It was pure euphoria in September when Oracle (ORCL +0.85%) reported a more than quadrupling of its backlog to an incredible $455 billion. A reported $300 billion cloud computing deal with OpenAI drove much of that increase. Shares of Oracle initially surged as investors focused on the projected revenue growth while ignoring some thorny questions about the Oracle-OpenAI partnership.
After a 23.1% drop in November, according to data provided by S&P Global Market Intelligence, Oracle's post-earnings gains have now been completely erased. Optimism has quickly faded, giving way to concerns about debt, OpenAI's ability to pay, and the potential bursting of the AI bubble.
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A debt-fueled bet on OpenAI
Oracle's balance sheet is already weighed down with debt, so it's no surprise that red flags are being waved as the company ramps up borrowing to build out massive AI data centers. Oracle sold $18 billion in debt a few months ago, and it's reportedly in talks to borrow another $38 billion in partnership with Vantage Data Centers to support its OpenAI contract.
The cost of five-year credit default swaps for Oracle's debt, which offers insurance against default, has surged in recent months to the highest level since 2008. Investors appear to be growing concerned about the wisdom of Oracle's massive debt splurge to support an AI start-up that is burning cash at an unprecedented rate.
On top of OpenAI's $300 billion deal with Oracle, the AI company has struck a deal for custom AI chips from Broadcom, signed a $38 billion cloud computing contract with Amazon Web Services, and agreed to purchase $250 billion of services from Microsoft Azure. These deals come despite the fact that OpenAI does not have the money to pay for them. The company will need to raise an incredible amount of capital over the next few years and increase its revenue dramatically.
The big risk for Oracle is that it builds data centers for OpenAI, taking on debt in the process, only for OpenAI to be unable to pay. OpenAI CEO Sam Altman has reportedly declared "code red" following a surge in competition, shifting resources away from critical revenue-expanding initiatives to improve the core ChatGPT product. Whatever lead OpenAI once had over its competitors is gone.
NYSE: ORCL
Key Data Points
Should you buy the dip on Oracle?
Oracle's debt-heavy bet on OpenAI could seriously derail the company if the worst-case scenario plays out. If the AI bubble pops, or even if it doesn't but OpenAI struggles to raise capital in a highly competitive environment, Oracle could be stuck holding a very expensive bag.
Oracle is taking on a lot of risks to participate in the AI infrastructure boom. If it all works out, the company's revenue will explode higher in the next five years. But with little room for error, investors would be wise to tread carefully as Oracle ties its fate to OpenAI.
