The Fed's Interest Rate Drama Has Only Just Begun. Here's 1 Big Reason Oracle Investors Should Be Excited.

The Federal Reserve cut interest rates by 0.25% last week, and guided towards further cuts in October and December.

Oracle is expected to spend heavily, and go even deeper into debt, as it builds out its AI infrastructure to service a $300 billion OpenAI contract.

Lower interest rates could more than offset increased interest payments caused by Oracle’s higher debt load.

10 stocks we like better than Oracle ›

By now, you’ve heard the news. After nine months of holding the line on interest rates, refusing to either lower them or (gasp!) raise them, the Federal Open Market Committee finally made its move last week.

It lowered its target interest rate by 0.25%, to a range from 4% to 4.25%.

The FOMC also expressed a willingness, if conditions don’t improve, to lower rates by similar amounts in each of its next two meetings. These meetings are scheduled to take place in October and December. This could end up lowering interest rates as far as 3.5% through the end of 2025. Further cuts in 2026 and 2027 — there’s a chance rates will fall by another 0.25% each year — could ultimately lead to a 3% FOMC target rate.

Here’s why all of the above is good news for investors in Oracle (NYSE: ORCL) stock.

Image source: Getty Images.

Oracle Corporation is one of America’s biggest tech companies. With a market capitalization of $877 billion, Oracle earned $12.6 billion on $59 billion in revenue over the last 12 months, with about 86% of revenue coming from the provision of database software hosted on the cloud.

These are very large numbers. They value Oracle at more than 71 times trailing earnings (which is a lot), and nearly 15 times annual sales. Granted, analysts forecast a fast earnings growth rate of nearly 20% annually for Oracle. But even so, it’s hard to argue that Oracle is anything but a very expensive stock.

Except for one thing.

Software is Oracle’s biggest business today. But as time goes on, Oracle will become more and more an artificial intelligence company — with Open AI as its biggest customer.

Two weeks ago, Oracle inked a $300 billion deal to lease server capacity to OpenAI to support the latter’s AI services. Stretched over a five-year timespan, the deal promises to grow Oracle’s new AI business alone to about $60 billion per year — a sum larger than all the revenue Oracle gathers across all of its businesses, combined, today.

In other words, this single contract will double Oracle’s revenue in five years’ time. It basically guarantees Oracle a 20% growth rate, even if the rest of the company’s businesses stop growing entirely.

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That’s before we even consider the effect of Oracle (maybe) taking a huge stake in TikTok.

However, there’s one wrinkle Oracle must iron out for this to happen. As The Wall Street Journal pointed out last week, in order to enjoy the future revenue that OpenAI (and TikTok) promise to bring, Oracle must first make “substantial investments in its network infrastructure” to support all the data that will be coursing through it.

Oracle has already been making pretty “substantial investments” in its AI capacity. We know this because, according to data from S&P Global Market Intelligence, as recently as 2023, Oracle was generating nearly $12 billion in annual free cash flow. But last year, that FCF number turned negative — not because operating cash flow decreased (in fact, it increased 11%, to $20.8 billion), but because capital spending more than tripled to $21.2 billion over the course of a year.

Result: Capital spending outstripped operating cash flow, and Oracle began burning cash for the first time in 35 years.

2024 may have been the first time this happened, but according to the Journal, it won’t be the last. Indeed, citing Wall Street analysts, the paper predicts that Oracle will burn “nearly $29 billion” over the next three years, turning FCF-positive again only in 2029.

This means Oracle will rapidly burn through the $11 billion it currently has in the bank, and probably need to add to its debt load, which currently stands in excess of $111 billion.

Servicing that debt load already costs Oracle $3.6 billion a year in interest expense. Adding another $18 billion (for example) to the debt load would therefore logically increase the company’s interest costs by about 16%.

However, if interest rates fall from 4.25% to 4% to 3.75% to 3.5% by the end of this year, the net effect of all those cuts would be to reduce Oracle’s interest expense by 18%. So, thanks to the Federal Reserve cutting interest rates, Oracle can probably raise all the new debt it needs to fund its expanding artificial intelligence business — and save money in the process.

The Fed’s interest rate cut couldn’t possibly have come at a better time for Oracle.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Oracle. The Motley Fool has a disclosure policy.

The Fed’s Interest Rate Drama Has Only Just Begun. Here’s 1 Big Reason Oracle Investors Should Be Excited. was originally published by The Motley Fool

The Fed’s Interest Rate Drama Has Only Just Begun. Here’s 1 Big Reason Oracle Investors Should Be Excited.

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