2024-01-10 14:38:12 ET
Summary
- C3.ai's growth is picking up and margins are stabilizing. This is a result of the business model transition maturing more so than business fundamentals improving.
- C3.ai's customer engagement is increasing but remains modest given the company's valuation.
- Despite the company's self-promotion, C3.ai is one of many competitors in a fragmented market.
- Growth will need to pick up significantly in coming quarters in order to support the company's current valuation.
C3.ai, Inc.'s ( AI ) business has shown signs of life over the past few quarters, with growth beginning to accelerate and margins stabilizing. Much of this is simply the mechanical result of the company's business model transition though. C3.ai has suggested that it is a leader in AI and years ahead of its peers, but the company is in danger of missing the generative AI boat. Given the size of the generative AI opportunity and the demand that vendors are supposed to be seeing, C3.ai's performance looks quite weak. The company's valuation implies a significant growth acceleration, creating downside risk if this does not eventuate.
Market
The generative AI market is expected to be worth 200 billion USD to 1.3 trillion USD in the next decade. There is an enormous amount of uncertainty associated with any estimate though given the nascent state of the technology. It is also unclear at this stage where value will accrue in the industry value chain. Even if generative AI lives up to expectations in the long run, there is a significant risk of disappointment in the near term as companies try to create viable business models.
The primary impact at this stage remains at the hardware layer, with limited benefits for infrastructure and application software. As a result, it is too early to draw conclusions from C3.ai's ongoing soft performance. C3.ai observed sales headwinds in the second quarter which the company suggested were more a result of greater scrutiny regarding governance and security, rather than softer demand. This stands in sharp contrast to Palantir Technologies Inc. ( PLTR ), which has suggested that it is seeing an acceleration of larger deals and shorter times to conversion and expansion.
C3.ai
Customer engagement continues to pick up, and C3.ai has suggested that its C3 Generative AI and Enterprise AI applications are gaining traction. The total number of customer engagements was 404, an 81% increase sequentially. C3.ai closed 62 agreements in the second quarter, including 36 pilots and trials, 20 of which were generative AI pilots. The low entry price point of pilots has made it significantly easier for C3.ai to land new accounts though, meaning these figures need to increase further to be really meaningful. Pilot project consumption data is in line with C3.ai's expectations, suggesting that customers are persevering with the platform and realizing value. Pilot conversion rates are also trending towards C3.ai's target of 70%. The company has signed a total of 109 pilots, of which 103 are still active (pilots still underway or converted to commercial). C3.ai's federal business is an area of strength at the moment, with bookings up 187% YoY.
C3.ai's no-code generative AI application is now available on the AWS marketplace. This product enables non-technical personnel to utilize C3.ai's software. C3's Generative AI qualified pipeline grew 55% sequentially. The extent to which this transfers to meaningful revenue remains to be seen though.
Positives on the pipeline side must be weighed against the fact that C3.ai's hiring remains anemic, and the company reportedly recently engaged in another round of headcount cuts. Job cuts were supposed to have occurred across multiple departments, in part for performance and cost saving reasons. C3.ai has stated that it continues to invest in the large market opportunity ahead of it though, and that any cuts have been performance driven.
Baker Hughes
C3.ai is making extensive use of partners both to distribute their software and to extend their platform's capabilities. They have established partnerships with Baker Hughes Company ( BKR ) (oil and gas market), Fidelity National Information Services, Inc. ( FIS ) (financial services) and RTX Corporation ( RTX ) (US defense and intelligence communities). The alliance program partners work with C3.ai to develop, market, and sell solutions that are natively built on or tightly integrated with the C3 AI Suite.
Baker Hughes C3 AI is a joint venture that aims to enable digital transformation in the oil and gas industry. Applications target use cases like:
- Energy management.
- Inventory optimization.
- Process optimization.
- Production optimization.
- Process schedule optimization.
- Reliability.
- Supply Network Risk.
- Well Development Optimization.
Baker Hughes is also supposed to be using C3.ai applications across its business to increase productivity and efficiency.
While these partnerships potentially aid application development and drive distribution, their success is questionable. Customer concentration is also an issue, with a substantial portion of revenue coming from related parties, most of which is from Baker Hughes. If this relationship were to sour, or C3.ai were to lose one of its other larger customers it would have a material impact on the business.
