- C3.ai is a leading AI company with many competitive advantages.
- The market, though early, is massive with almost an unlimited potential for growth.
- Valuation is more reasonable after the sell-off.
C3.ai, Inc. (NYSE:AI) went through one heck of a ride since its December 2020 IPO. The offering was priced at $42, opened for trading at $100 per share and closed at $92.49. It then quickly reached a high of $179 before falling back to earth at less than $70 per share. At this price, I see a good risk-reward speculative bet for my personal portfolio.
C3 is founded and led by Tom Siebel, a highly respected entrepreneur who is known for founding Siebel Systems in 1993.
The company provides an end-to-end platform for customers to build and train machine learning models and to operationalize the insights uncovered by these models. C3 delivers the C3 AI Suite for developing, deploying, and operating large-scale AI, predictive analytics, and IoT applications in addition to an increasingly broad portfolio of turn-key AI applications. Recently, the company also released Ex Machina, a no-code data exploration and data preparation tool for business analysts. The core of the C3 offering is a proprietary, model-driven AI architecture that enhances data science and application development.
Although there is much excitement about the promise of AI, deploying the technology remains a challenge. Challenges include:
- Difficulty integrating scattered data.
- AI apps can be expensive and difficult to maintain as many lack flexibility to handle different situations.
- Stability issues in production environments.
- Scarcity of AI talent.
- Governance & transparency issues.
C3 plays a role in addressing these difficulties. It enables traditional companies to deploy AI faster, with fewer lines of code, and without re-architecting their tech infrastructure. C3 acts as a middleware layer and uses a model-driven software design that provides customers a unified view of their infrastructure and increase the reusability of code across different environments. In short, C3 is the glue that holds AI stacks together and enables lower operating costs and greater agility.
Currently, the C3.ai platform is ingesting data from 622 million sensors, operates 4.8 million machine learning models, and executing 1.1 billion predictions a day.
IDC sizes C3's market - data integration, SaaS, and rapid app development platform - at $42 billion in 2019 reaching $72 billion by 2024.
There are three broad applications of AI:
- Organizations usually begin with deploying AI to improve in-house operational efficiency such as optimizing supply chains and production lines.
- AI is used to improve customer experiences, such as promotions that target individual customers and improving the speed of delivery.
- Lastly, selling market intelligence generated by AI applications.
Since its founding in 2009, the company claims to have spent 1,000 man years building a true end-to-end enterprise AI platform. Replicating this will be very difficult to new entrants.
C3 has also established market credibility with successful deployments with many high-profile customers. For example, in 2019, C3 started a partnership with Baker Hughes (BKR) which includes a revenue commitment of $450 million over five years. After this deal has been announced, the company quickly landed deals with Raytheon (RTX), IBM Global Services (IBM), and Fidelity National Information Services (FIS), Microsoft (MSFT), and Adobe (ADBE).
Competition includes Palantir (PLTR), which shows up most frequently in competitive deals. Palantir is a much bigger company in terms of revenue, market cap, and customers, but it services mostly government agencies while C3 services mostly commercial customers. Palantir is also more of a service company that does not empower customers to maintain their own AI systems, which can be a problem for certain commercial customers. In addition, Palantir must host customer data in order to integrate it, which can be a problem in certain industries that are subject to privacy regulations.
Lastly, customer checks suggest that C3's high touch service to be a key differentiator and helps the company win deals.
The company employs the classic land-and-expand strategy. The company's high-profile customers provide a halo effect, making it easier to the company to sell to their competitors and to smaller enterprises.
Channel checks also suggest C3 heavily discounts initial contracts to land deals, knowing it can raise prices in the future because of high ROI and switching costs for the customer.
Although the company offers an end-to-end platform, customers are able to consume the platform in a modular fashion. For example, customers could use C3 AI Suit for application development but then use another provider for storage. This flexibility allows the customer to pay for what they need and avoid "ripping and replacing" their existing investments. In addition, this allows C3 to develop new capabilities and upsell to their customer base.
FY20 (ended April) revenue grew 71% y/y to $157 million. However, FY21 is expected to grow only 11% due to the company's exposure to hard-hit verticals such as energy, aerospace & defense, and manufacturing, which accounted for 66% of total revenue. As these industries rebound, growth is expected to exceed 30% in FY22 and FY23. However, I believe Ex Machina and the growing interest in AI could drive upside to consensus estimates.
FY20 ended with a negative 40% operating margin and negative $61 million of operating cash flow. I don't expect the company to be profitable for several more years as it invests for growth. In FY22, the company plans to step up their sales & marketing to push down market and build scale, which should weigh on margins.
However, the company has over $1 billion cash and short-term investments and no debt, which should support many years of growth investments.
Although the company is currently unprofitable, it enjoys strong unit economics. The company generates 86% of its revenue from subscription which has a 77-78% gross margin. C3 also has one of the highest retention rate in the software industry with a gross dollar retention of 97%. With sales and marketing accounting for over 50% of sales and with a very high retention rate, the company should be very profitable once it fully penetrates the market through the reduction of sales and marketing.
The company recently announced the general availability of C3.ai Ex Machina, the company's no-code data exploration and preparation solution for machine learning workflow. By targeting a broader audience (business analysts) at a lower price point, Ex Machina could help the company penetrate down market, reduce its dependence on large deals, and increase customer acquisition velocity across every industry.
The second significant catalyst is the rebound of oil & gas, aerospace & defense, and manufacturing, which accounted for 66% of C3's FY20 revenues but got crushed in FY21 (ending April, so this is the "COVID fiscal year").
The company has significant customer concentration with the top 3 customers accounting for 44% of FY20 revenue. The company only has 64 customers across 30 logos. However, the growing interest for AI should help it quickly diversify.
The average contract is $12 million, making C3 a very high-end offering. Bears believe this may limit the market for the company. However, the high contract value likely reflects the company's strategy of landing high-profile customers to demonstrate its technology, and the fact that AI is still in its infancy. As the technology matures and as the company scales, average contract value should go down over time, making C3 more broadly assessable.
The C3.ai platform comes with a steep learning curve that might hinder adoption. Platform improvement over time could mitigate this issue going forward.
The company is currently unprofitable and is burning cash. However, unit economics is strong which bodes well for margins over the long run.
The company is very exposed to industries hard hit by COVID. Old & Gas, Aerospace & Defense, and Manufacturing account for 66% of its FY20 revenue. However, these industries are all rapidly recovering as the economy reopens.
Since the company is not yet profitable, we need to look at it on a sales multiple. The stock is trading at around 23 times forward EV to sales, down from a peak of nearly 80 times sales in February 2021.
As the leader in an emerging market with almost unlimited potential, it is understandable that the market got caught up with enthusiasm in February. Maybe 80 times forward sales is too high even for an AI leader. However, 23 times forward sales at a $6.7 billion total market valuation seems like a very reasonable price to pay for an AI leader with so many high-profile customers.
Needless to say, without positive earnings, C3 should be considered a speculative investment. However, with such massive potential upside, it is a bet worth taking for my portfolio.
This article was written by
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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