Shares of Oracle Corporation (NYSE:ORCL) have experienced a significant decline, plummeting as much as 37% from their record high reached in September. Investor sentiment has soured due to concerns over the company’s ambitious, debt-financed venture into the artificial intelligence (AI) infrastructure domain, leading to increased caution in bond and credit-default-swap (CDS) markets.
In simple terms, a CDS serves as a form of insurance against a company’s potential bankruptcy; a spike in its price indicates growing investor anxiety. Following reports that Oracle plans to accrue approximately $38 billion in debt to support its cloud and AI initiatives, the market reacted negatively, resulting in lower bond prices and rising yields. This situation has raised alarms among investors, marking a shift in the outlook for a traditionally stable investment-grade issuer.
Traders have intensified their hedging activities through 5-year CDS contracts, reflecting rising concerns related to credit risk amid the escalating competition in AI infrastructure investments across the tech sector. Analysts on Wall Street are particularly apprehensive that the significant borrowing required for these AI expansions may strain Oracle’s cash flows, resulting in delayed returns and increased credit risk, even for established companies in the industry. A recent survey of fund managers revealed that over half believe AI spending poses the top risk to the market. Nonetheless, some experts hold a less pessimistic view.
Brad Sills, a research analyst at Bank of America, highlighted that Oracle is structuring its AI compute contracts to ensure stable cash flows, utilizing non-cancelable, non-modifiable, take-or-pay agreements. This strategic move indicates a clear commitment to safeguarding financial stability amid its transition.
Oracle’s shift towards AI-related services marks a substantial pivot from its historical strengths in enterprise software and database management. The company is now focusing on expanding its data centers and cloud infrastructure designed explicitly for AI workloads, which will be funded through the issuance of new debt. Sills notes that Oracle’s entry into the AI compute market positions it as a “fourth hyperscaler,” aligning its growth with major industry players by increasing capital expenditures and GPU density.
The total addressable market (TAM) for AI infrastructure is anticipated to reach $200 billion in annual spending by 2028, with a projected compound annual growth rate (CAGR) of 42% over five years. Despite the challenges posed by rising borrowings, some bond buyers have adjusted their terms or demanded higher yields, leading to a cautious atmosphere among equity investors. The increased credit spreads and bond yields have added layers of complexity, contributing to uncertainties regarding execution risks and the timing of returns on AI investments.
Market observers are now monitoring Oracle’s performance in the credit market as a potential indicator of the financial health of the broader AI infrastructure sector. Although Oracle maintains its investment-grade status and its default risk remains low compared to its peers, the caution reflected in both its debt and derivatives markets is an unusual situation for a company of its caliber.
Despite current challenges, Oracle’s commitment to its AI transition and the significant market opportunities that lie ahead may still pave the way for future growth, highlighting the resilience and adaptability of the company in a rapidly changing technology landscape.