After surging earlier this year, shares of cloud computing giant Oracle (NYSE:ORCL) have fallen back by over 25 percent in the last month, bringing its trailing 12-month return to just 19.1 percent. While this selloff is the result of a combination of factors, one of the biggest drivers has been growing worry about Oracle taking on additional debt to fund CapEx on building new data centers. How risky is the debt Oracle is considering, and will Oracle go bust if it keeps adding new debts to its balance sheet?
Debt Fears Circle Oracle
Although Oracle itself hasn’t officially confirmed the reports, anonymous sources have told news outlets that the business is hoping to raise $38 billion through new debt sales. The debt would be used to buy GPUs in what is increasingly a high-demand market, as well as build new data centers throughout the US.
To get a sense of just what a massive change this level of debt could be for the business, we can turn to the balance sheet Oracle presented alongside its fiscal Q1 report in September. Non-current debt and notes payable totaled $82.2 billion at the end of the quarter, meaning that the $38 billion Oracle reportedly hopes to borrow would represent an increase of over 45 percent to long-term debt. Moreover, stockholders’ equity totaled $24.7 billion, meaning that the new debt load alone would represent more than 150 percent of current equity.
Though unconfirmed, there’s little doubt that the market is taking news of Oracle’s potential debt expansion very seriously. In addition to the stock selling off, the bond market has sharply sold off Oracle’s corporate debt, pushing yields substantially upward for existing 2032 and 2033 notes.
Will the CapEx Pay For Itself?
Though debt can be a useful tool for a business like Oracle that is trying to expand rapidly, investors are beginning to question whether Oracle’s projected growth numbers could be too optimistic. Oracle has said that it plans to reach $166 billion in annualized cloud revenue by 2030, nearly 10 times what it’s generating at the moment. It’s worth noting that Oracle does have $455 billion in remaining performance obligations, much of which is the result of a $300 billion deal with OpenAI announced earlier this year.
The problem with this is the concentration risk that Oracle faces from having so much of its backlog coming from a single massive customer. Though Oracle’s management has expressed confidence that OpenAI can pay the $60 billion per year it has committed to through the next five years, the AI startup is still losing about $5 billion annually.
As such, much of Oracle’s future revenue is predicated on OpenAI’s ability to keep growing successfully. While OpenAI is a private startup that doesn’t release detailed financial reports publicly, recent estimates have put its revenue for the first six months of this year at just $4.3 billion. Considering the scale of its obligations to Oracle and the fact that AI investors are increasingly concerned about OpenAI’s computing costs, this diminutive revenue could prove to be a red flag.
This could put Oracle in the uncomfortable position of borrowing heavily to build infrastructure that may be less valuable than it’s currently expected to be. In many cases, AI’s considerable promise has failed to translate to real productivity gains. Recently, this gap between potential and reality has caused the market to reconsider some of the ultra-high valuations placed on businesses with heavy exposure to AI.
Another concern that has been raised is the lifespan of the infrastructure Oracle and other AI majors are building. With GPUs evolving quickly, it’s possible that massive investments in data centers today could have a relatively short window in which to pay for themselves before becoming outdated. In Oracle’s case, the fact that heavy borrowing is being used to fund the construction of new data centers could amplify that risk, as the business may have to keep its CapEx high for quite some time to invest in fresh hardware and avoid falling behind technologically.
Could Valuation Be Another Problem?
Another worry for investors at the moment is likely to be Oracle’s lofty valuation. Even after a substantial retreat from the highs it reached earlier this year, ORCL is still trading at over 50x earnings and nearly 11x trailing 12-month revenues. The price-to-operating-cash-flow ratio is even higher, coming in above 85.
Even so, it’s worth keeping in mind that most analysts are still more or less bullish on Oracle. The consensus price target for ORCL shares is $344.04, representing an upside of over 54 percent from the last price of $222.85. Oracle also has 24 buy ratings, compared to just 11 hold ratings and two sell ratings.
Will Oracle Go Bust?
Although $38 billion in new debt probably doesn’t pose an existential threat to Oracle, it likely does change the risk picture around the business and the stock quite a bit. Oracle is trading at very high multiples on the promise of massive growth and a $300 billion contract from a startup that, while promising, still isn’t profitable. Given that the market is already starting to cool down a bit on AI, these dynamics could set Oracle’s stock up for further tough times ahead.
With that said, Oracle remains a large and successful business that is increasingly important in providing the cloud capacity needed by other large tech businesses. Unlike OpenAI, Oracle has also proven its ability to operate quite profitably. Oracle’s trailing 12-month net margin stands at 21.4 percent, paired with a more modest return on invested capital of 10.9 percent.
Right now, Oracle is likely a decent stock to hold, though its high valuation and the evolving set of risks around it may not make it as attractive to buy. While Oracle appears highly unlikely to put itself in a financial position that would lead to it going bust by taking on additional debt, the decision to expand its debt load by nearly half at a time when the market is already reconsidering AI’s long-term value could put ORCL in a bit of a precarious position.
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