By Adam Levine
Oracle's results may have come at the tail end of earnings season, but they were probably the most important read on tech investors' most pressing questions: Can software survive artificial intelligence, and will all of the massive spending ever pay off?
The latest numbers don't offer a ton of optimism. Oracle shares fell 8.5% on Thursday in the wake of the earnings report and continued to fall on Friday.
At its root, Oracle is a software company. The narrative around the sector has been negative since last fall. Customers, investors worry, will use AI to make their own bespoke software, as Palantir Technologies claimed it did during its last earnings call. Meanwhile, AI agents bring a threat to the software industry standard of user-based pricing. Agents are software that can use AI models to accomplish a complex series of tasks from simple conversational commands, replacing the people who are the basis of software revenue. Last week, Cloudflare CEO Matthew Prince revealed that machine traffic already outnumbers humans on the internet.
From its peak in September, the iShares Expanded Tech-Software Sector exchange-traded fund was down as much as 37%. It rallied in April and May, but it has already given back most of those gains in June. Microsoft stock just had its worst week since 2020.
Oracle has been on both sides of the AI trade, with investors debating its cloud-versus-software bona fides. Though the company's longstanding databases links them to AI data-software winners like Snowflake and Datadog, Oracle's software baggage may be weighing the whole company down. Both its legacy packaged software and cloud software segments underperformed Wall Street expectations -- which were modest to begin with -- and together sales rose only 2% from the year before.
The trading this past week within the software ETF revealed the bright line that has been drawn. Investors feel comfortable with a relatively small set of AI winners in data and cybersecurity applications. All of the other companies have to adapt to the new world, and prove to investors that their AI initiatives are working. It will ultimately come down to leadership for strategy and execution in this much larger group of software companies. Typically in these transitions, it's the companies that are most willing to disrupt current revenue sources in favor of new ones that come out on top.
It isn't just investors indicating their preference for infrastructure over software. Along with its earnings report, Adobe said its chief financial officer, Dan Durn, was leaving the company in June. He's taking the same role at Marvell Technology, whose chips are helping to power AI data centers.
The software ETF fell for its ninth consecutive session on Friday, down 0.4%.
Even the cloud isn't a haven anymore, as demonstrated with Oracle's report. There's new investor concern about Oracle Cloud Infrastructure, which rents out AI servers over the internet, and is better known as OCI. Fourth-quarter sales were up 93% from a year ago, once again the brightest spot on the company's report. OCI makes up a majority of Oracle's $638 billion multiyear backlog, which includes a $300 billion deal with OpenAI.
For Oracle's current fiscal year, which just began two weeks ago, OCI is likely to make up about 40% of companywide sales, according to the Wall Street consensus. That's up from 18% in fiscal-year 2025. If Oracle hits its target, OCI will be responsible for three-quarters of company revenue in 2030.
But this comes with a high cost and lingering execution risk. Like some peers, Oracle is reshaping its financials. To execute on OCI's growth, Oracle had to put its $32 billion in operating cash flow last year, plus another $24 billion, into capital expenditure. Capex is set to rise sharply again this year so that Oracle can fulfill its backlog commitments and meet its aggressive OCI targets. Analysts don't expect positive free cash flow until 2030.
Because it requires massive capex and the subsequent depreciation expenses -- which doubled in fiscal 2026 for Oracle -- AI cloud computing sales come with a lower gross profit margin than asset-light software does. That's already showing up in Oracle's financials. The company's gross margin declined from 77% in 2021 to 63% last year.
The margin story exemplifies the challenge for Oracle and other high-margin software companies. Even a successful transformation into an AI-first world might never drive software-like returns.
For now, the company is offsetting declining margins with operational efficiencies including widespread layoffs. But fewer employees and a more streamlined budget will just make executing on ambitious goals that much more difficult.
And then there's growing risk around whether all of the demand ever turns into revenue, given limited availability for land, buildings, and power for data centers. While Oracle's backlog grew $85 billion in the latest quarter, the company left its revenue targets unchanged.
Write to Adam Levine at adam.levine@barrons.com
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(END) Dow Jones Newswires
June 12, 2026 15:34 ET (19:34 GMT)
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