2023-05-15 13:29:12 ET
Summary
- C3.ai has traded with great volatility in 2023.
- Short seller Kerrisdale Capital has highlighted potential red flags in the company.
- I found the company's response fell short of a clear rebuttal.
- There is still value here, considering the $800 million in net cash and potential for accelerating growth.
- With the stock up 16% on preliminary results, this is an opportune time to reduce exposure to the name.
C3.ai ( AI ) may be the closest one can get to a cross between a "meme stock" and a reasonably valued secular growth story. After a vicious crash from all-time highs, the stock has seen a volatile start to 2023, largely fueled by renewed investor interest in artificial intelligence. The stock most recently collapsed in April after a short seller highlighted issues in the financial statements, and the company's subsequent response appears insufficient at best. Still though, the company retains nearly $800 million in net cash and the stock remains buyable if one still believes in management's ability to execute against guidance for accelerating growth rates. Yet with the stock trading 16% higher due to preliminary results, this is an opportune time to reduce exposure in light of the company's insufficient response to the aforementioned short report.
AI Stock Price
The tech bubble has burst, and AI's stock remains far from the $150 to $160 prices that it traded at in late 2020 after its IPO. Yet the stock has remained highly volatile in 2023, at one point delivering 200% gains.
I last covered AI in February, where I highlighted the stock as a meme stock with fundamental value. The stock is flat since then, and the next several quarters will be crucial in determining the future prospects for the company.
AI Stock Key Metrics
In its most recent quarter, AI saw revenue decline YOY, as the company has since completed its transition to a consumption-based revenue model.
AI has indicated that this transition will lead to revenues declining in the near term before accelerating rapidly after about seven quarters.
The tough macro environment continued to impact financial results, with the average deal being only $1.9 million in the quarter.
While management continues to guide for rapidly improving profit margins over the medium term, operating margins did not improve in this past quarter, which makes sense considering that operating leverage is the critical driving factor for margin expansion.
AI ended the quarter with $798.8 million in net cash, making up around 36% of the market cap.
Looking ahead, AI has guided for the fourth quarter to see up to $72 million in revenue, representing a 0.4% decline YOY. The non-GAAP loss from operations is expected to increase from around $8 million to $28 million.
On the earnings conference call , management reiterated guidance for positive non-GAAP margins starting in the fourth quarter of the next fiscal year and long-term margins of 20% or greater.
Management was upbeat on the call. They noted that they saw a "dramatic change" from what they saw two quarters ago, where they saw "a significant negative change in the business environment with the lengthening of decision cycles." Management instead noted that they are seeing increased interest in their solutions. They also noted that gross margin will be negatively impacted over the near term due to the greater amount of pilots, in which customers have unlimited run time to validate their use cases (similar to customer trial periods). Finally, management reiterated expectations for their cash balance to bottom at around $700 million during the upcoming fiscal year. On the morning of May 15 , AI stated that it expects revenue to come in slightly above that guidance at up to $72.4 million, with a non-GAAP projected loss of $23.9 million. Management stated that demand "seems to be accelerating" and the stock has in turn traded sharply higher as of the time of writing. I must caution, however, that the implied beat to guidance is very modest and would still reflect flat revenue growth YOY. While it is promising that management seems to still retain the same optimism expressed on the conference call, today's rally (on top of the already volatile trading patterns shown this year) does not look justified.
Is AI Stock A Buy, Sell, or Hold?
It is already uncomfortable to place trust in a company to deliver accelerating growth rates considering that decelerating growth should be expected long term, but on top of that, a short seller in Kerrisdale has come out with damning allegations . In a company press release , AI attempted to debunk the allegations surrounding its unbilled receivables by stating that it is "quite common in the software industry." However, it cannot be ignored that unbilled receivables are particularly notable at AI, as that balance ballooned YOY and represented 33% of total revenues through the first few months of 2022.
One also cannot ignore the fact that AI has gone through many name changes in the past decades, with each name change seemingly being tied to the prevailing trend at that time. Seeking Alpha reader Robert 7809591 summarized it quite well here .
It also does not help that CEO Thomas Siebel comes off quite promotional in my opinion - you can listen to an interview of his following the short report here . There is a lot of "hair" on this investment thesis, with substantial doubt being raised on management's ability to execute against accelerating growth rates.
With the stock trading at around 10x sales, that accelerating growth is necessary to justify current stock prices.
Consensus estimates are calling for just 20% growth in the next fiscal year, but management has guided for "around 30% growth." In regards to those consensus estimates, management stated that "I'd say that it's achievable at least to what the Street is saying, and we certainly are interest -- we certainly are targeting a higher growth so our model actuates as we plan it to actually." Again - coming off quite promotional, if not a bit "wishy-washy" given that they have explicitly given medium-term guidance of their own.
Assuming that the company achieves 30% growth next year, 20% net margins over the long term, and the stock trades at a 1.5x price to earnings growth ratio ('PEG ratio'), I could see fair value hovering at around 9x sales, implying substantial upside over multi-year periods when factoring in many years of growth and the net cash on the balance sheet. But if growth hovers at around 20%, then fair value drops to around 6x sales, implying that the stock is fully valued. Yet even at that lower estimate, it is still implying considerable acceleration in revenue growth rates. There is always the risk that revenue does not accelerate moving forward, even as the company digests its transition to consumption-based pricing. If revenue growth slows to around 10%, then I can see fair value standing at around 3x sales, implying a stock price of around $12 per share. This is an investment in which the upside potential is quite significant, especially if the stock can earn a sustained premium multiple due to its artificial intelligence association. But there remains great execution risk, and my confidence is admittedly not at its highest point after examining management's response to the short report. While the net cash position offers some support, it is also possible that the company greatly disappoints on cash projections and is unable to reduce its cash burn. I also note that it is not clear if AI can offer a compelling artificial intelligence product moving forward given that mega-cap tech titans Microsoft ( MSFT ), Alphabet ([[GOOG]], [[GOOGL]]), Meta Platforms ( META ), and Amazon ( AMZN ) have suddenly generated considerable public hype for their future products. There might be opportunities to trade around the stock's volatility, but I view today's stock surge as being more of an opportunity to lighten up than add to a position given the elevating risks (competition, short report) are coinciding with deteriorating reward (rising stock price). I am downgrading my rating to "hold" and intend to significantly reduce my already-tiny position.
For further details see:
C3.ai Squeezes Higher On Preliminary Results: Why I'm Selling (Rating Downgrade)