Oracle Did Everything Right. It’s Time to Take Profits.

Safra Catz, CEO of Oracle, has executed Microsoft’s cloud playbook to near perfection. (Will Oliver/EPA/Bloomberg)

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In February 2021, my Tech Trader predecessor, Eric Savitz, published a cover story about an up-and-coming cloud giant that was also a legacy software free-cash-flow machine: Oracle. It was founded in 1977 by its now-chairman and chief technology officer, Larry Ellison, who this past week became the richest man in the world.

“Oracle has been able to reinvent itself for the cloud-computing era,” Eric wrote, comparing the coming transformation to Microsoft’s remarkable comeback. “Once Wall Street begins to understand Oracle’s cloud transformation—and as that change gradually shows up in the numbers—the upside is considerable.”

Eric couldn’t have made a better call, and his timing was close to perfect. Since then Oracle has delivered a 437% gain in total return, which is a 45% annualized rate, compared with 14% annualized rates for both the S&P 500 index and the tech-heavy Nasdaq 100 index.

Oracle CEO Safra Catz has executed the Microsoft playbook to near perfection. Three years ago, Oracle began breaking out cloud services in its quarterly reporting, which surprised a lot of people. Cloud revenue was growing by 45% and already accounted for 31% of the company’s sales. In the latest quarter, it was up 28% and represented half of revenue.

But that actually understates what’s happening within Oracle’s cloud. The subset of the business known as Oracle Cloud Infrastructure, or OCI, is growing far faster—55% in the latest quarter. This is the business that rents cloud servers to clients and competes with Amazon Web Services, Microsoft Azure, and Google Cloud. It’s what Eric called Oracle’s “juiciest opportunity.”

With this week’s earnings report, the company said its backlog of signed contracts had risen to $455 billion, up $317 billion in just three months. Catz projected that $381 billion in sales over the next five years would come from renting cloud servers, an annual growth rate of 70%.

The backlog news sent Oracle stock soaring 36% to a record high.

For fiscal 2030, Catz expects $144 billion in cloud server sales. This past fiscal year, which ended in May, Oracle generated $57 billion in total revenue. Amazon.com’s AWS, which leads the industry, had $108 billion in sales last year. If Catz is right, Oracle will be even more transformed than Microsoft by the shift to the cloud.

Created with Highcharts 9.0.1Cloud GainsOracle has returned 437% since Barron’s cover story about the company in February​2021.Source: FactSet

Created with Highcharts 9.0.12022'25-1000100200300400500%Oracle Corp.NASDAQ 100 Index​(NASDAQ Calculation)

For several years now, I’ve thought that Oracle was underpriced. Wall Street’s mind-set around the company always centered on its legacy database software. It grew sales slowly, but it was also a cash-flow machine that allowed the company to halve its share count through stock buybacks from 2006 to 2023. In those years, Oracle’s forward price/earnings ratio averaged around 15, appropriate for a mature software company with a rapid cash return program. At the end of fiscal 2024, the forward P/E was 19.

In the minds of many growth investors, Oracle still looked like a boring value play.

But people finally started catching on, and, if they weren’t paying attention before this week, they are now. Oracle’s forward P/E reached 34 on Tuesday and skyrocketed to 46 on Wednesday.

Whenever a stock has a run like this, even the bulls need to step back and reconsider their investment.

In the case of Oracle, the company has set a very high bar—taking a segment that recently represented about a fifth of revenue and growing it by 1,300% over five years. That’s a rare kind of growth, in the realm of AI-leader Nvidia, which has grown its data center sales by over 3,400% in five years. For Oracle’s new stock price to make sense, it will have to approach Nvidia’s unprecedented success.

There are also questions about the quality of the backlog. On Wednesday, The Wall Street Journal reported that nearly all of Oracle’s backlog growth came from one customer, OpenAI, which signed a five-year $300 billion contract with Oracle that’s set to begin in 2027. Investors should ask themselves where that $300 billion is coming from.

Oracle declined to comment on the deal; OpenAI didn’t respond to my questions.

OpenAI is still burning through cash and relies on investors to fund its rapid growth. The company’s largest funding round to date was a $40 billion infusion, half of which is conditioned on OpenAI converting from a nonprofit to a public-benefit corporation by the end of the year. That switch is still waiting on approval from regulators in California and Delaware.

Even assuming OpenAI gets the entire $40 billion, it will have to raise a lot more money to meet its $300 billion commitment.

SoftBank is OpenAI’s largest investor, and if it wants to back this latest play it will need a mixture of other investors and more debt, which already stood at $137 billion in June, according to FactSet. The company has $41 billion in cash and short-term investments. Its recent Vision Fund 2 has struggled to find outside investors and its $72 billion in investments was recently valued by the company at $49 billion.

Oracle faces its own question: How will it build out the capacity to fulfill the OpenAI deal? Over the last 12 months, Oracle had $22 billion in operational cash flow. That was swallowed up by $27 billion in capital expenditures. In the past year, Oracle added $27 billion in debt, which is up to $112 billion. That debt is likely to grow much higher if the company is to meet its new commitments.

The bottom line is both sides of this deal face hundred-billion-dollar questions, and we don’t yet have the answers. For Oracle investors, the profits have piled up; it’s time to take some money off the table.

Write to Adam Levine at adam.levine@barrons.com