Oracle Corporation (NYSE: ORCL) Is Still Investment Grade

What happened

Oracle Corporation (NYSE: ORCL) is still investment grade. The cost of insuring its debt has jumped, but a 295-basis-point credit-default-swap spread is a market price, not a downgrade to junk.

CNBC reported on October 19, citing S&P Global Market Intelligence, that five-year default insurance briefly reached 300 basis points and stood at 295, up 287% in one year. S&P Global Ratings still lists Oracle Corporation (NYSE: ORCL) at BBB- with a stable outlook. BBB- is the lowest investment-grade rung.

Read more: Oracle (ORCL) stock analysis and investment case

Why it matters

At 295 basis points, insuring $100 million of Oracle Corporation (NYSE: ORCL) debt for one year costs about $2.95 million. A 287% increase implies a year-ago spread near 76 basis points, so the annual premium has risen by roughly $2.19 million per $100 million of protection. That is a sharp repricing of risk, but it is not a 2.95% default probability and does not predict a downgrade by itself.

The latest filing explains the concern. Oracle Corporation (NYSE: ORCL) reported $23.103 billion of first-quarter operating cash flow and $28.499 billion of capital expenditures, leaving negative free cash flow of $5.396 billion. It also had $125.0 billion of senior notes and other long-term borrowings outstanding at August 31.

The financing bridge was substantial. Oracle Corporation (NYSE: ORCL) raised $19.909 billion through its at-the-market stock program and received $11.363 billion of customer prepayments with a significant financing component. Together those two sources totaled $31.272 billion, or $2.773 billion more than the quarter's capital expenditures. That covered the cash need on paper, but equity issuance and customer financing are not the same as recurring self-funded cloud cash flow.

The countercase is real. Oracle Corporation (NYSE: ORCL) ended the quarter with $38.934 billion of cash, cash equivalents and restricted cash. Its remaining performance obligations reached $664 billion, and management says current liquidity and available financing are sufficient for committed spending. A stable BBB- rating means the agency has not concluded that the company belongs in speculative grade.

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What's next

Watch the next rating action, sustained CDS pricing, quarterly free cash flow, customer prepayments, equity issuance and refinancing costs. A downgrade below BBB- would make the credit event official. Better evidence would be capital expenditures falling below internally generated cash while cloud contracts ramp, without another large financing bridge.

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