"There is a risk here that we might have two low BBB ratings for Oracle, maybe even by calendar year-end," Morgan Stanley credit analyst Lindsay Tyler said in a podcast on Friday.
"This has raised justifiable investor questions around fallen angel risk," she said, using a phrase for companies that fall from investment grade to junk.
"I think the fallen angel risk down to high yields is not immediate, but it is a medium-term risk just when you're considering execution and monetization."
Oracle has become a speed bump for the fevered AI sector, forcing investors to revalue the colossal spending and lofty growth promises that had driven outsized gains in the stock prices of chipmakers and AI businesses.
Its share price has halved since June to $129 and bonds 0#ORCLUSDABMK= have sold off, yanking yields up to the 7% to 8% range normally associated with debt below investment grade and compared to 2.5% to 3.5% for Alphabet and Amazon bonds.
“If you study Larry Ellison, you’ll see there’s a few times he’s bet the company," North Carolina State Treasurer Brad Briner, who chairs the state’s investment authority overseeing retirement funds for public employees, told Reuters.
"He’s been successful but it’s always uncomfortable for bond investors. We get the downside risks but don’t get as much upside."
Oracle has pointed to a staggering growth in remaining performance obligations (RPOs), a measure of future revenue, of $638 billion, as expected return on the capital it is deploying.
"Is this visionary or expensive? The big four (Alphabet, Amazon, Meta, Microsoft) entered this cycle with leverage below 1x and are aggressive but defensible. Oracle is not," Algebris Investment said in a note in June on market intelligence platform AlphaSense.
According to Moody's Ratings senior account analyst David Gonzales, leases reduce upfront capital investment but impede financial flexibility because the data centres are not owned, hence cannot be sold or pledged to support additional borrowing.
Alex Haissl, head of software & cloud equity research at Rothschild & Co Redburn, has a sell recommendation on the stock.
"What is challenging is that the market still assumes that these data centers come online on time, that they get the revenues, that they get the profits," said Haissl.
"We're much more cautious about the economics," he said, highlighting the ambitious projections Oracle has made for its high-margin cloud services.
S&P's Chang said the mismatch between data centre leases for 15 to 19 years and short-term customer deals up to five years is also an "absolutely key risk".
"You have to assume that multiple years out the AI demand is the same or hopefully better than today for this ecosystem to remain viable and for Oracle to meet their lease payments to data centre owners," he said.
Customer concentration is another risk, given almost half of the RPOs comprise contracts with AI firm OpenAI.
Colby Stilson, head of fixed income at Brown Advisory, is wary. "If our investment thesis is based on revenue yet to come, especially when it's revenue coming from companies that have a lot of risk associated with them or don't have positive free cash flow generation, that makes that investment even more tenuous," he said.
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