C3.ai: The Correction Has Further To Go
Summary
- Shares of C3.ai have dipped more than 40% from mid-February highs, especially following a very disappointing fiscal Q3 earnings release.
- C3's small customer base and exposure to the oil and gas industry has pressured its growth amid the pandemic, with Q3 revenue growing at only 19% y/y.
- Pro forma operating losses also continued to grow, raising questions about the company's ability to scale profitably.
- Still sitting at a ~35x forward revenue valuation, C3.ai is still vulnerable to a deeper correction.
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The tech rout of the past several weeks has been painful, but it should have communicated a very clear message to investors: many tech stocks that have been propped up on "stories" and hefty expectations of future growth are very susceptible to a correction. 2020 and 2019 were banner years for new IPOs: virtually every new issuance flew off the figurative shelves and reached nosebleed valuations. Least of all among these was C3.ai (NYSE:AI), an enterprise AI platform that went public only a few months ago at just $42 per share, and still today is sitting ~2x gains from the IPO price.
After C3.ai's recent Q3 earnings release, which underwhelmed the Street and sparked a selloff that was amplified by the broader market pullback, shares have declined ~40% from February highs:
Data by YCharts
Yet in my view, the correction in C3.ai shares still has quite a ways to go. I mentioned several of these red flags in my prior article on this company, but here are the key bearish items for investors to watch out for:
- Pandemic has pressured C3.ai into a position of nearly no growth. A company of C3.ai's scale (~$200 million in annualized revenue) should be growing at 30-40% or more, if it was a healthy company. Examples of SaaS companies at this scale include Sumo Logic (SUMO) and Bill.com (BILL), the latter of which is growing at a ~30% y/y clip. C3.ai's Q3 revenue, meanwhile, grew at only 19% y/y - a reflection of the impact the pandemic has had on its customers, most notably its largest customer Baker Hughes.
- C3.ai still has enormous customer concentration risk. Baker Hughes represented nearly half of C3.ai's revenue in fiscal 2020 (the year ending in April of 2020), and overall the company has only 30 customers. To me, this signals that C3.ai is still a relatively immature company that hasn't merited its ~$10 billion market cap.
- Losses continue to grow. C3.ai's most recent financials also show that the company's pro forma losses continue to build. Over the past year, meanwhile, most SaaS companies have seen tremendous profitability improvements due to a reduction in sales, marketing, and T&E (travel and entertainment) costs. This raises questions about whether or not C3.ai is able to scale profitably.
- Lockup expiration is coming. C3.ai went public in December, which means the 180-day lockup period has not yet passed. We've seen with other hot IPOs like Palantir (PLTR) that the buildup toward the lockup expiration usually triggers a wave of selling. In other words, C3.ai shares could still lose a lot further from here.
AI is one of the hottest areas in technology right now, and C3.ai - with its catchy name and flashy technology - benefited a lot from investors' future-focused mindset and attraction to in-the-moment tech names. Fundamentally, however, C3.ai's execution is a bit lacking, and I doubt the company will be able to sustain its outsized valuation.
Even at C3.ai's current post-correction stock prices near $95, the company trades at a $9.60 billion market cap. After we net off the $1.12 billion of cash on C3.ai's most recent balance sheet, its enterprise value is $8.48 billion. Versus Wall Street's FY22 revenue expectation of $237.8 million (+32% y/y), C3.ai trades at a heady 35.7x EV/FY22 revenue multiple. In a down market, that's an unfathomable valuation to bear.
Steer clear here - it's not time to buy the dip in C3.ai just yet.
Q3 download
Let's now discuss C3.ai's most recent quarterly results and its business slowdown in more detail. The Q3 results are shown in the table below:
Figure 1. C3.ai Q3 results
Source: C3.ai Q3 earnings release
As previously mentioned, C3.ai's revenue grew at only a 19% y/y pace to $49.1 million, only slightly beating Wall Street's $47.3 million expectations (but still disappointing in the fact that most SaaS companies have reverted to pre-pandemic growth rates and are reporting healthy deal flow, whereas C3.ai is still limping behind).
That being said, there are a few positive points to highlight. C3.ai's CEO Tom Siebel, a software industry veteran who founded Siebel Systems, noted that the company has broadened its technical go-to-market partnership with Infor, which will hopefully open more doors for C3.ai and begin to help diversify its limited customer base. Per Siebel's prepared remarks on the Q3 earnings call:
Let me address a few of the significant customer wins in the third quarter. Firstly, Infor. We have formed a strategic wide ranging relationship with Infor, a multibillion dollar ERP software provider. Under the terms of the agreement, Infor will be integrating many existing Infor applications with the C3.ai suite and the C3.ai applications to market, sell and deploy AI based solutions to their customers under the Infor brand. This will evolve into a broader partnership with Infor to market C3.ai solutions to Infor customers, including C3.ai reliability, C3.ai CRM, and C3.ai Ex Machina, a next generation predictive analytics application that empowers anyone to develop, scale and produce AI based insights without writing code."
In terms of other wins: the company has also worked with Raytheon (RTX) on an aircraft readiness program with U.S. Army Aviation, potentially leading the door to other high-profile public sector engagements. These deployments have helped C3.ai's reliance on the oil and gas sector to decline to 38% of revenue for fiscal 2021 to date (down from 59% in the prior year).
On the negative side, however, C3.ai's profitability margins can't seem to find solid footing. We typically hope that as smaller software companies grow with scale that margins can slowly inch upward. In Q3, C3.ai's pro forma operating losses widened to -$11.9 million, also representing a contraction in pro forma operating margins to -24%, from -20% in the year-ago quarter.
Figure 2. C3.ai pro forma profitability
Source: C3.ai Q3 earnings deck
Overall, I view C3.ai's third quarter performance, and its execution during the pandemic, to be rather mixed: there appears to be solid go-to-market expansion plans underway, but ~20% growth is hardly near good enough to justify a ~35x forward revenue valuation.
Key takeaways
Based on valuation, an upcoming lockup expiration, and a growth rate that continues to see pressure from oil/gas weakness (though the company has made progress toward diversifying away from Baker Hughes), I think the correction in C3.ai shares still has further to go. Continue exercising extreme caution here and wait until the price dips further before wading in.
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Comments (20)
Fell bad for everyone who did not sell at lot higher price and still holding.
