3 Ways Oracle’s OpenAI Deal Could Play Out. Only 1 Looks Good for the Stock.

Oracle and OpenAI are closely linked. The stock market isn’t loving it. (Kyle Grillot / Bloomberg)

Oracle shares are hovering near the lowest levels since early June, having shed nearly $400 billion in value since their all-time peak in September, as investors continue to question the cloud computing giant’s financial ties to ChatGPT creator OpenAI.

Oracle stunned markets when it unveiled a stronger-than-expected forecast for so-called Remaining Performance Obligations, or RPO, a key industry metric that often acts as a proxy for long term revenue projections.

That RPO forecast of $455 billion, however, was largely tied to a $300 billion commitment from OpenAI, which has found itself under increased scrutiny following a series of deals, investment agreements, and broader AI ambitions equal to around $1.4 trillion.

And that’s left Oracle shares as a proxy for AI investor skepticism.

Oracle is also borrowing heavily to build the cloud and computing infrastructure, which will be powered by Nvidia’s cutting-edge processors, in order to prepare for that OpenAI revenue. That’s likely to leave it cash flow negative for this year and next.

Bond investors are reacting in kind; the cost to insure $10 million in Oracle debt has surged to a multiyear high of around 119 basis points, meaning an investor would need to pay $11,900 each year for five years against the risk of default.

D.A. Davidson analyst Gil Luria says this move underscores the larger risk Oracle has assumed in relying on OpenAI for such a substantial portion of its longer term revenue.

“While we do not believe default is a likely outcome for Oracle, we believe that the increase in the cost to insure Oracle’s debt is an indication the market realizes Oracle has borrowed too much for a customer that may or may not materialize,” Luria said in a note published Tuesday.

That, he argues, leaves three likely scenarios for Oracle stock—only one of which is positive. The first scenario is that OpenAI achieves superintelligence and meets its $1.4 trillion in spending commitments. That would mean Oracle gets paid, and everyone walks away happy.

That’s the only positive scenario for Oracle, however. The worst-case would be if OpenAI fails, Luria said, forcing Oracle to “scale back the build out, write off some land and power contracts and start working down the debt.” It could still use the completed capacity in the open market, given the high levels of demand for AI compute, but the margin and profit assumptions would change for the worse.

Luria’s most-likely scenario is based on OpenAI “resetting expectations based on more reasonable assumptions next year” in terms of its spending and revenue. “At that point we believe Oracle would be behind Microsoft and Amazon but ahead of CoreWeave on the creditor list, which could help it salvage some of the backlog,” he said. “This would be detrimental, but is mostly reflected in the current share price.”

Oracle shares have fallen 1.8% to $196.60 in late morning trading, the lowest since June. Oracle and OpenAI didn’t immediately respond to requests for comment.

Is such bearishness warranted? HSBC’s Stephen Bersey, who heads the bank’s U.S. technology research, doesn’t think so. He believes the market has overreacted to Oracle’s OpenAI ties and will keep its investment-grade credit rating by using different funding options.

HSBC carries a buy rating on Oracle stock with a 12-month price target of $382, implying a 105% gain from current levels.

“Oracle has been studying the data center model for more than a decade as it meticulously planned to take share from established players like Amazon and Microsoft,” he added. “And Oracle has been impressively executing to plan and making tremendous gains against these incumbents.”

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