AI with Nobias technology: Does C3.ai Inc trade with an especially high valuation?
Artificial Intelligence has been a secular growth theme of the digital age and upcoming 4th industrial revolution for years now. We’re still in the early innings of proliferation of A.I. technologies and investors are looking for a way into the ground floor before A.I. empowered companies really start to take off. The excitement surrounding the long-term secular growth potential of A.I. technology played a major role in the share price rally that C3.ai, Inc. (AI) experienced in the immediate aftermath of its initial public offering in December of 2020.
AI shares priced at $42/share and soared some 140% on their first day of trading. C3.ai shares hit highs of $183.90 in late December; however, they’ve been on a downslope ever since. Today, C3.ai trades for just $50.12. They’re languished in the $50 area for months now.
Chris Lau, a Nobias 4-star rated analyst, published an article highlighting C3.ai’s recent share price performance on July 26th. AI closed the trading session on that day at $51.50. Not much has changed during the last couple on months; therefore, his analysis remains useful.
Lau wrote, “Since its all-star performance after its initial public offering, C3.ai (NYSE:AI) has trouble holding the $50 level. The short interest of 8.6% on AI stock is not very bearish. And the valuations, such as its price-sales ratio of almost 30x, is not out of the ordinary.”
Lau noted that the persistent weakness was interesting because the company hadn’t seen any major headlines in weeks. His thought was that investors are waiting around for a clear indication of improving sales/profits to help to justify the stock’s speculative valuation.
C3.ai posted its fiscal Q4 results on July 2, 2021 and Lau highlighted the results saying, “In the fourth quarter, revenue grew by a modest 26% Y/Y to $52.3 million. Non-GAAP gross margin rose only slightly to 81% for the fiscal year 2021, up from 77% in FY 2020. The bad news is that costs still exceed revenue: non-GAAP operating income was negative $15.4 million.”
This top-line growth was disappointing to Lau. He wrote, “C3.ai is priced for hyper-growth but revenue growth of 26% is not impressive.” He continued, highlighting the company’s forward looking guidance provided during its Q4 presentation. Lau wrote, “C3.ai forecasted another non-GAAP loss from operations for the first quarter of 2022 and the 2022 fiscal year. It will lose between $28 million and $35 million in Q1 and up to a $119 million loss for the full year.”
With projected losses mounting up, it’s paramount that the stock partners with large corporate firms on big sales/subscription services to quickly turn its growth potential into a more lucrative business. Lau believes this is what it’s going to take to break out of the stock’s current slump saying, “Sooner or later, customers like Bank of America (NYSE:BAC), Standard Chartered Bank or Kosh will want to get more out of the AI product line.”
With regard to big business, Lau notes that competition from big-tech is a major threat for this smaller software firm. He wrote, “Microsoft (NASDAQ:MSFT) has a solid track record of growing software subscriptions. Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) has a near-monopoly in the search engine and online advertising market. Both companies post consistently strong revenue and profits.” And therefore, he concluded his piece with a rather bearish warning, saying, “In times of uncertainty, AI shares are not suitable for speculators. Buy and hold investors who thought that AI would trade at $100 or more should rethink that assumption. The company will not post a profit this year and will test the most patient shareholder.”
Stavros Georgiadis, another Nobias rated 4-star analyst, wrote an article on AI more recently (September 10, 2021) and arrived at a very similar conclusion to Lau’s. Georgiadis highlighted many of the same fundamental trends, noting that “FOMO trading” was the cause of C3.ai’s initial rally (FOMO stands for the “fear of missing out”, ironically relating to greed inspiring investors to buy something amidst a strong rally before it trades higher) and echoed Lau’s remarks regarding the Q4 fundamentals not staking up to the stock’s high valuation.
Georgiadis wrote, “A 72% selloff off its highs is a reminder that IPOs are too risky for most investors.” However, he coupled that statement with some reassurance saying, “That being said, investors who bought it during the IPO procedure still have a decent gain of about 21% right now.”
Like so many others, Georgiadis is bullish on the future prospects of artificial intelligence overall. He wrote, “Through 2025, the global AI market is expected to grow by $76 billion dollars at a compound annual growth rate (CAGR) of almost 21%. Another report pegs the CAGR at 40% from 2021 to 2028, and adds that “the continuous research and innovation directed by the tech giants are driving the adoption of advanced technologies in industry verticals, such as automotive, healthcare, retail, finance, and manufacturing.”
With specific regard to C3.ai, he said: “C3.ai says it can offer AI software solutions and applications for a plethora of industries ranging from utilities to healthcare to retail and just about everything in between. Furthermore, the company claims that it can deploy its tools in three to six months, as opposed to years.
