Oracle’s talks with xAI have reportedly stalled.
One artificial intelligence (AI) stock that has been getting some attention lately is Oracle (ORCL -1.47%).
A couple of months ago, media outlets reported that Oracle was rumored to be in negotiations for a $10 billion cloud server contract with Elon Musk’s AI start-up, xAI.
However, recent stories from Bloomberg and Reuters suggest that talks between xAI and Oracle have subsided. While this is an unfortunate development, I still see many reasons to own Oracle stock as the AI narrative continues to evolve.
What’s the deal?
xAI is one of many start-ups looking to disrupt the AI realm. One of the most important aspects of building quality AI tools is having access to top-tier chips known as graphics processing units (GPUs).
GPUs are used in many different generative AI applications and are also quite expensive. At the moment, Nvidia‘s H100, A100, and new Blackwell GPUs are considered to be the best chips money can buy.
It’s important to note that xAI has been an existing customer of Oracle’s for some time. Under the agreement, xAI is renting a series of Nvidia H100 GPUs to help train its large language model, Grok.
But back in May, after raising $6 billion in venture capital funding, xAI looked to deepen its partnership with Oracle as the start-up began shaping its plans to build a data center and its own supercomputer.
Although it appears that Oracle will not be further monetizing its relationship with xAI at the moment, the company still has plenty of upside that should not go overlooked.
Image source: Getty Images.
Why it doesn’t matter
The table below breaks down Oracle’s financial profile for its fiscal year 2024, ended May 31.
| Category | Year-ended May 31, 2024 | Year-ended May 31, 2023 | Change (%) |
|---|---|---|---|
| Cloud services and license support revenue | $39.4 billion | $35.3 billion | 12% |
| Cloud license and on-premise license revenue | $5.1 billion | $5.8 billion | (12%) |
| Hardware revenue | $3.1 billion | $3.3 billion | (6%) |
| Services revenue | $5.4 billion | $5.6 billion | (3%) |
| Total revenue | $52.9 billion | $49.9 billion | 6% |
| Operating expenses | $37.6 billion | $36.9 billion | 2% |
| Operating income | $15.4 billion | $13.1 billion | 17% |
| Net income | $10.5 billion | $8.5 billion | 23% |
Data source: Oracle investor relations.Â
When looking at the revenue figures above, I would not be surprised if your initial reaction was concern. Although total sales rose 6% year over year, Oracle experienced declining growth in three of its four reportable revenue segments. Moreover, this level of revenue growth pales in comparison with other large enterprise software businesses leading the AI revolution.
Nevertheless, I’d encourage investors to take these trends with a grain of salt. The one area of revenue that I am looking at the most is the company’s on-premise licensing services. While revenue from this business declined 12% year over year, I actually view this as a net positive.
Why? Cloud computing infrastructure is becoming increasingly more utilized across enterprise level businesses. In particular, on-premise services are becoming replaced with off-premise infrastructure. Therefore, I see the deceleration of Oracle’s on-premise licensing services as a catalyst for the company’s other cloud services.
Interestingly, cloud services are the only area of Oracle’s business that grew during fiscal 2024. Considering the shift from on-premise to off-premise is likely to play out over the next several years, I think Oracle’s cloud services business is set to experience exponential growth.
The bottom line
A 6% revenue growth can look uninspiring, but it’s important that investors give Oracle’s management some credit when it comes to managing the entire business.
Operating expenses only rose 2% during fiscal 2024, a theme that I find impressive considering the impacts abnormally high inflation has had on businesses of all sizes. More importantly, profits rose in excess of 20% thanks to the combination of revenue growth and a disciplined approach to managing costs.
While the deal with xAI could have been lucrative for Oracle, I think investors honing in on this development alone are being shortsighted. The company still ended fiscal 2024 with $98 billion in backlog, with 39% of that business expected to be recognized as revenue over the next 12 months.
Should Oracle start to see some acceleration in its cloud services business thanks to both increased demand for AI and a gradual shift of on-premise solutions being replaced for off-premise cloud infrastructure, I think even higher profits could be in store.
Investors with a long-term horizon should consider a position in Oracle. The company represents a compelling opportunity in the AI space outside of the obvious megacap technology players.