Oracle's $300 billion investment in OpenAI backfires.

Oracle (ORCL) has encountered a significant setback after its stock dropped over 40% from its peak in September, wiping out more than $360 billion in market value. On Thursday alone, the company's market cap plunged by $67 billion, following its second-quarter earnings report. Investors remain concerned that Oracle's heavy reliance on OpenAI (OPAI.PVT) could be detrimental to its financial health.

Earlier this year, Oracle's first-quarter projections, fueled by AI-driven growth, sent its stock to new highs, briefly elevating founder Larry Ellison to the title of the world's wealthiest individual. At that time, Oracle reported an extraordinary rise in its remaining performance obligations (RPO)a measure of future revenue from signed customer contractssurging 360% to reach $455 billion. A major portion of that figure, at least $300 billion, came from OpenAI's Stargate project. However, since then, Oracles stock has been on a downward trajectory.

Concerns surrounding OpenAI's rising costs have only intensified. The company's financial commitments, including deals with Nvidia (NVDA), CoreWeave (CRWV), AMD (AMD), Broadcom (AVGO), and Oracle, could push its expenses to a staggering $1.4 trillion. Adding to the uncertainty is the growing competition from Googles (GOOG) Gemini AI models, making investors even more cautious about Oracle's future prospects.

"The markets perception of OpenAI has shifted dramatically in recent months," noted BNB Paribas analyst Stefan Slowinski. "Clearly, the OpenAI ecosystem is facing significant challenges." Both Slowinski and other Wall Street experts share the view that Oracle's biggest risk lies in OpenAIs potential inability to cover the massive costs associated with its AI infrastructure.

OpenAIs CEO, Sam Altman, recently declared a "code red" as the company faces intensified competition from Google, which could threaten OpenAI's ability to generate revenue and meet its ambitious financial goals.

Analyst Gil Luria from DA Davidson highlighted the difficulty Oracle faces, noting that the company must expand its data center capacity to support OpenAI, all while dealing with substantial uncertainty over whether OpenAI will be able to fulfill its financial obligations. "Oracle is in a tough spot, having to invest heavily in infrastructure for a customer whose ability to pay is unclear," Luria explained.

Oracle's second-quarter earnings report only deepened investor concerns. Capital expenditures for the quarter amounted to $12 billion, exceeding expectations, while free cash flow loss hit $10 billionfar higher than the anticipated $6 billion. Additionally, Oracle raised its full-year capital expenditure forecast to $50 billion, up from a previous estimate of $35 billion.

Despite these issues, Oracle executives attempted to reassure investors about the company's financial situation. New co-CEO Clay Magouyrk claimed that Oracle has over 700 AI customers and that its infrastructure could quickly be repurposed to serve other clients if OpenAIs demand falters. "If OpenAI were unable to meet its financial commitments, we can swiftly redirect the infrastructure to other customers," said TD Cowen analyst Derrick Wood.

Furthermore, Oracle emphasized that it will not need more than $100 billion to complete its data center projects and reaffirmed its commitment to maintaining an investment-grade credit rating. Despite these reassurances, investors remain wary, especially considering the companys BBB bond rating, which is just one notch above junk status.

While Oracles RPO grew by $68 billion during the latest quarter, fueled by new commitments from clients like Nvidia and Meta (META), the broader sentiment in the market remains negative. As analyst Slowinski observed, the market is currently doubtful about the returns on investments in AI and is skeptical about the large capital expenditures Oracle has made.

Sources:

• Oracle made a $300 billion bet on OpenAI. It's paying the price.