In theory, this sounds like great business efficiency. In practice, I would argue that it is a severely flawed business model. The company has delivered solid revenue growth, but at the same time is burning cash and losing money. That’s not an ideal business model.” Georgiadis touched upon AI’s lack of an ability to produce profits, saying, “C3.ai’s fiscal year ends on April 30, and from fiscal years 2019 to 2021 it has reported losses of $33 million, $69 million and $56 million. Free cash flow for 2020 and 2021 are both negative.”
C3.ai’s management continues to highlight its operational success. Georgiadis quoted a recent press release from the company which read, “operating at massive scale, as of July 31, 2021, the C3 AI Suite and Applications were integrated with 849 unique enterprise and extraprise data sources, process 1.7 billion predictions per day, manage 24.4 trillion data elements, and evaluate 33.8 billion machine learning features daily.”
However, he says, “Despite those numbers, though, it seems the company still can’t make a profit.” And therefore, like Lau, Georgiadis ended his report on a bearish note, concluding, “AI stock is expensive, and the company has a lot of potential, but it’s losing money, and has a troubled business model that does not deliver results. Avoid it for now.”
Anthony Di Pizio, a Nobias 4-star rated author, offers a different (bullish) perspective in his August 19th C3.ai report titled, “Why C3.ai Is a Buy Ahead of Earnings”. He wrote, “Artificial intelligence was once science fiction, but it's now very real. Except today, its applications are more business-focused as opposed to personal robots, like in the movies.”
Di Pizio continued, saying, “Large technology companies might have the resources to build these big, complex AI applications themselves, but for others, it's a total pipe dream from both the cost and knowledge perspectives. That's where C3.ai shines, by offering thousands of pre-built applications that can cut out 99% of the software programming otherwise required.” He says that C3.ai is the “bridge between artificial intelligence and the companies that need it” and offered a real-world example of the type of work that AI does saying: “Take the oil industry, for example. In an unlikely collaboration, C3.ai has developed a comprehensive partnership with energy giant Baker Hughes, and the pair now have their own line of applications marketed to other oil companies. Dubbed BHC3.ai, it's used to analyze swathes of data from oil projects to predict potential equipment failures, drive efficiency, and reduce carbon emissions.”
Like others, he notes that the stock trades with an especially high valuation. Di Pizio wrote, “The company projects it will generate $245 million in full-year revenue for 2021, so with a market capitalization of $5.1 billion, the stock trades at over 20 times sales. In other words, it's still quite expensive, especially since it's unprofitable.” But, he continues, “With a compound annual growth rate of 25%, the price-to-sales multiple will shrink materially over the next couple of years (assuming the share price remains the same).”
Di Pizio concluded his piece saying that those who buy shares after the stock’s 70%+ dip could be rewarded over the long-term saying, “C3.ai has over 4.8 million machine-learning models helping to make 1.5 billion predictions per day across all the industries in which its customers operate. With up to 28% revenue growth estimated for the upcoming quarter, grabbing some stock at these prices could look like a deal over the long term.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
During C3.ai’s more recent quarter (reported on September 1st, 2021) the company did exceed Di Pizio’s revenue growth target. However, this wasn’t enough to move the share price higher because of poor guidance. The company produced year-over-year sales growth of 30% year-over-year to $52.41 million.
The company’s subscription revenue increased 29% to $46.1 million. C3.ai offered forward looking Q2 and full-year 2022 guidance. Management called for sales of $56-58 million during the upcoming quarter and net losses of $30-37 million. For the full-year, C3.ai is estimating sales of $243 - $247 million and operating losses of $107-$119 million.
With all of this in mind, the credible authors that the Nobias algorithm tracks offer a “Neutral” stance on the stock moving forward. Just 49% of credible authors are bullish on shares. However, the average price target amongst the credible analysts that Nobias tracks for AI shares is currently $85.25. This implies upside potential of approximately 70% from the stock’s current price of $50.12.
It is worth noting that the range of price targets provided by blue chip analysts (those who receive a 4 and 5-star rating by the Nobias algorithm) is quite wide. Right now, we see price target estimates that range from $45/share to $122/share.
Once again, this implies that the professionals on Wall Street are split on this stock as well. The upside potential is certainly, but it seems that without a clear catalyst, shares may languish here, down 70% from their 52-week highs, even longer.
Disclosure: Nicholas Ward has no AI position but is long MSFT and GOOGL. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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Disclaimer: The Nobias star rating is based on past performance results and is not an indicator of future results. These past performance returns do not represent returns that any investor actually earned. Assumptions made include the ability to purchase the stocks recommended by the author under liquid markets where the transaction would be at the market price for the day. In reality, loss in liquidity may have a material impact on the returns that actually may have been earned. Further, returns are calculated without any including transaction costs, management fees, performance fees or expenses, or reinvestment of dividends and other income. This information is provided for illustrative purposes only.