Schlumberger
Schlumberger Limited ( SLB ) is leveraging AI in areas like drilling automation, digital twins for production optimization, and carbon capture and storage modeling. These use cases are much more specific to the oil and gas industry and require far greater domain expertise. To enable these efforts, Schlumberger has partnered with Dataiku. Schlumberger aims at providing customers with a single end-to-end platform for AI and believes in open data architectures based on common standards.
Dataiku provides an analytics platform that is aimed at analytics leaders, data scientists, business analysts and data engineers. Their core product is Data Science Studio, which is focused on cross-discipline collaboration and ease of use and enables users to start machine-learning projects rapidly. Dataiku is focused on collaboration and open-source support and has a strong online user community.
Schlumberger expects its digital revenue to reach around 3 billion USD by 2025, with new digital technology offerings currently growing roughly 60% annually. Much of this isn't comparable to the products offered by C3.ai but the growth and scale of Schlumberger's digital solutions are notable.
Differences in the solutions offered by Baker Hughes and Schlumberger, and the relative success of those solutions, are not necessarily important to C3.ai. While end market strength is a positive, what matters here is that contrary to the claims of C3.ai, there are a range of similar platforms. Schlumberger is a technically competent organization, and its choice to partner with Dataiku (and the success of its solutions) demonstrates the viability of competing platforms.
Alteryx Acquisition
The market for analytics software remains fragmented, with vendors having limited differentiation. There is also a high probability that the hyperscalers and companies like Snowflake Inc. ( SNOW ) and Databricks will capture much of the analytics opportunity.
Recognizing that C3.ai's platform is only one of many in a fragmented market; it is worthwhile considering the success and valuation of competitors. While C3.ai is differentiated by its focus on use case-specific applications and scalable AI, Alteryx has been moving towards a scalable end-to-end machine learning platform. Alteryx's recent struggles and decision to sell at a relatively low valuation are therefore instructive. Despite having a far larger business, higher growth rate and better margins than C3.ai, Alteryx recently agreed to be acquired by Clearlake Capital Group and Insight Partners for 4.4 billion USD cash .
Financial Analysis
C3.ai's revenue increased 17% YoY in the second quarter to 73.2 million USD. North American revenue increased 28% YoY, while EMEA revenue decreased 11% YoY. Q3 revenue is expected to be 74-78 million USD, representing 14% growth at the midpoint.
While accelerating growth is a positive, this is an expected outcome of C3.ai's business model transition. Ignoring the impact of easier comparable periods, C3.ai's growth remains soft though.
Figure 2: C3.ai Revenue (source: Created by author using data from C3.ai)
C3.ai's gross profit remains depressed due to the higher mix of pilots, which carries higher costs. Pilots and a switch to consumption pricing mean that C3.ai is investing ahead of growth, dragging on margins. This process is maturing though, which should mean that margins stabilize or even improve in the coming quarters.
C3.ai expects to be cash flow positive in FY2025. This is a somewhat meaningless metric though given the company's heavy use of stock-based compensation.
Figure 3: C3.ai Gross Profit Margin (source: Created by author using data from C3.ai) Figure 4: C3.ai Operating Expenses (source: Created by author using data from C3.ai)
Conclusion
C3.ai's growth should continue to accelerate in the coming quarters, largely as a function of the company's business model transition. This should not be mistaken for a sudden surge in demand though. The hype around generative AI is likely a tailwind for C3.ai but the company's growth in absolute terms is low, particularly in light of the growth acceleration achieved by companies like Palantir and UiPath Inc. ( PATH ).
Expectations of lower interest rates and easing macro concerns have driven software valuations significantly higher. This has particularly benefitted smaller, fast-growing and unprofitable companies. Valuations are beginning to look stretched though, particularly relative to interest rates. A significant and broad-based acceleration of growth appears to be baked into the valuation of many companies, C3.ai included. If this growth doesn't eventuate, or investor sentiment sours, there is likely a significant downside from current price levels.
Figure 5: C3.ai Job Openings (source: Created by author using data from Seeking Alpha)
For further details see:
C3.ai: Missing The Boat