AI Spending Boom: Oracle's Cloud Gamble & The Risks Ahead

The Global AI Spending Surge: An Overview

Global spending on artificial intelligence (AI) is estimated to reach $1.5 trillion this year, according to Gartner. This figure is projected to climb further, with total spending expected to hit $2 trillion in 2026. This growth is fueled by the immense opportunities presented by generative AI.

Oracle: A Key Player in the AI Cloud Computing Market

One company has built a massive $10 billion business from the demand for AI compute in just a few years and anticipates capturing a significant market share. Management projects this $10 billion in annual sales to grow to $144 billion within five years, supported by existing contracts.

The Enormous Opportunity Ahead

A number of companies are rapidly building out data centers, leasing space, and securing equipment to meet the demand from technology companies training and deploying large language models. Contracts from companies like OpenAI and Anthropic, both leading LLM developers, are worth tens of billions of dollars per year. The largest cloud computing platforms – those owned by Amazon, Microsoft, and Alphabet – are struggling to keep pace with the rising demand. As AI companies look to diversify their compute providers, Oracle has emerged as a strong alternative, providing robust networking capabilities and competitive pricing. However, Oracle Cloud Infrastructure (OCI) lacks the scale of the three market leaders. This hasn't stopped OpenAI from committing $300 billion to Oracle's cloud business over five years, starting in 2027. As a result, Oracle reported a significant increase in its backlog of remaining performance obligations, reaching $455 billion at the end of the company's first quarter, up from $137 billion at the end of the fourth quarter. Of that $455 billion, $300 billion is tied to OpenAI, with Oracle adding another $18 billion in contracts on top of that. Management anticipates securing additional contracts in the near future and expects OCI’s remaining performance obligations to exceed $500 billion by the end of the current quarter. If management can successfully grow OCI from $10 billion to $144 billion over the next five years, its cloud business will be similar in size to Alphabet's, based on current growth rates. Should Oracle achieve similar operating margins to the leading providers today (20% to 37%), it could significantly boost its earnings. While management highlights the existing backlog supporting its revenue outlook, it is crucial to consider the significant risks involved in investing in Oracle stock at this time.

The Future is Uncertain

Oracle burned $5.9 billion in cash over the past 12 months as it expanded OCI capacity. The company took on $27 billion in debt over the past year and now holds $111 billion in debt on its balance sheet. Oracle will need to take on more debt and burn more cash to build out the capacity required to meet the demand for its cloud computing business. To put things in perspective, Microsoft is committing $30 billion in capital expenditures for the current quarter and will likely maintain that pace throughout the year. Amazon anticipates spending over $100 billion in 2025, mostly on additional compute capacity. Alphabet updated its target spend to $85 billion for the year, as demand for its cloud infrastructure continues to outstrip supply. While these companies have significant backlogs, none are as large as Oracle's current backlog. Oracle plans to spend $35 billion this year, with OCI revenue of $18 billion. Meanwhile, its three biggest competitors are producing strong positive free cash flow due to their large, established cloud businesses and substantial businesses outside of cloud computing. Oracle's legacy software business does not generate sufficient cash to keep up with the demand for AI compute. Moreover, Oracle faces the risk of a long-term contract with OpenAI. OpenAI has committed to spending $300 billion on Oracle compute, starting in 2027. According to the company's CFO, OpenAI is bringing in only $13 billion in revenue this year.

Assessing the Risks

Oracle faces the risk of not being able to fulfill its obligations to OpenAI, or that the deal will not be as profitable as expected. Oracle must have offered very attractive pricing relative to its larger competitors to attract such a significant commitment. This could lead to a significantly worse margin profile compared to Amazon, Microsoft, and Alphabet. Nevertheless, shares of Oracle have skyrocketed, reaching a forward PE ratio of 45 based on estimates for fiscal 2026. This is significantly higher than its larger cloud competitors, making the stock a riskier investment. If Oracle can execute, build the necessary capacity, and OpenAI upholds its end of the deal, it could be a major winner over the next five years. However, the stocks of the other three cloud computing providers appear to be much better values with considerably less risk at present.