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Cloud Computing Rivalry Heats Up

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Arch rivals Oracle Inc. (ORCL - Free Report) and SAP AG (SAP - Free Report) are gearing up for another battle after the German company announced that it is on the verge of acquiring California-based cloud-computing software company SuccessFactors Inc. for $3.4 billion in cash.

SuccessFactors is a leading developer of software used by firms to evaluate employee performance. The acquisition is expected to provide SAP a much needed growth platform in the Software-as-a Service (SaaS) market, where it faces significant competition from Oracle. Analysts believe that the acquisition will boost SAP’s competitive position in human resource applications, while reaffirming its commitment to SaaS as a key business model.

However, we believe that Oracle is better positioned for growth compared to SAP, primarily owing to accretive acquisitions it has made over the past few years, which has evolved into a strong product pipeline. In October this year, Oracle acquired RightNow Technologies Inc, a premier Software-as-a-Service (SaaS) provider and a rival of SAP for $1.43 billion. For further details please see Oracle to Acquire RightNow.

The acquisition expanded Oracle's public cloud offering. The public cloud, which originally comprises existing products including fusion applications, expanded the company’s penetration into the SaaS application space. The addition of RightNow also helped Oracle to target Salesforce.com Inc.’s (CRM - Free Report) service cloud offering and took the prevailing competition between the two to the next level.

On the other hand, SAP has been a laggard in this space over the years. According to Bloomberg, Oracle has spent more than $42 billion on acquisitions since the beginning of 2005, while SAP had only made only two large acquisitions in its history before SuccessFactors. SAP lags Oracle in the SaaS market, owing to its late entry in the market and this will hurt its competitive position going forward, in our view.

SaaS Consolidations to continue… 

SaaS has gained immense importance in recent times due to the increasing adoption of cloud computing. According to research firm IDC, cloud services are moving from the early adopter stage to a core part of mainstream operations. IDC forecasts that approximately 80% of new software offerings will be available as cloud services by 2014 and over a third of software purchases would be through the cloud. Most importantly, public and private clouds are expected to drive 15% of IT spending, growing 4x to 5x the rate of the overall IT market.

According to research firm Forrester, cloud computing revenue is expected to increase from approximately $41.0 billion in 2011 to $241.0 billion in 2020, while another firm, Gartner projects revenue of $148.8 billion by 2014, higher than Forrester’s forecast of $118.7 billion for the same period.

SaaS, a software delivery method that enables data access from any device with an Internet connection and web browser, touched the $10 billion mark in 2010 and is expected to more than double to $21.3 billion by 2015, much faster than traditional software, according to market research firm Gartner. Customer Relationship Management (CRM - Free Report) continues to be the most prolific market for SaaS, with revenues estimated to reach $3.8 billion in 2011, up from $3.2 billion in 2010.

This huge growth potential has prompted companies such as Oracle and SAP, who were initially hesitant to enter the domain, to spend more on accretive acquisitions in order to gain traction in this market. Both Oracle and SAP paid huge premiums to acquire RightNow (22.0%) and SuccessFactors (54.0%), which clearly reflects the huge growth potential.

Beside Oracle and SAP, Salesforce.com also continued its acquisition spree in 2011, in a bid to diversify its traditional customer relationship management (CRM - Free Report) software. Salesforce has acquired Radian 6, Assistly, Manymoon, Heroku and Etacts in 2011. Most recently, the company announced the acquisition of Model Metrics, a mobile and social cloud consulting services company.

Our Take

We expect further consolidation in the SaaS market going forward. According to Gartner, Oracle will continue to acquire and roll out more cloud oriented products over the next couple of years, thereby boosting its position in the SaaS market. SAP is also expected to get more aggressive with its acquisition strategy in order to make up for its late start.

We believe that competition will continue to increase in cloud computing markets. Niche companies, which are easy to integrate within existing or new product lines will be the primary acquisition targets going forward, in our view. We also believe that companies with significant free cash flow will have an upper hand over the long term.

We remain Neutral on Oracle, SAP and Salesforce over the long term (6-12 months). Currently, Oracle has a Zacks #2 Rank, which implies a Buy rating on a short-term basis. Both SAP and Salesforce have a Zacks #3 Rank, which implies a Hold rating on a short-term basis.




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