Oracle's AI Debt Surge Fuels Credit Concerns Among Traders

Oracle's aggressive foray into the artificial intelligence (AI) market has turned into a focal point for investors and analysts, with its $300 billion deal with OpenAI sparking both optimism and caution. The cloud infrastructure company, long a secondary player in the cloud market, now finds itself competing with tech giants like Amazon and Microsoft for a slice of the AI computing power race according to analysts. However, its heavy reliance on OpenAI and massive debt-fueled infrastructure spending have begun to raise red flags.

Recent developments show Oracle is now the biggest non-financial issuer of investment-grade debt, having raised $18 billion in a September bond sale to fund its AI expansion according to CNBC.

The company's five-year credit default swaps, which offer bondholders insurance against default, have hit record highs, signaling growing concerns over its ability to meet future obligations. At the same time, Oracle shares have dropped nearly 36% from their September peak, erasing the gains made after it disclosed a huge backlog of AI-related contracts.

The company's debt-to-equity ratio has surged past 378%, significantly higher than its cloud competitors, which remain under 50%. Analysts are now questioning whether Oracle can maintain this pace of spending without facing a liquidity crunch. The financial strain is compounded by the fact that OpenAI, its largest client, is not yet profitable and is expected to burn billions in cash through 2029 according to Forbes.

Why the Standoff Happened

Oracle's transformation into a key player in the AI infrastructure market came in September when it revealed a $300 billion contract with OpenAI, effectively locking in a five-year agreement for cloud computing power. This deal, along with a surge in remaining performance obligations, initially drove a 36% stock rally. But the euphoria quickly faded as investors began to realize the financial and operational risks involved. Oracle's free cash flow has turned negative, a first since 1992, and its capital expenditures have jumped to $50 billion for the current fiscal year-up from $35 billion earlier according to Seeking Alpha.

Analysts warn that while the AI market is still in its early stages, Oracle's financial structure is unusually exposed. Moody's, S&P, and Fitch have all flagged Oracle's heavy debt load and its dependence on a handful of AI customers, including OpenAI and Elon Musk's xAI, which are themselves projected to burn through billions in the coming years.

Risks to the Outlook

The main concern for investors is the lack of transparency around how OpenAI plans to fund its ambitious spending. With Oracle expected to invest over $1 trillion in AI infrastructure by 2030, the question of who bears the risk if demand falls short is increasingly pressing according to Investing.com. Additionally, Oracle's lease commitments have surged by nearly 150% to $248 billion, a move that reflects both its confidence in the AI market and its financial strain. These long-term obligations could become a burden if the AI boom slows or if customer contracts are renegotiated.

Credit default swap prices have also spiked, reflecting investor nervousness. Oracle's five-year CDS now trade at 135 basis points, nearly four times the level of its cloud competitors. This suggests the market is pricing in a higher default probability, despite Oracle's current investment-grade rating. The company's debt load is expected to rise further, with Morgan Stanley estimating it could hit $290 billion in the next three years according to Morningstar.

What This Means for Investors

For now, Oracle remains optimistic. It has projected cloud infrastructure revenue to reach $166 billion by 2030 and claims it's securing new bookings beyond OpenAI. However, analysts remain skeptical. RBC's Rishi Jaluria noted that the challenge lies in converting the $523 billion in remaining performance obligations into actual revenue according to Barrons. Oracle is also trading at a 56% premium to its cloud peers on a price-to-earnings basis, a valuation that hinges on its ability to deliver sustained growth according to Barrons.

Despite the risks, some investors see value in Oracle's position. The company is now the cheapest cloud player on a forward P/E basis, and its aggressive AI investments may pay off if the market continues to expand. However, with credit ratings under pressure and debt rising, the road ahead is fraught with uncertainty. As Oracle's stock continues to fluctuate, the market is watching closely to see if its AI gamble will pay off or if it's building a bubble that could burst.