As C3.ai Stock Falls, Is It A Buy?
Summary
- Artificial intelligence is the next great growth frontier.
- C3.ai is positioned as a market leader in the AI space.
- C3.ai's customers help sell the AI product - this is how the company will be able to distribute its AI products across a variety of industries.
- I rate shares a buy on account of accelerating revenue growth and the long growth runway.
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C3.ai (NYSE:AI) is an artificial intelligence technology company which came public via IPO in December of last year. The stock has tumbled since its all time highs, but the market may be misunderstanding the business models and forward growth levers. While the stock does not trade cheaply based on trailing growth rates, I expect growth rates to accelerate considerably and for the company to take advantage of a long growth runway. I rate shares a buy.
C3.ai Stock History
After completing its initial public offering at the beginning of December, exuberant enthusiasm in artificial intelligence sent the stock to as high as $183 per share.
It was not until interest rates began inching higher that AI began a dramatic decline. The stock now trades just around $64 per share, lower than the December 9th opening price of $100 but still over 50% higher than the IPO price of $42.
C3.ai Stock Earnings
AI’s recent earnings results showed robust growth, with subscription revenue growing 23% year over year.
AI guided for the next quarter to see total revenue of $50 million, up 22% YOY. Full year fiscal 2021 revenue is expected to reach $181 million, up 15% from the prior year. This growth rate might not make much sense for a stock trading at 40 times trailing sales, but past numbers do not tell the entire story.
Is C3.ai Stock A Buy?
As can be gleaned by its stock ticker, AI sells enterprise artificial intelligence software to power digital transformation.
The proof is in the pudding. AI was able to deploy its software in just 52 weeks for a Fortune 50 bank, helping it drive $14 billion in additional daily trades.
For another healthcare manufacturing customer, AI’s software was deployed in just 4 weeks, helping the company increase unit production by 300%.
As referenced earlier, AI’s revenue growth rate might not appear so impressive. While AI did grow fiscal 2020 revenues by 71%, this past year’s results have been less impressive.
I wouldn’t be so quick to dismiss this as another case of revenue growth deceleration. AI’s business strategy involves landing important customers in their respective industries. These kind of customers take considerable time to bring on board. As we can see below, AI’s customer list includes some well known names.
This strategy is important to understand. Artificial intelligence can be useful in almost every industry, but AI is certainly not able to know exactly how that might be the case. That’s where the big customers come in. Take for example the case of Baker Hughes (BKR), one of AI’s most important customers. BKR is one of AI’s market-partners.
BKR found great success in using AI’s software such that it is essentially an ambassador for AI’s products. BKR intends to sell AI’s software to others within the oil & gas industry. The details of the arrangement are described below:
“This arrangement was revised in June 2020 to extend the term by an additional two years, for a total of five years, with an expiration date in the fiscal year ending April 30, 2024 and to modify the annual amount of Baker Hughes’ commitments to $53.3 million, $75.0 million, $125.0 million, and $150.0 million, over the fiscal years ending April 30, 2021, 2022, 2023, and 2024, respectively. Baker Hughes revised revenue commitments are inclusive of their revised direct subscription fees of $27.2 million per year.” (March 2021 10-Q)
By now the business strategy might be making more sense. AI will focus its efforts on earning the business of critical customers in every industry. Those customers would then drive AI’s future growth. Wall Street analysts expect revenue growth to accelerate considerably moving forward, to 32% over the next year.
(Seeking Alpha Wall Street Consensus Estimates)
I expect AI to grow into its valuation over time, but its high current multiple and high forward growth promise a volatile ride. It is difficult to assign a price target for this stock as I anticipate accelerating revenue growth. I expect the company to be able to grow revenues at a 30% clip over the next decade or more, but this is admittedly difficult to project and counts on AI executing strongly on bringing on more market-partners. With over $1.1 billion in cash and no debt on the balance sheet, AI has the liquidity profile to fund its current losses until operating leverage takes hold.
Risks
AI has high customer concentration risk. As of the latest quarter, 2 customers accounted for 28% of revenue and 3 customers accounted for 45% of accounts receivable. Over the long term, I do not expect the current customer concentration to make a big deal. However, loss of any current customer would greatly impact revenue growth. Further, if AI’s market-partners are unable to sell the product, then AI’s growth rates would also be materially impacted.
Investors should expect volatility. The fact that the stock has already dropped more than 50% from its all time highs does not promise any margin of safety. Even if the stock drops 50% from here, then it would still trade at 20 times sales, which would still be within the range of what is considered “fairly valued” in light of the 32% consensus forward growth rate.
There is great competition in the space including from Chinese investment abroad. I expect this to be a “winner takes most” industry and there is no guarantee that AI will be that winner in the end. AI should be a small position in a diversified portfolio and investors should carefully monitor the growth through the market-partner ecosystem. If BKR fails to deliver on its revenue commitments to AI then I may need to rethink my thesis.
Conclusion
AI was a poster child of the tech bubble, but after falling more than 50%, the stock has become more than reasonably valued. There is reason to believe in accelerating growth, as AI’s market-partners will help drive growth in their respective industries. There are not many enterprise artificial intelligence investment opportunities in the public market, but AI appears to be a solid investment opportunity itself. I rate shares a buy.
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This article was written by
Julian Lin is a top ranked financial analyst. Julian Lin runs Best Of Breed Growth Stocks, a research service uncovering high conviction ideas in the winners of tomorrow.
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Analyst’s Disclosure: I am/we are long AI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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