Oracle’s earnings report last week didn’t do much to soothe concerns about how the company will fund its artificial-intelligence investments. In fact, investor sentiment has taken a turn for the worse.
The company’s standing in the equity and credit markets has taken a hit. Shares of Oracle have dropped about 15% since Wednesday’s close, including a 2.7% drop in Monday trading. All the while, Oracle’s five-year credit-default swaps (CDS) —a key indicator of credit risk — have been surging.
While Oracle’s revelations about its pipeline of AI deals in the coming years continue to positively surprise investors, the company came up short with its revenue for the latest quarter while raising its capital-expenditure outlook. Investors worry Oracle will need to take on high levels of debt to fund its data-center buildout, which could deplete its cash.
The negative sentiment deepened at the end of last week due to rumors that the company had pushed back the completion dates to 2028 from 2027 for some of the data centers it is developing for OpenAI, according to a Bloomberg report. If delays were to occur, that could impede Oracle’s ability to convert its $300 billion contracted deal with OpenAI into revenue, further pressuring Oracle’s cash flows and margins.
Oracle rebutted claims of delays, saying in a statement that “all milestones remain on track.”
However, the spread on Oracle’s five-year CDS widened further on Friday to 147 basis points, up from under 60 basis points in September, according to LSEG. That means the cost of insurance on Oracle’s bonds has more than doubled. Friday’s closing level for the five-year CDS marked the highest level since the 2008-09 financial crisis, according to Bloomberg data.
In September, Oracle issued $18 billion in bonds, including a rare 40-year issuance, to fund its AI infrastructure expansion. On its earnings conference call, Oracle shared that the buildout would require less than the $100 billion some analysts have projected but didn’t share a specific time frame for its spending plans.
Oracle’s CDS spread has become a proxy for AI credit risk in general, as companies increasingly turn toward debt financing to fund their data centers. With less robust free cash flows and higher existing debt levels than the “Magnificent Seven” hyperscalers, Oracle has become a poster child for investor fears regarding the leveraging up of the AI trade.
Although analyst Dave Novosel of GimmeCredit is retaining his outperform rating on Oracle’s debt, he acknowledged in a Monday note that there is a “considerable amount of risk surrounding the future
revenue garnered from today’s capital spending.” He estimated that Oracle could have negative free cash flow of $21 billion by the end of the fiscal year in May.
However, Novosel is optimistic that Oracle can bring down its debt levels despite burning cash, estimating that its ratio of debt to earnings before interest, taxes, depreciation and amortization will fall from a multiple of 3.9 to 3.8 by the end of the fiscal year as the company grows revenues and administrative costs shrink to a smaller percentage of sales.
“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,” Novosel wrote. S&P Global’s downgrade trigger for Oracle’s credit rating, or the level of debt that would lead Oracle to lose its investment-grade status, is four times debt-to-Ebitda.
Citi analyst Tyler Radke wrote in a Sunday note that Oracle’s data-center buildout is designed with fungibility in mind, meaning that the infrastructure can be repurposed for different uses.
D.A. Davidson’s Gil Luria doesn’t appear to share that optimism. In Oracle’s 10-Q filing last Friday, the company reported that it had $248 billion of previously undisclosed lease commitments for data centers and cloud commitments for terms of 15 to 19 years. These additional long-term obligations are another sign that Oracle will be “significantly strapped for capital” and could have difficulty maintaining its investment-grade credit rating, Luria wrote in a Friday note.
Citi’s Radke was less concerned about the spike in lease commitments, interpreting it as a “direct result of Oracle proactively securing all essential energy and building resources” to fulfill its AI commitments.
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