Oracle: Palantir Partnership Is Big (NYSE:ORCL)

Investment Thesis

As Oracle (NYSE:ORCL) continues to build out its position as one of the leaders in the AI database market, particularly in advanced database structures built for vector databases that store mountains of data for Large Language Models (LLMs), I believe that the company’s strong positioning in the generative AI race including through its Oracle Database 23c system, allows them to strategically leverage the rapid expansion of the AI sector, which is projected to balloon.

Key to helping them cement their position within the AI ecosystem is their recent partnership with Palantir. Palantir (PLTR), being one of the leading AI solution platforms for enterprise customers and governments, has been on a tear with strong growth and a rapidly growing customer base. As these enterprise customers dump their mountains of data onto the Palantir platform, they need strong database architecture to support this. Oracle fits right in. I think the stock is a buy.

Why I Am Doing Follow Up Coverage

While Oracle’s earnings have continued to perform since the last time I wrote on them in November, their stock price has trailed the S&P 500, generating a total return of -0.68% vs. the S&P 500’s total return of 9.03%. Earnings (as reported in their FY Q3 2024 report last month) show continued growth. Recent earnings show a 7% YoY rise in total quarterly revenues, with cloud services and license support revenues up 12% and 11%, respectively. Revenue of $13.28 billion slightly missed estimates, but profits of $1.41/share beat estimates of $1.38/share.

In my opinion, we see a stock that has trailed the market, but the fundamental business continues to grow and largely beat expectations. I think that’s powerful.

The Palantir deal, I believe, is an excellent catalyst to help the market understand more where Oracle fits within the AI story. Hint: I think they are integral.

Why The Palantir Partnership Is Big

Usually, a smaller company (Palantir) announcing a partnership with a company worth over $300 billion is not as note worthy for the larger company. I disagree in this case. I think Palantir partnering for them is just the beginning of what we could see for Oracle.

In early April 2024, Oracle announced this partnership with Palantir to address the growing market for AI-integrated expansive cloud infrastructure. Palantir’s platforms such as Foundry and Gotham, which process large volumes of data, will benefit from Oracle’s planned investment of $10 billion to boost its data center capacity​​.

Palantir is set to transition Foundry workloads to Oracle Cloud and will deploy Gotham and its generative AI tool Artificial Intelligence Platform (AIP) across Oracle’s distributed cloud. With the cloud AI market expected grow at an annual rate of 36% through 2032​​, the partnership is expected to help their current clients realize the full benefits of cloud and AI. In essence, the Palantir partnership will allow Palantir to accelerate their growth through Oracle cloud infrastructure while Oracle uses them as a case study to show how they can run powerful AI models on their platform through their critical database technology.

For reference, Palantir booked a 70% YoY increase in U.S. commercial revenue in Q4 2023, attributed to strong customer growth, and deeper engagement across different markets. And this was before Oracle could help them grow (plus return the favor by helping Oracle’s cloud division).

The company supports counterterrorism and fraud investigation initiatives of government agencies such as the Department of Defense and the U.S. Intelligence Community, as well as data-driven decision-making and risk management requirements of commercial clients in finance, healthcare, and manufacturing industries.

All of this will now run on Oracle. They are deeply integrating themselves into the value chain for AI cloud using their powerful databases.

AI Databases Are A Big Part of the AI Wave

Beyond Palantir, the proof of Oracle’s AI cloud databases is becoming extremely evident. Oracle’s focus on integrating AI functionalities into database capabilities reflects its efforts to gain a significant portion of the small but rapidly growing $1.3 billion vector database market.

We saw this on the last call as well, with Oracle’s founder Larry Ellison noting:

Oracle signed another big Generation 2 cloud infrastructure contract with NVIDIA in Q3. Oracle’s Gen2 AI infrastructure business is booming. -Q3 Earnings Call.

For AI, there is little more powerful than having one of the leading AI chip makers deciding to power their cloud infrastructure plan with their own system.

At the center of these key contracts and “booming” business is a remake of how database technology will evolve.

Traditional databases cannot keep up with the demands of large AI datasets. Vector databases, on the other hand, can scale, store and manage high-dimensional data needed for tasks such as image recognition, natural language processing, and sensor data analysis – all common requirements in AI applications. As more organizations needed to search within unstructured data, the growth in the market vector databases did not come as a surprise. Some of the leaders include open-source vector database Milvus and the server-less vector database Pinecone.

In response, Oracle has developed Oracle Database 23c, which integrates vector data capabilities within the existing database environment so users can store, retrieve, and analyze vector data using their existing organizational data.

