Oracle: Cloud Infrastructure Margin Should Improve as Scale Expands

Key Morningstar Metrics for Oracle

• Fair Value Estimate: $330
• Morningstar Rating: ★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

On Oct. 7, tech media outlet The Information reported that Oracle‘s ORCL graphics processing unit rental business generated a 14% gross margin in the quarter ended Aug. 31. Oracle shares were down as much as 5% in intraday trading following the news.

Why it matters: While Oracle’s move to expand market share can lead to lower prices that squeeze margins, we do not think its 14% GPU rental gross margin differs materially from similar services provided by other major hyperscalers.

• In our view, pure infrastructure-as-a-service offerings will be margin laggards in the overall cloud portfolio due to their highly commoditized nature. The attractiveness of the cloud computing market mainly comes from its vast market potential rather than unit economics.
• It is noteworthy that the 14% gross margin figure does not include Oracle Cloud Infrastructure’s platform-as-a-service offerings, such as multicloud databases. These services should have higher margins that can lift OCI’s overall margin profile.

The bottom line: We maintain our $330 fair value estimate for wide-moat Oracle as the news fits with our prior understanding and we expect the cloud segment gross margin to stabilize over time. We will review our forecasts based on Oracle’s updated financial outlook during the AI World conference next week.

• We still believe Oracle Cloud Infrastructure has a wide moat. We think OCI is now at a scale to deliver consistent returns on invested capital above its cost of capital over the next 20 years, thanks to strong switching costs commonly seen across cloud infrastructure services.

Long view: We became more optimistic about OCI’s long-term profitability after Oracle announced a 359% jump in remaining performance obligations during the last earnings call.

• Building out cloud capacity at a larger scale leads to higher bargaining power in front of suppliers, a prerequisite for OCI to enjoy a cost advantage similar to other major hyperscalers.