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Oracle is dragging down other canaries

Oracle (ORCL ) released its fiscal third-quarter results last Wednesday matching analyst overall expectations but spooking people with lighter than expected new application software licenses. The next day its stock was down about 8%.

Canariesistock_000001785888xsmall With a jittery market, people are looking for any sign of a recession or a recovery depending on whether you are a bear or a bull. Analysts started downgrading other software stocks or decreasing price targets after the Oracle earnings announcement. Companies suffering guilt by association include: SAP ( SAP ), Informatica (INFA), Parametric (PMTC), (CRM), Tibco (TIBX) , Kenexa (KNXA), RightNow (RNOW), Taleo (TLEO), VMware (VMW), CA (CA) and Citrix (CTXS).

That’s a wide spectrum of software firms but the general feeling (bear case) is that a recession is going to reduce IT spending. There are two key considerations, besides your normal due diligence, when deciding to buy, hold or sell on a software stock.

First, how much of its software sales are generated from the financial services sector. Financial firms are generally significant IT systems buyer but are very much impacted by this economic climate. One may argue that any merger & acquisitions (M&A) activity creates IT sales opportunities but that will not make up for projects delayed or cancelled. Many of these firms will be struggling with new regulations, liquidity issues and adjusting to changing or disappearing revenue streams rather than implementing major software projects.

Second, software firms that are dependent on big-ticket projects for their sales may be impacted by IT/business groups delaying these purchases or even outright cancelling them for this year. Do not fool yourself into thinking that cool new software is too important to delay. Most everything can be delayed if business conditions warrant.

On the flip side, downturns may be the best time for companies to invest for the future. You cannot cut yourself into growing your business. Slashing costs may help your bottom line in the short-term but it rarely ever helps you increase sales or improve the customer experience. Some companies may follow this advice but many will just be stalling or slashing costs. It’s the deer in the middle of the road at night syndrome – too frightened with the oncoming car to just jump out of the way.

Mark Veverka in his Barron’s “Plugged In” column this weekend titled “Oracle: No Profit of Doom” states “A disappointing top line is never a good thing for a software company, but Oracle’s results weren’t a huge shock. They were more a function of the economy than anything amiss at the Redwood Shores, Calif., outfit. But investors didn’t see it that way… I’d suggest that investors pay more attention to Oracle’s earnings expansion going forward, rather than obsess about revenue growth in a sluggish economy.”

The shares of software companies are already down 13.1% YTD as reflected in the iShares S&P GSTI Software Index (IGV). The downturn may continue until people see a light at the end of the tunnel. Historically, the end of the summer has been an opportune time to buy software firms selling to corporate customers.

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