q16‐closed Textura and Opower purchases, rather than finding an organic 113 percent CAGR over the coming two fiscal years.”
While Oracle’s proposed acquisition of NetSuite would add only $673 million in trailing 12‐month (July 1, 2015 to June 30, 2016) subscription revenue to Oracle’s $2.2 billion in trailing 12‐month (June 1, 2015 to May 31, 2016) SaaS and PaaS revenue, the larger revenue growth potential comes in the cross‐selling opportunities of Oracle’s broader portfolio of cloud software into NetSuite’s large SMB customer base, the ability to accelerate NetSuite adoption through Oracle’s large enterprise appeal distribution channel resources and other natural synergies across the businesses.
Deal Details
# On July 28, 2016, Oracle announced its intent to acquire NetSuite for approximately $9.3 billion, a 19 percent premium on NetSuite’s value at previous day’s market close
# Due to large ownership of NetSuite stock by Larry Ellison and his family, the deal is facing normal regulatory scrutiny and must be validated by the tendering of the majority of shares not owned by NetSuite executives or any person affiliated with the Ellison family
# The NetSuite acquisition is Oracle’s largest deal since it bought PeopleSoft for more than $10 billion iin 2004, and builds on cloud portfolio expansion efforts that permeated Oracle’s acquisition history for the past few years
NetSuite improves Oracle’s ERP position to help win the cloud applications war
Amid Oracle’s efforts to build out its cloud portfolio and become the leading cloud vendor, ERP has not been the focus for prior acquisitions. Instead, cloud acquisitions over the last two‐and‐a‐half years have predominantly centered on building out Oracle’s Marketing Cloud and Data Cloud capabilities. While those services differentiate Oracle from other cloud vendors and position it well in the marketing cloud space, Ellison said, “The leading applications vendor in the cloud this generation will also be whoever wins the ERP war.” Oracle has not been the one winning the cloud ERP war — Oracle foe SAP has. But together NetSuite and Oracle can threaten SAP’s position more aggressively.
Though these vendors have seen initial traction in the cloud applications space, the shift of ERP deployments to public cloud is slower overall than CRM and HR workloads because of the complexity of ERP implementations and demand for industry‐specific customizations. TBR’s 1H16 Public Cloud Customer Research indicates SAP’s and Oracle’s shares of adoption in the ERP space have declined marginally over the past year, in favor of NetSuite. Although SAP and Oracle have been migrating on‐premises customers to cloud, legacy perceptions around complexity plague these vendors and drive customers to look for easier, more agile options. NetSuite’s adoption spike among respondents signals a shift in which customers are starting to trust public cloud for even the most complex workloads; however, this shift will be slow overall with faster pockets in different industries.
From Table, it is evident legacy vendors Oracle and SAP are achieving faster cloud software revenue growth than cloud‐native vendors NetSuite and Salesforce; however, legacy vendors are currently generating notably lower gross margins as they continue to invest to facilitate early stage growth. Oracle’s experience integrating large acquisitions will lend to the successful integration of NetSuite’s technology and go‐to‐market efforts, and will help Oracle approach the cloud SaaS and PaaS revenue and gross margin levels of peer SAP, while enabling accelerated growth as Oracle aims to challenge Salesforce for its position atop the market.
Oracle’s acquisition of NetSuite will immediately increase Oracle’s revenue and customer base incrementally, but simultaneously brings those customers who had strategically chosen a smaller, nimbler NetSuite as their business applications vendor into the mammoth ecosystem that is Oracle. There is potential for this merger to immediately alienate NetSuite customers who want to avoid navigating larger‐scale vendors such as Oracle. Moving forward, customers will have to weigh the potential drawbacks of doing business with a large legacy vendor such as Oracle with the increased vertical expertise and breadth of business solutions Oracle’s portfolio offers over the narrower portfolios of still‐autonomous and smaller cloud‐native vendors such as Salesforce and Workday.
Similar roots and strategic synergies indicate a natural blend of businesses
NetSuite got its start in 1998 as one of the first cloud companies with the help of a personal investment from then‐ Oracle CEO Larry Ellison. Despite growing questions of a conflict of interest between his own Oracle software business and NetSuite, Ellison remained a majority investor in NetSuite’s 2007 IPO and thereafter. Amid this, NetSuite hired Oracle’s former vice president of marketing, Zach Nelson, as CEO in 2002. These common roots lend to similar corporate cultures, and bring into question Larry Ellison’s intentions and potential 20‐year forethought upon original investment and continued support.
The strategic alignment between Oracle and NetSuite to run customers’ entire businesses makes this acquisition a logical purchase for the emerging cloud giant. While NetSuite’s expertise and revenue majority come from its ERP suite, the company’s broader goal is to be the software running behind an entire business, not just one function; aligning well with Oracle’s goals of being the one‐stop shop for businesses. This notion holds especially true in the SMB and midmarket spaces, where NetSuite has seen success, as customers look for integrated cloud solutions to easily deploy and scale with their growing and changing business needs. NetSuite will support Oracle’s down‐ market push with expertise in public cloud applications and the SMB space, while Oracle’s large enterprise and vertical expertise will expand NetSuite’s addressable customer base. Recent NetSuite efforts to build up its e‐ commerce offerings and tailor solutions to specific verticals will blend with Oracle CX Cloud solutions and find support from Oracle’s Global Business Units’ industry expertise, respectively.
As NetSuite challenged SAP in the SMB and midmarket cloud ERP space, the largest advantage SAP had was its complementary on‐premises capabilities (whereas NetSuite only offered public cloud), and its broader and more comprehensive distribution channel. Though NetSuite had begun scratching the surface of meaningful international partnerships that would begin to fill this void, its acquisition by Oracle immediately gives it access to more than 25,000 worldwide partners.
Overall, Oracle’s pending acquisition of NetSuite is a logical merger of two businesses that have similar aspirations to be the single software provider running a customer’s entire business. NetSuite’s current subscriptions will add to Oracle’s revenue base as Oracle aims to accelerate cloud growth to reach over $10 billion in annual SaaS and PaaS revenues. Further, NetSuite’s install base of primarily SMB and midsize customers will provide cross‐sell opportunities for Oracle’s expansive cloud suite, and NetSuite’s solutions will see greater growth potential through Oracle’s industry‐oriented businesses and global distribution routes. NetSuite’s competitive cloud ERP solution will also improve Oracle’s competitiveness as it challenges Salesforce, SAP and others for cloud applications dominance.
Meaghan McGrath, analyst at TBR
