(Bloomberg) — Oracle Corp.’s ambitions to dominate the artificial intelligence buildout are running into a key hurdle: funding a spending spree without further damaging its credit standing.
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The tech giant is burning cash faster than it can generate revenue as it’s in the midst of a $250 billion data-center expansion. That’s led S&P Global Ratings to cut the company’s credit ratings to BBB-, just one step above junk status. Moody’s Ratings has a negative outlook, meaning another cut is possible over the medium term.
“They’re in a difficult spot,” said George Catrambone, head of fixed income at DWS Americas. As the credit cycle enters a later stage, “I think it gets increasingly more difficult for some of these companies to maintain ratings, but more importantly fund their expansion.”
The risk for Oracle is falling behind in a race it set out to conquer. Other AI hyperscalers, like Alphabet Inc. and Meta Platforms Inc., are on an opposite course, generating more than enough cash to fund investment. That gives them “greater financial flexibility to outspend Oracle and weather industry downturns,” according to S&P.
The ratings agency said it has continually underestimated how much Oracle would need to spend upfront for AI investments. That investment has led the company to burn through more than $20 billion over the last four quarters, after capital expenditure.
“Oracle wants to hang on to that investment-grade rating, and to do that, they’re going to have to show that they are not flooding the market with more supply,” said Andrew Wells, chief investment officer at SanJac Alpha. “They’re kind of on the ropes and they have to decide: Do they disappoint the bond investors or the equity investors?”
The market has been taking notice. Even prior to the S&P downgrade, Oracle’s bonds were trading closer to the yield curve of BB-rated credits than similarly-rated BBB debt. This week, Oracle bonds due in 10 years were yielding about 6.4%, slightly below 6.7% of 10-year BB paper, and at a meaningful premium to the 10-year BBB curve, which stood at 5.7%.
“This is the beginning of a pushback, there is a cost of capital, it’s not free,” said Catrambone, adding that hyperscaler spending so far has been aided by a favorable macro backdrop with credit spreads near multi-decade tights. “What if the Fed does come and winds up having to raise rates?”
Oracle’s capital expenditure is expected to be rising through at least fiscal 2029, research firm CreditSights has said. That’s not dissimilar from other so-called hyperscalers, including Google, Meta, Microsoft Corp., and Amazon.com Inc. Collectively, these firms plan to spend as much as $725 billion this year alone, primarily on AI data center equipment.
Their ability to generate cash, however, differs dramatically. In a sign of how cash-flow concerns can affect credit investors, bonds of rocket and AI conglomerate SpaceX have been trading poorly since their debut last month with the company expected to keep burning cash through 2030. At the opposite end of the spectrum, Google posted free cash flow of about $73 billion last year.
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Oracle, for its part, has been exploring novel ways to reduce its cash burn, including asking some customers to pre-pay for costly computing components that go into data centers. The company’s executives have vowed to maintain its credit standing.
“Oracle remains strongly committed to maintaining an investment-grade credit rating as our top capital allocation priority,”a spokesperson said in an emailed statement. “We remain confident in and focused on executing our business plan over the next months and years.”
Costly Options
The stakes are high. Oracle doesn’t only risk losing access to the much bigger high-grade debt pool. It also cannot afford to lose the trust of its corporate customers who provide the data that make up its database business. If it wants to avoid investing its way to junk status, it may have to issue more equity or cut back on capital expenditure or both. These options are costly and may not be enough to stem the bleed.
In its quarterly filing, Oracle said it expects its cash-funded capex to grow in the coming fiscal year. S&P estimated that the free cash flow deficit could widen to $42 billion in that period.
The company has amassed a large backlog of contracts that should generate future revenue but will be recognized over time. Meanwhile, the cash must be deployed upfront.
That timing mismatch is a key focus for investors. “It doesn’t affect revenue today, so it’s going to be hard for them to cash flow their way out of this,” said SanJac Alpha’s Wells.
The risk is also concentrated with roughly half of Oracle’s $638 billion of remaining performance obligations, a measure of contracted future revenue, tied to OpenAI, according to S&P estimates.
Oracle said last month it expects to raise about $40 billion through debt and equity this fiscal year, including a previously announced $20 billion at-the-market stock sale. It sold $25 billion of investment-grade bonds in February and has about $117 billion of debt in the Bloomberg US Corporate Bond Index, making it the second-largest non-financial issuer after Amazon.
“People are starting to ask questions on how much debt capacity do they really have, and the answer starts becoming that they need to show progress in terms of AI monetization,” Bloomberg Intelligence tech credit analyst Robert Schiffman said.
–With assistance from Brody Ford.
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