This integration positions Oracle to capitalize on the continued growth of both structured and unstructured data, further influencing related markets such as AI data management and AI-powered storage, projected to reach $110.68 billion by 2030, up from $22.90 billion in 2023.

Research analysts in space are excited about this new technology. In a blog post highlighted by Oracle in February, one analyst noted:

Oracle is rapidly out-innovating other cloud service providers when it comes to generative AI LLM pragmatic business conversational capabilities…. – Marc Staimer, Senior Analyst, Wikibon

Valuation

Oracle’s forward P/E ratio (non-GAAP) stands at 20.76, below the sector median of 22.85, representing upside potential of 10.06% if the stock converged on the sector median valuation. Similarly, its forward PEG ratio (non-GAAP) stands at 1.66, compared to the sector median of 1.80, indicating upside potential of up to 8.43%. On the more extreme end, Oracle’s forward price to cash flow ratio could rise by up to 28.12% before it is at sector median, coming in at 16.89, below the sector median of 21.64.

In essence, if we were to average these discounts below their respective sector medians, these factor-based data points would show that the company’s stock could appreciate up to 15.54% before it traded at sector median valuations (on average).

Keep in mind, I think this company is not just average. I think Oracle has huge potential within the AI database market and could definitely be a market leader. With that, they should likely trade at an above sector median multiple. But to be conservative

Why I Think This Is Not Priced In

While I believe that Oracle has more than validated their position within the AI market, their stock price performance since my last report has shown that investors have not yet rewarded the company (as I mentioned earlier, the stock falls well behind the market since my last piece on them).

Part of what I think will be key for investors to understand is what gives Oracle a moat in this market. Part of what gives them a moat (over some other hyper-scalers) is their unique database technology. One of the other big pieces is their ability to build and maintain large database physical infrastructure.

For example, one proposed cloud computing expansion plan in Japan, as showcased by their founder and CTO Larry Ellison on the last call shows how key their expertise in scaling cloud infrastructure is here:

…there is a tremendous amount of demand, the data centers take longer to build, and we… are getting very good at building them quickly and getting the building the power and the communication links in, we’re doing faster than we have ever happened in the past. And the thing is once we deliver the hardware, the hardware comes up very, very quickly because the process of bringing up the hardware is now automated. -Q3 Earnings Call

Risks To Thesis

While I believe Oracle could have strong upside, the software developer has one big risk (in my opinion): competition.

For instance, strong market competition in vector database space could impact Oracle’s performance if they did not get ahead of the curve here. There are many well funded competitors.

One example is Pinecone, which raised $100 million on a $750 million valuation in Series B funding in early 2023, and has established itself as one of the key players in the industry. In January 2024, it introduced a serverless vector database that allows organizations to build GenAI applications easily with any LLM of their choice.

Adding to this, Oracle is known to have higher maintenance costs compared to its competitors. This came to light especially when Microsoft announced it would house Oracle hardware in its data centers, leading to suspicions of increased fees. A report also revealed that their Java licensing terms run at two to five times more than other solutions.

Oracle is expensive, and this industry is full of competition. But I think what matters here is that people, organizations and governments trust Oracle with their data. This trust is key to how I think Oracle can charge more for their solutions.

CTO Ellison, in the last earnings call, alluded to this trust component. Governments will need AI databases just as much as people or other entities will too. He and his team are ready to serve them, noting:

Pretty much every government is going to want a sovereign cloud and a dedicated region for that government… For the first time, we’re beginning to win business country – per countries for sovereign cloud where the national government and the state governments are moving to that Oracle OCI region. -Earnings Call

While Oracle has competition, I think their edge here is brand loyalty and trust. These will allow them to maintain their position as the de facto database management software for computer networks of today and in the future with AI.

Takeaway

I believe Oracle continues to be a buy, as their recent partnership with Palantir reinforces the validity of how powerful their solutions are​​ and their recent results show their AI talk is more than talk- it’s action.

With the firm’s leading industry expertise in database systems, I believe the company can take advantage of their technological scalability (new server investments) in supporting their current users to utilize AI database enhancements without needing to migrate to a new database system. Oracle is a powerful player in the traditional database market. Palantir reinforces that they will be a powerful one as well in the AI database market.

While competitive risks exist from specialized AI database companies (among others), Oracle’s long-standing market presence, comprehensive cloud solutions, and physical server investments will help grow its customer base and reputation for reliability. I am excited to see how their AI story plays out.