2024-01-08 12:25:41 ET
Summary
- C3.ai, Inc., an AI platform-as-a-service company, has the potential for a rebound rally in 2024 due to its long runway for future growth.
- The company has made progress in diversifying its customer base and has a consumption-based business model that allows for growth with clients over time.
- Generative AI continues to fill C3.ai's pipeline, including and especially among smaller trial pilots that can grow into much larger deals over time.
- C3.ai has solid partnerships with major cloud providers and a strong leadership team, and it trades at a reasonable valuation.
It's the start of 2024, and many investors are rightly worried about the course of the markets for the year. With such a hefty rally kicking in during the tail end of December, stocks look rich again and are priced for perfection, relying on both a reduction in interest rates as well as a "soft landing" for the economy in order to justify valuation multiples.
Amid increased uncertainty, however, it's never a bad idea to continue expressing single-stock bets on companies that have long runways for future growth. And while the generative AI buzz has passed its zenith phase in the stock market, I still think investors have a great opportunity to buy into C3.ai, Inc. ( AI ), the AI platform-as-a-service, or PaaS, product that helps companies build and deploy AI applications.
Over the past year, C3.ai has shot up more than 140% - yet even so, the stock is also down ~40% from highs notched last June above $40. In my view, both fundamentals and valuation provide ample justification for C3.ai to stage a rebound rally this year.
I last wrote a bullish opinion on C3.ai in November, when the stock was trading at similar levels. Since then, however, C3.ai has provided a fiscal Q2 earnings update that in my view has significantly enhanced the bull case for the name.
Earlier investors in C3.ai may recall that one of the biggest risks in the company at the time of its IPO (three years ago, at $42 per share - higher than where it sits today) was its large customer concentration to Baker Hughes (BKR) and its low overall sub <50 customer count at the time. The company has since made great strides in adding more customers to its base, but this quarter started reporting new deal pilots as well - which are growing at a much higher y/y pace than revenue.
Partly as a result of continuing its transition toward a consumption-based business model, C3.ai has also effectively lowered the barriers to entry for newer, smaller customers to test out C3.ai for a more limited set of use cases before more broadly expanding it throughout the enterprise. And continued corporate interest in how to adopt generative AI has also stuffed C3.ai's pipeline with more and more deals. While these deployments may start off smaller than what C3.ai was used to in the past, the consumption business model allows the company to grow with its clients over time.
Here is the full long-term bull case for C3.ai:
- Rapid interest in generative AI has dramatically increased C3.ai's TAM. C3.ai believes that the explosion of generative AI alone has expanded the company's total addressable market, or TAM, to be larger than the market it addressed in calendar 2022.
- Consumption-based business model unlocks tremendous growth potential. Other companies that have become successful growth stories through usage-based pricing include Snowflake ( SNOW ) and Twilio ( TWLO ); and this business model gives C3.ai the opportunity to start smaller with new clients and grow their business over time.
- Industry diversification. AI is a "horizontal" technology, meaning it can be equally applied and benefited from by companies in any industry. Historically, C3.ai has concentrated in heavy manufacturing and oil, due to its relationship with Baker Hughes. More recently, however, the company has expanded applications in production to cover customers in financial services, healthcare, and other expansion industries for C3.ai.
- Solid partnerships. C3.ai is well-embedded with Amazon AWS, Google Cloud, and Microsoft Azure, with specific enterprise applications that are optimized for different cloud environments. C3.ai's cloud-agnostic approach gives it broader reach across all potential customers.
- Rich cash balances. C3.ai has about $800 million of cash, unencumbered of debt - giving it plenty of financial flexibility as it works toward its goal of hitting pro forma breakeven by the end of FY24. Cash burn is minimizing quickly.
- Star leadership. C3.ai's CEO, Tom Siebel, is a well-known software industry veteran, best known for selling his startup Siebel Systems to Oracle for $5.8 billion.
In spite of these strengths, C3.ai still trades at reasonable - albeit not exactly value level - stock prices. At current share prices near $27, the company has a market cap of $3.27 billion; and after we net off the $762.3 million of cash on the company's most recent balance sheet, its resulting enterprise value is $2.51 billion.
