Mergers and acquisitions have been one of the top corporate themes of the year in 2021. Companies that have done well in recent years have been taking advantage of struggling companies, new startups and record-low interest rates in order to make acquisitions that they hope will be value-accretive.
In most cases, these merger announcements have been followed by the stock price of the acquisition target rising to the acquisition price and the stock price of the acquiring company either booking modest gains or remaining flat.
However, there have been exceptions, and one of these exceptions has been software giant Oracle Corp.’s (ORCL, Financial) recently-announced plan to acquire electronic medical records company Cerner Corp. (CERN, Financial).
A difficult acquisition
On Friday, Oracle announced that it plans to acquire Cerner for $95 per share in cash, or approximately $28.3 billion in total equity value. The deal should close sometime in calendar 2022.
Oracle expects the deal to be immediately value accretive. It will be Oracle’s biggest acquisition ever, adding significant amounts of health data to its ever-growing cloud services business.
Oracle’s stock plunged 6% following the announcement, however. On Monday, the stock dropped another 5% to trade around $91.64, giving up the majority of its gains from earlier this month when it beat earnings estimates on both the top and bottom lines.
Meanwhile, Cerner is still trading around the $90.49 mark, which is well below the $95 acquisition price. It’s almost as if investors are betting that the deal will not be completed.
Analysts seem to be primarily concerned with two things about the Cerner acquisition. For one, the acquisition would be a heavy burden on Oracle’s already-strained balance sheet. The cash-debt ratio of 0.29 and the Piotroski F-Score of 3 out of 9 show a potentially unstable financial situation. It’s possible that the company could end up having to finance the deal at least partially with stock, even if it valiantly tries the all-cash route first.
The second concern analysts have regarding the acquisition is that Cerner could harm Oracle’s growth story in the eyes of investors, leading to the market attributing the stock a lower valuation multiple. Cerner’s three-year revenue per share growth rate is 5.4% and its three-year Ebitda per share growth rate is 6.5%. These numbers are significantly below Oracle’s equivalent rates of 13% and 14.4%, respectively.
The valuation is out of line
The main values of the Cerner acquisition likely have to do with the company’s health care data as well as a networking effect. However, those fearing a growth dilution may have a point. If the company’s year-over-year growth rates begin to decline after the acquisition, investors may lose enthusiasm for the stock.
That’s not a good sign, especially since it is accelerated growth that has caused Oracle’s valuation multiples to increase in recent years. The stock currently trades for a price-earnings ratio of 26.57, which is higher than its 10-year median price-earnings ratio of 18.
The GuruFocus Value chart tells a similar story. Based on the combination of past returns, historical valuations and analyst estimates of future earnings, the GF Value chart rates the stock as modestly overvalued.
Investors are losing faith
Oracle’s recent declines indicate that investors could be losing faith in its growth prospects. While the company should continue growing for many years to come, that growth might not match its current valuation multiples.
Additionally, Cerner trading below its acquisition price is a potential red flag. Anyone with faith that the deal will go through should theoretically be jumping on the easy money from the arbitrage opportunity. Normally, institutional investors close this gap long before retail investors even catch word of the acquisition.
There is another factor that is likely contributing to Oracle’s recent price declines. A broader market decline is ongoing as investors digest the spreading Omicron variant of Covid-19 as well as the U.S. Federal Reserve’s decision to hike interest rates next year. The S&P 500 was down 1% on Monday, with the majority of stocks in the index down 1% to 3% for the day.
All in all, while Oracle remains a leader in cloud services and will likely see many more years of growth, that growth could begin slowing down as more competitors enter the field and Oracle becomes a more mature company, focusing on slow and steady growth and shareholder returns over the speedy growth of the past. In light of this, value-focused investors who are interested in the stock may want to wait until the valuation falls more in line with historical averages.
