Analysis:Oracle Corp goes for high-stakes ratings gamble in AI strategy

Cloud computing behemoth Oracle Corporation finds itself on the precipice of a credit rating downgrade to junk status, as the artificial intelligence industry faces skepticism over excessive debt-driven expansion. The U.S. multinational is the lone software giant among its peers that is heavily investing in AI infrastructure, burdened with significant debt and a mounting debt-to-EBITDA ratio of 4.3.

Oracle has signed roughly $260 billion in data center leases, many of which commence in the coming year, a fact that has alarmed investors and rating agencies.

In June, Oracle disclosed negative free cash flows and substantial capital expenditures, totaling nearly $260 billion, which triggered alarm among investors. This disclosure led S&P Global Ratings to lower Oracle's credit rating to BBB- – one notch away from the junk category – in July. Oracle's debt of $129.5 billion is approximately 4.3 times its EBITDA, an indicator of financial strain.

Unlike its competitors, Alphabet, Amazon, Microsoft, and Meta, Oracle's leverage and cash flow situation are considerably more precarious.

Analysts anticipate that Oracle's capital expenditures may reach $95 billion in fiscal 2027, while anticipated customer repayments could be $25 billion of that figure. Despite its substantial software business, Moody's Ratings projects that Oracle's leverage will significantly increase in the near term, potentially reaching 5x temporarily. To finance these ventures, Oracle may need to issue additional debt and curtail share buybacks and equity capital raises.

Oracle's massive lease commitments, which are not yet classified as debt but are considered in estimates, exacerbate its financial strain. Moody's Ratings' February note highlighted that leverage could approach 5x temporarily, putting Oracle in a precarious position. The company's funding requirements are extensive, requiring further debt issuance despite its severely constrained credit ratings. Moreover, Oracle must cut back on share buybacks and raise equity capital to sustain its operations.

While Oracle remains committed to disciplined capital allocation and preserving its investment-grade credit rating, Moody's Ratings' senior account analyst David Gonzales cautions that a sustained EBITDA leverage ratio above 4.5, particularly if data center rents are included, could trigger another downgrade. Morgan Stanley's Lindsay Tyler warns of the risk of Oracle falling into the fallen angel category, transitioning from investment grade to junk status, albeit not immediately but rather in the medium term.