$325 price target signals a strong bullish call! Bernstein backs Oracle Corporation (ORCL.US): AI business value may be significantly undervalued

Investment bank Bernstein said in its latest research report that as investors' concerns about artificial intelligence (AI) potentially disrupting the software industry intensify, it believes Oracle Corporation (ORCL.US) should be one of the stocks investors focus on, because the company has both an AI data center business and a core database business, and the latter is also expected to benefit from AI development. Bernstein emphasized that Oracle Corporation has consistently been the most controversial stock in its coverage universe and also the stock among the companies it covers about which investors have proactively called to inquire the most. Investors see the stock's potential value but are still trying to judge the likelihood and timing of that potential being realized. However, Bernstein believes that as more data validates the quality of its business, the market's view of Oracle Corporation will change. The firm said Oracle Corporation's business economics are actually better than it had previously expected. The firm also updated Oracle Corporation's financial model for the next 10 years, incorporating information and performance guidance recently disclosed by management, and demonstrated how much value management is creating for the company. Bernstein noted that Oracle Corporation currently has two potential catalysts worth watching: 1) OpenAI's initial public offering (IPO). The firm believes this will significantly raise the market's awareness of OpenAI's and the broader generative artificial intelligence (Gen AI) industry's ability to pay the computing power fees they have committed to. 2) Oracle Corporation could return to positive free cash flow (FCF) as early as the second half of fiscal 2028. Bernstein believes that the potential upside in Oracle Corporation's share price far exceeds the downside risk. Over the next few quarters, as more data and information are gradually disclosed, Oracle Corporation's share price should rebound. The firm gave Oracle Corporation an "Outperform" rating with a price target of $325, implying 171% upside from the stock's Monday closing price of $119.79. The following is Bernstein's detailed analysis in the research report. Bernstein said Oracle Corporation is uniquely positioned across multiple dimensions, not only among the companies it covers but also across the entire software and technology industry. The stock currently trades at a significant discount to its recent all-time high and remains under pressure, even though management at its recently held Financial Analyst Day met nearly all of Wall Street's demands and even provided more information. However, Oracle Corporation and its share price remain highly controversial. For years, the market has believed that Oracle Corporation lagged competitors in cloud computing and was even a loser in cloud computing. But now the situation has changed, mainly in the following aspects: 1) Oracle Corporation's SaaS business continues to grow strongly, led primarily by Oracle Fusion and NetSuite; 2) Oracle Corporation's database business is migrating to the cloud. The multicloud database business achieved triple-digit growth, driven mainly by its traditional competitors Microsoft Corporation, Amazon.com, Inc. and Alphabet Inc. Class C. 3) The second-generation Oracle Corporation cloud infrastructure (OCI Gen 2) business is growing strongly, thanks to its unique technology and broad adoption by sovereign cloud customers; the related technology is embedded into third-party IaaS/PaaS products through original equipment manufacturer (OEM) cooperation models and is also adopted by private cloud customers. In addition, there is the OCI AI business, which has been at the core of most bearish views on Oracle Corporation. Even though the company gave direct answers and in many cases even provided exact figures, it failed to dispel the market's bearish narrative, because Oracle Corporation is to some extent at the center of multiple AI debates, including: Is the AI infrastructure buildout boom a bubble? Is building AI data centers actually a good business? Can AI labs succeed? So why is Bernstein still optimistic about Oracle Corporation? The firm listed the main reasons the market is bearish on Oracle Corporation and rebutted them, including: 1) "The AI data center business is a bad business" Bernstein noted that Oracle Corporation explained at the Financial Analyst Day that although the gross margin of AI data centers will be lower than the company's traditional business gross margin, the operating margin of its AI data center business will reach about 34%. As data center construction is completed, the related business's impact on the company's overall operating margin will rebound. The impact of AI data centers on the company's operating margin will be relatively limited, and free cash flow will turn positive starting in fiscal 2028 and continue to grow thereafter. 2) "Can Oracle Corporation raise the funds necessary to build the AI data center capacity required?" Bernstein's model shows that the funds Oracle Corporation needs to raise in the future will gradually decrease. Based on the additional data the company provided at the Financial Analyst Day, the firm noted that after recently completing $10 billion in equity financing and $10 billion in debt financing, Oracle Corporation will no longer need any additional financing and is expected to achieve positive free cash flow in fiscal 2028. 3) "Single-customer concentration risk (OpenAI-related business exposure)" Bernstein said OpenAI's committed contract amount of $300 billion accounts for less than 48% of Oracle Corporation's current remaining performance obligations (RPO). And from an annual revenue perspective, that proportion is even lower. Nevertheless, investors remain concerned about this, but the firm expects these doubts to gradually fade as OpenAI files its S-1 registration statement and goes public. Bernstein also discussed downside risk under an alternative scenario: what risk Oracle Corporation would face if all contract commitments listed in RPO failed to materialize, including contract commitments from customers such as Meta and xAI. The firm's analysis shows that, given the stock's current valuation level, its potential downside risk is relatively limited. 4) "Contract duration mismatch" The market is also concerned that Oracle Corporation needs to commit to physical data center contracts with terms of 10 to 15 years, while AI customer contracts have terms of only 5 to 6 years, which may create a duration mismatch. The market worries that if Oracle Corporation's revenue contracts are terminated or fail to be renewed, the company may be left with idle physical data center capacity. But Bernstein believes this is highly unlikely because very few suppliers can replace Oracle Corporation. Moreover, for a company in a growth phase, why spend money on the infrastructure needed to operate the business (even if some costs can be saved) rather than use the funds to drive business growth more effectively? Finally, regarding what level Oracle Corporation's near-term and long-term business economics may reach, Bernstein believes that, based on its updated 10-year financial model, Oracle Corporation is much closer to achieving significant returns on the investment made to date than many realize: 1) Revenue: Oracle Corporation's fiscal 2030 revenue is expected to reach $234 billion, above the firm's previous forecast of $211 billion. From fiscal 2025 (the year including the announcement of large deals including the one with OpenAI) to fiscal 2035, Oracle Corporation's revenue is expected to grow about 8x. 2) Operating profit: Oracle Corporation's operating profit is expected to increase from $18 billion in fiscal 2025 to $80 billion in fiscal 2030 and reach $160 billion in fiscal 2035. 3) Capital expenditure: Capital expenditure will increase from $21 billion to about $46 billion in fiscal 2028. The previous $21 billion in capital expenditure was mainly used for the SaaS business and second-generation OCI CPU-related business. The aforementioned $46 billion does not include an estimated $94 billion in alternative non-cash capital expenditure financing. Overall, capital expenditure is expected to begin declining after fiscal 2028. 4) Free cash flow: Oracle Corporation is expected to achieve positive free cash flow in fiscal 2028 and reach about $30 billion in fiscal 2029 (the firm uses a more conservative estimate of $28 billion), then continue to grow, with expectations of reaching $80 billion in fiscal 2030 and $233 billion in fiscal 2035.