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Oracle rating cut on "controversy"

A Goldman Sachs analyst downgrades his stock recommendation for the database giant, citing several "controversies."

Citing several "controversies," a key analyst today downgraded his stock recommendation for database giant Oracle (ORCL), warning that the company faces few prospects for near-term improvement and may fall short of Wall Street's revenue expectations for the quarter.

Analyst Rick Sherlund of Goldman Sachs said the controversies involve previously stated concerns over slowing server sales; whether application sales may have slowed in the current quarter; fears that the Year 2000 bug will divert customers' resources away from server sales; and the looming threat that Microsoft (MSFT) will pose to the database company by 1999.

"On balance, we see less upside in Oracle's near-term fundamentals, exposing the stock to longer-term investor concerns," Sherlund said in an analysts' note. "Controversy is negative for tech stocks, and Oracle will need to weather its share of the controversies unless it can begin to perform more consistently on both the applications and the server business."

The company, which previously was listed as recommended for purchase by the investment firm, was lowered to "market performer." However, Sherlund's earnings estimates of 23 cents a share for the second quarter that ended November 30 and $1.10 for the year remain unchanged.

Oracle's stock fell after the downgrade was announced, down 1-7/16 to close at 31-7/8.

The company, which is scheduled to report its second-quarter results December 11, declined to comment because it is in its legally mandated "quiet period." Analysts expect it to report earnings of 23 cents for the quarter, according to First Call.

In his stock recommendation, Sherlund cited Oracle's server sales, which grew a weak 6 percent in the fiscal first quarter that ended August 31. Although the company's server sales may grow to 20 percent (as analysts expect) in the second quarter, it would nonetheless fall below levels of the past several years, according to Sherlund.

He also noted that Oracle's applications software business has averaged 78 percent growth over the past four quarters, but that appears to have dropped to around a 40 percent growth rate in the quarter. Sherlund said the results appear to have faltered, despite the important release of foreign language versions of the software during the quarter.

"We are becoming more frustrated that Oracle is having difficulties getting all parts of the story moving up together," the analyst added. "Each quarter over the past year, we have observed weakness in either the server or the applications business."

The Year 2000 bug may slow future growth for Oracle server sales. After 1998, Sherlund said it's likely that it will be too late to implement a new enterprise resource planning (ERP) system and have it up and running by the turn of the century.

ERP applications automate supply chain management; Oracle is looking to expand this market by offering applications specific to industries, such as oil and gas companies, utilities, and educational institutions.

Finally, Sherlund stated that Microsoft is offering aggressively priced server products "on top of its increasingly scalable Windows NT server operating system." He added that Oracle's competitors are also touting the use of Windows NT and SQL servers.

"We believe this issue is still a year or two away before there is much actual encroachment into Oracle's space as new versions are delivered from Microsoft, but this issue will require strong near-term fundamentals to offset investor apprehensions about the longer-term implications of this trend and pricing pressures that may result."

Other analysts, however, said the company is set to move forward. Joseph Farley with UBS Securities said Oracle is fairly well positioned and will be a predictable grower going forward with 25 to 30 percent year-over-year growth. Any negative reaction to the company's revenue growth is a "gap between perception and reality," he said.

"Applications growth will not smooth over the slowing growth from databases. The database business is mature; the applications business is healthy but not big enough to mitigate the slowdown in databases. It's a transitional thing," Farley added.

He predicted that the database market should grow in the teens and that the company's position in that area has never been stronger against competitors like Sybase (SYBS) and Informix (IFMX).

"There are legitimate alternatives with IBM and Microsoft, but for direct competition for databases, Oracle is alone...the de facto choice."

Melissa Eisenstat, an analyst with Oppenheimer & Company, said the Goldman Sachs report did not say anything that has not been known for some time.

"The database business is slowing and the applications business is growing and that is inevitable, given the relational database market is more mature," she noted. "It would be great if [databases] were growing faster, but the company's fundamentals are as good as they can be. Fundamentally, Oracle is a great company and they are killing the competition...They have positioned themselves as a complete enterprise software vendor, so they are not just dependent on databases alone."

Eisenstat added that many businesses want to deal with just one vendor, especially with big-ticket items. So by offering a variety of products and services, Oracle is positioning itself to get additional revenue from its existing customers.

As for the company's stock, she expects 25 percent growth in calendar 1998 with $1.19 earnings per share, giving it a realistic value of just about $30 a share. "The company is really well-positioned and healthy, but does it translate to upside in stock? No," Eisenstat said.