Deep dive analysis of Oracle’s AI opportunity

Oracle (NYSE:) is at a critical juncture as it navigates the evolving AI landscape. The company’s strategic positioning within the AI infrastructure market will significantly influence its future growth.

With a year-to-date performance outpacing many of its peers, Oracle’s stock is up 23%, driven by its strong positioning in the AI hardware space and the perceived scarcity of such resources, which has funneled business toward Oracle Cloud Infrastructure (OCI), said analysts at Morgan Stanley in a note dated Monday.

However, while the AI opportunity appears promising, analysts remain cautiously optimistic, maintaining an ‘equal-weight’ rating with a price target of $125.

Oracle’s management has guided for 50%+ year-over-year (YoY) growth in FY25 Cloud Infrastructure revenue, driven by the robust build-up of its Remaining Performance Obligation (RPO) in recent quarters.

This suggests that as infrastructure capacity becomes available, Oracle is poised to convert these obligations into significant revenue. However, the lack of transparency around the duration of RPO poses challenges in using this metric alone to forecast near- to medium-term revenue accurately.

“We estimate ~ $0.9B in FY24 AI Infrastructure revenues, which could approach $10B+ in FY27 driven by additional GPU generations and the recent OpenAI deal,” the analysts said.

This growth is expected to be fueled by the deployment of additional GPU generations and the recent OpenAI partnership.

However, analysts’ model incorporates prudent assumptions, including significant discounts for utilization and price concessions, given Oracle’s premium pricing compared to peers and the uncertainties surrounding utilization dynamics with newer GPU generations.

In addition to AI infrastructure, Oracle’s traditional infrastructure revenue is also expected to grow, albeit at a more measured pace. Analysts estimate that traditional infrastructure revenues could grow from approximately $5.5 billion in FY24 to around $10 billion by FY27.

This growth is anticipated to be driven by a mix of large customers such as TikTok and Uber (NYSE:), along with the broader installed base. However, the forward estimates reflect no significant growth from large logos, as potential usage growth could be offset by slowing TikTok usage and regulatory concerns.

A large portion of Oracle’s future AI infrastructure revenue could come from its partnership with OpenAI. Initial reports suggest that Oracle is building a ~100K GB200 cluster, which will be used for inference workloads by OpenAI.

Given the timing uncertainty and the nature of these workloads, analysts model a ~$0.2 billion revenue contribution in FY25, growing to nearly ~$3 billion by FY27. However, the potential for upside surprises exists, depending on how these factors play out.

Oracle’s capital expenditure (capex) estimates remain a key area of focus for analysts. The GPU investment implied by the revenue build suggests a related investment of approximately $45 billion between FY25-27, compared to analysts’ model reflecting around $91 billion in capex over the same period.

However, execution risks remain, particularly around the timing and availability of capacity, pricing sustainability, and the durability of Oracle’s cloud infrastructure revenue, which is heavily concentrated among a few large customers.

Risk-Reward analysis: Tepid growth limits upside

Analysts’ risk-reward analysis presents three scenarios for Oracle:

Bull Case ($180.00 price target): Increased OCI adoption accelerates cloud revenues, while the database cycle bolsters license revenues, driving EPS to $7.11 for CY25. Investors afford Oracle a ~25x multiple, reflecting ~15% EPS growth in CY25.

Base Case ($125.00 price target): Cloud services continue to see strong adoption, offsetting weakness in license revenue, driving organic revenue growth towards 10% in FY25. Operating margins expand modestly, with investors affording a ~19x multiple on CY25 EPS, based on ~11% EPS growth.

Bear Case ($95.00 price target): The adoption of cloud solutions fails to offset declining license revenues, leading to margin compression and slowing EPS growth. The forward EPS multiple is ~16x on CY25, with investors skeptical of the longer-term benefits of Oracle’s cloud transition.