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Oracle’s Cloud Bill Is Finally Coming Due

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Oracle Corp.

ORCL -5.65%

forgot to read the manual about being a safe haven.

The 44-year-old enterprise software pioneer has been one of the hottest stocks in technology, with its shares up 27% for the year ahead of its fiscal fourth-quarter results late Tuesday. Some of that strength stems from the market’s rotation out of the sector’s more richly valued names. But many investors are also optimistic that Oracle’s long transition to becoming a cloud software business is finally starting to bear fruit.

Results for the quarter ended May 31 helped buttress that view. Revenue rose 7.5% year over year to $11.2 billion, beating Wall Street’s forecasts and showing the company’s best growth since 2012. That helped revenue rise nearly 4% for the full fiscal year, topping $40 billion for the first time. Chief Executive

Safra Catz

also told analysts during the company’s conference call that growth in the current fiscal year should exceed the rate seen the previous year; analysts had projected a slowdown for fiscal 2022.

Still, Oracle’s projection for the current quarter was on the low side of Wall Street forecasts. And the company also plans to lean into its recent cloud momentum by doubling its capital expenditures this year, to around $4 billion.

“We are confident that the increased return in the cloud business more than justifies this increased investment and our margins will expand over time,” said Ms. Catz on the company’s conference call Tuesday.

But Oracle’s stock was at its highest valuation in years at around 17 times forward earnings ahead of the results, and some analysts worried that the new spending means operating margins have peaked. Oracle’s share price fell about 6% Wednesday morning.

Cloud transitions can be expensive for companies that have their roots in the traditional software-licensing model. Building a competitive cloud service and wooing customers costs a lot up front that is made back over the course of subscription contracts.

Microsoft’s

operating margins fell to 30% for its fiscal years 2015-17 compared with 38% three years prior as the company made its own transition. They have since come back strong, reaching 40% for the trailing 12-month period ended March.

But Microsoft is also much larger, with a much stronger position in the cloud. The company’s Azure public cloud computing service is second only to Amazon’s AWS, and its Commercial Cloud segment—which wraps Azure in with other cloud services and applications like Office 360, Dynamics and LinkedIn—is now generating more than $60 billion in annual revenue and averaging year-on-year growth rates at well over 30% each quarter. Mark Moerdler of Bernstein estimates that Oracle has just 4% of the platform-as-a-service market, compared with Microsoft’s share of 26%.

Hence, Oracle has a lot of catching up to do. Even $4 billion a year in capital expenditures is unlikely to close that gap much. Microsoft, Amazon and Google spend many times that amount annually. And much of Oracle’s appeal to investors during its slow growth phase over the last decade rests on a strong free cash flow position that powers both aggressive stock buybacks and a decent dividend. Spending money to make money is a long established part of the cloud game, but it entails risks for investors who might have thought Oracle could grow while playing it safe.

Big tech firms are investing in data centers as they compete for the $214 billion cloud computing market. WSJ explains what cloud computing is, why big tech is betting big on future contracts. (Video from 12/2/19)

Write to Dan Gallagher at dan.gallagher@wsj.com

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