Oracle Inks 10-Year, $7 Billion Contract With DoD -- What Investors Need to Know
Key Points
Oracle won a defense contract worth up to $7 billion last month.
The contract will span up to 10 years, potentially growing Oracle's sales by up to 1%.
Profit margins should not be affected.
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It's not often investors take a look at a $7 billion contract and decide that's a reason to sell a stock or not buy it -- but that's kind of what happened to Oracle (NYSE: ORCL) last month. Oracle shares started July trading north of $140 per share, but by the end of the month, they were trading below $130.
In the meantime, in between time, on July 23, Oracle landed a Department of Defense contract potentially worth $7 billion.
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Oracle's big military contract
Not all at once, to be sure. As Oracle explained, its new contract under the U.S. Department of Defense Enterprise Software Initiative (ESI) will pay out $3.3 billion over the first five years, rising to $7 billion total if extended through a full 10 years.
Best case, that's only $700 million per year, and for a company that regularly does $67.3 billion in annual sales, that's barely a 1% increase. Still, it's an increase, not a decrease. You'd expect that to give Oracle stock at least some kind of lift.
Oracle explained that the purpose of the ESI contract is to enable military organizations and contractors to "expedite the procurement of Oracle commercial products and services" by providing a "centralized framework" for ordering Oracle software products. The contract will go into effect this summer, too -- so basically immediately -- and can therefore be expected to give an immediate lift to Oracle sales to the Defense Department and its contractors.
That's good news, not bad.
What it means for Oracle in dollars and cents
So, why aren't investors reacting more positively to the news? A couple of thoughts come to mind.
Expediting and centralizing orders may make it simpler for Oracle to sell software and artificial intelligence services to the military and its contractors. It doesn't necessarily mean that Oracle will be selling new or more software and services, though, than it ordinarily would. In other words, while it's possible that this $7 billion in sales represents incremental sales growth -- it's also possible that it doesn't.
That aspect of the contract is simply unclear.
At the same time, the fact that the military is buying $7 billion in software and services doesn't mean this is a bulk order giving the customer a volume discount -- potentially hurting Oracle's operating profit margin (which continues to rise, growing each year for the past three years and hitting 33.2% last year). To the contrary, Oracle noted in its announcement that "pricing, deliverables, and performance criteria" will continue to be "defined at the order level," just as in the past.
To me, this sounds like Oracle will continue to earn its rich profit margins on software and services sales to the military.
It's just that now, making those sales in the first place will be faster -- and easier.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Oracle. The Motley Fool has a disclosure policy.