Meanwhile, for next fiscal year FY25 (the year for C3.ai ending in April 2024), Wall Street analysts are expecting the company to generate $366.6 million (+20% y/y), pitting the stock's valuation at 6.8x EV/FY25 revenue. For a company that can reasonably expect to accelerate revenue growth from current levels (as the consumption business model is holding down current growth rates, effectively deferring revenue to later as earlier-stage customers continue to expand their relationships over time), I'd say this is a fair valuation.
I see C3.ai rallying to at least $35 by the end of the year, representing ~30% upside from current levels and a price target that represents 9.5x EV/FY25 revenue. Stay long here and use the recent dip in this stock as a buying opportunity.
Q2 download
Let's now go through C3.ai's latest quarterly results in greater detail. The Q2 earnings summary is shown below:
C3.ai's revenue grew 17% y/y to $73.2 million, accelerating over Q1's 11% y/y growth pace and essentially in-line with the company's guidance, which called for a range of 15-20% y/y growth. Note, however, that the company missed consensus expectations of $74.3 million (+19% y/y, and at the high end of the company's guidance range) by a two-point margin.
The company chalked up the miss to consensus to two factors: first, macro-related deal scrutiny, especially in relation to AI products; as well as softer performance in Europe that the company has deemed "unacceptable." Per CEO Tom Siebel's remarks on the Q2 earnings call :
Now, we did see sales headwinds in the quarter. While the interest in AI applications and especially generative AI is growing substantially, we’re also seeing, in many cases, lengthening decision cycles. Virtually every company in the last 3 to 6 months has created a new AI governance function as part of its decision-making process. These AI governance functions assess and approve those AI applications that will be allowed to be installed in the enterprise. This has candidly added a step to the decision process in AI. You might have heard it here first, but you will be hearing this from every AI vendor in the next few quarters. Take it to the bank.
It has simply -- it has added a step to the process and it is lengthening the normal sales cycle. So this had -- this provided a sales headwind in the quarter. And while the increased scrutiny lengthens the sales process, we believe that this is a healthy process to ensure that companies are adopting safe and appropriate AI solutions. So, we’re all for it. And did it move revenue, a little bit, a click below the center of the range? Yes, it did, okay? But get over it. The world is a better place, people are making very careful well-informed decisions. They have their best people on it, and we will all be happier for this in the long run.
So, it did -- that dynamic did provide an unexpected headwind to our Q2 sales revenue performance. In addition, our sales execution in Europe was candidly unacceptable. And since then, we’ve taken -- we’ve been through our planning meetings and we’ve taken appropriate organizational steps to immediately improve sales execution in Europe."
Still, however, as a long-term investor I'm more keen to look past this quarter's revenue results and shorter-term sales headwinds and am more interested by the company's longer-term deal metrics. Notably, bookings are up 100% y/y in the quarter, while new deal pilots are up 177% y/y. Siebel noted that of the company's 36 pilots closed in Q2, 20 were based on C3.ai Generative AI, which was a 150% increase versus Q1. The company notes that with its lower starting price points, it has been able to close many more new deals and reduce barriers to entry for new customers.
The chart below shows that visually as well. Versus last year, while the company also landed one deal in the $5-$10 million range, it has doubled the count of deals in the $1-$5 million range and nearly tripled the sub-$1 million deal bracket:
Lastly, though C3.ai is still unprofitable, it's worth noting that operating cash burn of -$45 million in the first six months of FY24 is roughly half the cash burn of -$91 million in the year-ago period - giving us plenty of comfort that the company's ~$800 million cash balances will hold the company over for quite some time.
Key takeaways
With tailwinds from generative AI not set to dissipate, and with C3.ai planting seeds for the future with smaller deals that have the potential to grow into much larger clients, it's a great time to invest in C3.ai, Inc. while investors have slightly soured on the story.
For further details see:
C3.ai Is Broadening Its Market And Accelerating Pilot Deals