Oracle (ORCL 6.25%) is set to be a major beneficiary of the AI infrastructure boom. The company has accumulated a $638 billion backlog of business, which is equal to about eight years of revenue at the current annual run rate. In the most recent quarter alone, $67 billion in new AI infrastructure contracts were signed.
However, it's fair to say that many investors are a little skeptical, with the stock down by more than 55% from its 52-week high. There are two main unanswered questions that seem to be weighing on Oracle's stock price. First, can the companies committing to spend billions with Oracle actually meet these obligations? Second, can Oracle deliver on its backlog while balancing the need to raise capital to do so?
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Oracle's massive backlog
Oracle reported $638 billion in remaining performance obligations, or RPO, in its most recent quarterly report. RPO is Oracle's term for contracted future revenue, or backlog, and this figure is 363% higher than it was a year ago. For context, this is now larger than the backlog of much larger tech company Microsoft (MSFT +1.26%).
Now, over half of this is reportedly from OpenAI. The AI company behind ChatGPT has signed a contract worth more than $300 billion over a five-year period starting in 2027, according to multiple reports, which is by far the largest individual cloud deal ever signed. Other major customers contributing to the backlog include Meta Platforms (META 2.65%), SpaceX (SPCX 3.08%) through its xAI subsidiary, Nvidia (NVDA 2.43%), and other tech heavyweights.
NYSE: ORCL
Key Data Points
It's also important to clarify what "AI contracts" include. The primary product is OCI (Oracle Cloud Infrastructure) compute capacity, which essentially refers to rented data center capacity and GPUs. Most contracts are multi-year, and only about 12% of the backlog is expected to convert to revenue over the next year.
The unanswered questions investors need to consider
As mentioned, there are two big unanswered questions.
First, can Oracle's customers reasonably fulfill their contracted obligations, especially when it comes to OpenAI? So far, OpenAI hasn't had much trouble raising capital, but it is still a private, cash-burning company, and the $300 billion or so it has committed to spend with Oracle isn't its only large obligation. The AI company has committed to about $350 billion in spending with Broadcom (AVGO 4.97%), $250 billion with Microsoft (Azure), about $100 billion on Nvidia systems, as well as deals with AMD (AMD 5.59%), Amazon (AMZN 1.92%), and others. In all, OpenAI is estimated to have committed well over $1 trillion in hardware and cloud infrastructure spending.
With spending commitments like that, it's not surprising that the market is a little skeptical. In fact, it was reported last week that OpenAI plans to delay its IPO, and this was a big reason why Oracle's stock has had its worst week in many years.
The second question is how much Oracle will need to erode its financial condition to deliver on these orders. In the current fiscal year, Oracle's estimated $95 billion in capex will require it to raise $40 billion in new capital, pushing its long-term debt above $100 billion. Free cash flow turned negative in the company's most recent fiscal year for the first time in a while, and this is likely to be the case for the foreseeable future. Plus, Oracle's gross margins could come under pressure as infrastructure costs rise, and there's always the longer-term risk of AI disrupting the enterprise software industry.
Is Oracle stock a bargain or a trap?
Let's be clear. If Oracle can successfully deliver on its obligations and get a strong ROI on its capex, the company's stock could be an absolute bargain at the current level. And to be fair, the company has a long track record of solid execution.
At its current price, Oracle stock trades for just over 18 times forward earnings estimates. The last time Oracle had a price-to-sales ratio at its current level was in early 2024, largely before the AI infrastructure spending wave began. And this is for a company that not only has a massive backlog but is also growing its actual revenue at 21% year-over-year. It's also worth noting that Oracle's guidance for the current quarter calls for 28% revenue growth (at the midpoint), which would represent a significant acceleration.
In a nutshell, Oracle has some major risk factors, but the price is right, and the risk-reward dynamics look attractive at these levels. In fact, I recently opened a small position in Oracle, and plan to add more if the stock remains at or near these levels.
