Oracle Is Getting Hammered Over AI Spending. It’s Time for a Second Look.

The cost of insuring Oracle debt against default has taken off. Above, Oracle headquarters in Redwood Shores, Calif. (Justin Sullivan/Getty Images)

Key Points

• Oracle plans to spend $50 billion on AI data-center projects this fiscal year, a 40% increase from the previous year.
• Oracle’s stock has fallen about 45% from its early October peak due to debt concerns and lower-than-expected growth forecasts.
• The cost to insure $10 million in Oracle debt for five years has surged to 144 basis points, a multiyear high.

Oracle stock fell to its lowest levels since early June, extending its late autumn slump, as investors continue to question the huge amounts of debt the cloud-computing company is taking on to fund its new artificial- intelligence strategy.

But some analyst are starting to hint that it could be time to reassess Oracle’s place in the AI investment boom. They suggest that recent moves in its stock and bond prices could be overdone.

The reasons for concern are clear. Oracle told investors last week that it plans to spend around $50 billion during the current fiscal year, which ends May 31, on its AI data-center projects. That is $15 billion more than Wall Street had forecast and a 40% increase from the previous fiscal year.

Co-CEO Clay Magouyrk further rattled investors’ nerves, declining to put a figure on the amount of money Oracle would need to cover the gap between what it can pay via its own revenue and what it plans to spend on AI.

“We’ve read quite a few that show an expectation of upward of $100 billion,” Magouyrk told analysts on a conference call. “We expect we will need less, if not substantially less, than that amount.”

Oracle’s overall debt stands north of $100 billion already, however, and reports suggest it is planning another debt sale worth $38 billion. It is also paying a cash dividend to shareholders. And when the company reported its fiscal second-quarter result last week, forecasts for growth in revenue and profit were lower than expected.

Those competing needs for cash, plus the prospect of slower-than-expected growth in earnings, are weighing on the stock, which has fallen about 45% from its early October peak. They also are hurting Oracle’s reputation in the bond market.

The cost to insure $10 million in Oracle debt for five years has surged to a multiyear high of around 144 basis points, meaning an investor would need to pay $14,400 annually to protect themselves against the risk of default.

A big portion of this concern is the expanding time gap between Oracle’s spending and when those outlays will generate revenue, via completed data-center projects and in the broader business.

“Oracle is entering into the heaviest phase of its AI infrastructure buildout, and [its third quarter forecasts] highlighted the timing mismatch of buildout spend to revenue conversion,” said Bank of America analyst Brad Sills. He has a Buy rating and a $300 price target on Oracle stock.

“We instead focus on the underlying fundamentals: AI demand continues to swell, large site builds are progressing on schedule, and [Oracle Cloud’s] fungible architecture enables the company to serve compute demand across diverse chip sets and contract types,” he said.

Oracle shares were 2.6% lower at about $185 on Monday afternoon.

Oracle has an impressive backlog of revenue-generating contracts, which it pegs at around $523 billion.

However, a large portion of that is tied to OpenAI. Investors fear that the company, the creator of ChatGPT, may have to delay some of the $1.4 trillion in spending commitments it has made to various parties unless it sees an enormous boost in revenue.

Gimme Credit analyst Dave Novosel thinks some of that concern could be misplaced.

“Management again emphasized that virtually all of the spending is going toward equipment for the data centers, as opposed to land, buildings, or power,” he said in a note published Monday. “Furthermore, that equipment is purchased very late in the data center production cycle. As a result, the gap between spending and revenue recognition is quite small.”

Novosel also expects Oracle’s operating margins will improve in the second half of its fiscal year, saying profits will be notably stronger because revenue is increasing at percentages in the high double digits. That will take the group’s overall leverage modestly lower relative to profit, even if Oracle adds $21 billion in debt in the next fiscal year.

“We acknowledge the considerable amount of risk surrounding the future revenue garnered from today’s capital spending,” he said. “But we think that even if revenue is materially less than expected, which could happen if the projected OpenAI revenue does not materialize as planned, leverage can remain flattish.”

Write to Martin Baccardax at martin.baccardax@barrons.com