By Vidya Ranganathan
LONDON, Aug 4 (Reuters) - Cloud computing giant Oracle Corp is on the cusp of a junk-grade credit rating and its shares have tanked as the artificial intelligence hyperscaler becomes
the fall guy of investors' concerns over the sector's debt-fuelled spending binge.
The U.S. multinational is an outlier among top software firms racing to buy chips and build computing power to leapfrog the AI boom, forced by its limited cash reserves to borrow heavily and undertake massive long-term leases.
The extent of the splurge came to light in June, when Oracle's results for the fiscal year ending in May 2026 showed its free cash flows were negative, the bulk of its revenue was spent on capital expenditure and it had signed roughly $260 billion of data centre leases, some starting next year.
The disclosures rattled investors and put Oracle squarely in the crosshairs of ratings agencies which have long warned about the company's heavily leveraged balance sheet.
S&P Global Ratings was the first to move, lowering Oracle's credit rating to BBB-, one notch above junk, in July.
As per Oracle's reported numbers, its debt of $129.5 billion was roughly 4.3 times EBITDA, or earnings before expenses such as interest payments, depreciation, taxes and amortisation.
A debt-EBITDA ratio above 4 signals financial strains, but the ratio can vary with methods and metrics each analyst uses.
Oracle's peers Alphabet Inc., Amazon, Microsoft Corp. and Meta Platforms Inc. have ratios under 1.
Oracle's massive lease commitments, which it does not yet have to count as debt but which analysts include in estimates, paint an even more worrying picture.
"While multiple other hyperscaler providers are building out AI infrastructure, none are as leveraged or cash flow negative as Oracle entering into this build phase," Moody's Ratings said in its February note explaining its negative outlook on a Baa2 rating, one tick above S&P's.
Despite the scale and profitability of its software business, "leverage will increase materially in the near term and could approach 5x temporarily," Moody's said.
The funding needs are so large, Oracle will need to issue more debt despite its ratings being severely constrained, while it also cuts back on share buybacks and raises equity capital too, analysts said.
Oracle expects capital expenditures of up to $95 billion in fiscal 2027, though it expects repayments from customers for up to $25 billion of that.
Oracle declined comment for this article. In earnings calls, it said it remains committed to disciplined capital allocation and preserving its investment-grade credit rating.
S&P analyst Andrew Chang projects Oracle's debt-EBITDA, which per his estimate was 3.6 in May, peaking at 4.4 in the coming two fiscal years, given negative cash flows and high expenses, but his base-case scenario is the ratio will not exceed the 4.5 mark that will trigger another downgrade.
"We could downgrade Oracle if Oracle sustains leverage exceeding 4.5 times," Chang said.
Fitch rates Oracle BBB, the same level as Moody's, and said in February a sustained EBITDA leverage ratio above 3.5, or above 4 if rents were included, would trigger negative ratings action.
FALLEN ANGEL
"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 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.
A LOT AT STAKE
Oracle's fiscal 2026 earnings report showed a robust record 17% revenue growth during the year.
A majority of analysts on LSEG still rate Oracle stock a buy. Funds such as T. Rowe Price and Neuberger Berman hold its bonds.
"While Oracle has the most strained balance sheet within the sector, we believe they are committed to investment-grade ratings and will manage their liabilities accordingly," said Neuberger's senior portfolio manager David Brown.
Yet, days before the S&P downgrade, Oracle's earnings report was explicit that changes to its credit rating "could negatively affect the value of both our debt and equity securities and increase the interest amounts" paid on outstanding or future debt.
A downgrade could also reduce access to or cost of short-term financing and affect the terms of long-term commitments including data centre leases, it said.
Indeed, funding for large-scale projects, such as the $14 billion debt issued by RD Michigan Property Owner data centre campus, and interest rates on another $10 billion revolving credit are explicitly linked to Oracle's rating.
In December, the Financial Times reported that Blue Owl Capital had backed out of funding a $10 billion Oracle data centre project intended to serve OpenAI due to concerns about Oracle’s spending commitments and rising debt levels. Blue Owl told Reuters the decision was unrelated to Oracle's debt.
Credit protection on Oracle, measured by 5-year credit default swaps, recently surged to an 18-year high of 215 basis points, signaling bond markets are pricing risk much higher than its current credit rating merits. CDS for peers trade around 80 bps.
(Additional reporting by Ross Kerber in New York; Editing by Alistair Bell)
