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We are maintaining our Neutral recommendation on Oracle Corp (ORCL - Analyst Report) after the company reported better-than-expected second quarter results, primarily driven by strong new software license sales and stringent cost control. However, the decline in hardware revenue continued for the company.

Going forward, lower hardware volumes remain a concern. As Oracle sells higher-margin products compared to its competitors, we anticipate that a sluggish market may act as a headwind for hardware volume.

Moreover, Oracle is a late entrant in the cloud computing space and thus is trying to gain traction in the segment through aggressive acquisitions. The company is paying a premium value for these assets in order to catch up with the dominant players like salesforce.com (CRM - Analyst Report) and International Business Machines Corp (IBM - Analyst Report). We believe that these acquisitions come with certain integration issues and may not perform as per company expectations, which will eventually hurt profitability going forward.

As of November 30, 2012, the company had an aggregate of $19.8 billion outstanding notes payable (including the current portion) compared with $14.8 billion as of May 1, 2012. The company currently has $1.25 billion due for repayment in fiscal 2013. Most recently, Oracle raised $5.0 billion in debt, which has further leveraged the balance sheet. 

Nonetheless, we believe Oracle’s innovative product pipeline is expected to drive market share in the emerging cloud computing, business intelligence and big data analytics segments.

Oracle enjoys a dominant position in the enterprise software and database management system market and higher spending on enterprise IT will positively impact the company. According to market research firm Gartner, worldwide enterprise IT spending is expected to increase 2.5% year over year to $2.68 trillion in 2013.

Moreover, increasing adoption of the company’s engineered systems (Exadata and Exalogic) will continue to drive market share going forward. Additionally, Oracle’s strong cash balance of $33.70 billion and free cash flow of $12.82 billion enable it to pursue strategic acquisitions, further share repurchase and increase dividend payment.

The company’s strong and relatively stable cash flow, continuing share repurchase activity and dividend payout appears sustainable and makes the stock quite attractive, in our view.

Currently, Oracle has a Zacks #2 Rank (Buy).

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