Oracle's stock price experienced a significant drop on Tuesday following a media report detailing slim profit margins in its rapidly growing artificial intelligence cloud business. The report, citing internal company documents, raised questions about the profitability of Oracle's strategy centered on renting servers equipped with high-demand Nvidia chips.
The disclosure has introduced a new variable for investors who had previously rewarded Oracle for its aggressive expansion into AI infrastructure, a move that has substantially increased the company's contracted revenue backlog over the past year.
Key Takeaways
- Oracle's stock fell nearly 4% after a report revealed low profit margins on its AI cloud services using Nvidia chips.
- The company's gross profit margin for this segment was reported to be around 14%, compared to approximately 70% for its other business lines.
- The report analyzed data from the August-ended quarter, showing about $125 million in gross profit from $900 million in revenue for the Nvidia-based server rentals.
- Despite the sell-off, some Wall Street analysts defended the company, suggesting margins will improve as the business scales.
Report Triggers Investor Sell-Off
Shares of the enterprise software company turned lower late Tuesday morning after a report from The Information brought the profitability of its AI cloud operations into focus. According to the publication, which cited internal financial documents, Oracle's business of renting out servers with Nvidia GPUs is operating on much thinner margins than the rest of the company.
For its most recent quarter ending in August, this specific segment generated approximately $900 million in revenue. However, the gross profit from that revenue was only about $125 million. This translates to a gross profit margin of roughly 14%, a stark contrast to the nearly 70% margins Oracle typically sees across its other operations.
The market reacted swiftly to the news. Oracle's stock, traded under the ticker ORCL, dropped close to 4%, closing at 280.05. This decline pushed the stock below its 21-day moving average, a technical indicator often watched by traders.
Oracle's Big Bet on AI Infrastructure
Over the past year, Oracle has made a substantial strategic pivot towards becoming a major provider of cloud infrastructure for AI companies. This involves significant capital investment to build data centers and equip them with thousands of Nvidia's graphics processing units (GPUs), which are essential for training large AI models. This strategy has been a key driver of its stock performance, with shares rallying nearly 70% this year before the recent pullback.
Context of Oracle's Recent Performance
The recent stock decline comes after a period of strong performance driven by enthusiasm for its AI and cloud growth. Before Tuesday's trading, Oracle shares had already pulled back by nearly 20% from a record high of 345.72, which was reached on September 10.
That peak followed the company's fiscal first-quarter earnings report, where it revealed a massive increase in its cloud-related backlog. As of August, Oracle had $455 billion in contracted revenue, representing a 359% increase from the previous year. A significant portion of this growth is attributed to a major partnership with OpenAI.
The OpenAI Partnership
A report from The Wall Street Journal on September 10 stated that OpenAI, the creator of ChatGPT, signed a five-year deal with Oracle for cloud computing services. The deal is valued at an estimated $300 billion, highlighting the immense scale of Oracle's ambitions in the AI cloud market.
While the large backlog has been a source of optimism, the new report on profit margins raises questions about how the company will finance the extensive data center build-out required to service these large contracts and what the ultimate return on that investment will be.
Wall Street Analysts Offer Perspective
Following the report and the subsequent stock sell-off, several Wall Street analysts provided notes to clients defending Oracle's long-term strategy. They suggested that the low margin figures might be temporary and not reflective of the full lifecycle of a cloud contract.
Stifel analyst Brad Reback noted that his firm had already forecast gross margins for Oracle's cloud business to be around 16%. He argued that as the AI cloud segment grows and achieves greater scale, its profitability should improve significantly.
"While it's entirely possible new, sub-scale, GPU workloads are below the ~25% level, we believe that as this OCI segment scales, gross margins should meaningfully improve," Reback wrote.
John DiFucci, an analyst at Guggenheim, offered a similar view. He pointed out that there is often a time lag between when Oracle incurs costs to build out its cloud infrastructure and when it begins to recognize the full revenue from renting those servers to clients.
"We wouldn't be surprised to see lower gross margin contribution at the beginning of an AI training deal before the revenue starts, but we believe it's reasonable to expect any deal to be at least 25% gross margin over its life – or Oracle wouldn't sign it," DiFucci explained.
Both Reback and DiFucci maintained their "buy" ratings on Oracle stock. The company is expected to provide more details on its strategy and financial outlook at its upcoming "AI World" conference and analyst day in Las Vegas.
Broader Impact on AI-Related Stocks
The concerns surrounding Oracle's profitability had a ripple effect across the market, particularly on other companies connected to the AI infrastructure boom.
- Nvidia (NVDA): The chipmaker's stock saw its daily gains trimmed following the report, finishing with only a fractional increase.
- Neocloud Providers: Specialized AI-focused cloud companies such as CoreWeave (CRWV) and Nebius Group (NBIS) also saw their stock prices decline.
The market's reaction indicates that investors are now looking more closely at the underlying economics of the AI gold rush. While revenue growth has been explosive, the focus is beginning to shift towards sustainable profitability and the high costs associated with licensing essential technology like Nvidia's advanced GPUs.
