To The Moon

Summary

• C3.ai has been one of the biggest winners in the tech sector in no small part due to its stock ticker.

• The company maintains a strong balance sheet, and management expects the net cash position to remain above $700 million this year.

• I am skeptical that revenue growth can accelerate as much as consensus estimates indicate.

• The valuation is egregious even using aggressive assumptions - I am downgrading to sell.

ICT World Forum@CeBIT

Sean Gallup

Euphoria is back. C3.ai (NYSE:AI $C3.ai, Inc.(AI)$ ) has surged higher and higher despite its near-term business outlook remaining unclear. There is not yet evidence of a real turnaround, yet AI is trading at among the richest valuations in the tech sector. I find it likely that the stock has been chosen by meme-traders due to its attractive stock ticker, which is an unsustainable trend over the long term. Sure, the valuation is not nearly as egregious as that seen for prior meme-stocks and the company maintains a strong balance sheet position, but I cannot ignore the undeserved premium to higher quality tech peers. I rate the stock a sell but note the high risk in shorting meme stocks.

AI Stock Price

Meme traders appear to have found a new hero. AI has been a surprising sector leader amidst the generative AI boom.

Chart

Data by YCharts

I last covered AI in May where I explained why I was downgrading the stock after preliminary results. There, I expressed concerns regarding valuation, yet the stock has surged 40% higher since then.

AI Stock Key Metrics

In its most recent quarter, AI saw revenue growth come to a standstill at $72.4 million.

summary financials

FY23 Q4 Presentation

Remaining performance obligations (‘RPOs’) declined sequentially, largely due to the smaller deal bands seen in the quarter.

deal bands

FY23 Q4 Presentation

Management has stated that the stall in revenue growth is to be expected as the company transitions to a consumption-based business model. Based on the company slides, management believes that revenue growth is about to accelerate from here.

consumption-based transition

FY23 Q4 Presentation

The company ended the quarter with $812 million in cash, making up just over 15% of the market cap. The net cash position had previously been a big positive point for the bullish thesis when the stock traded at much lower levels. Looking forward, management has guided for up to 11% YOY revenue growth in the first quarter and 20% YOY growth for the full year - but I note the wide range.

guidance

FY23 Q4 Presentation

On the conference call, management stated that their company has been “at the vanguard of enterprise AI of the enterprise AI market for over a decade.” That commentary may raise some eyebrows but is consistent from this management team which has not shied from promotional language.

Management noted that they expect the latter half of the year to see higher growth rates on a sequential basis, which is consistent with their full-year guidance and commentary surrounding their consumption-based model transition but still daunting nonetheless. Management reiterated expectations for their cash position to decline to its lowest level at around $700 million this year. Management continues to expect profitability on a run-rate basis starting in the fourth quarter of this fiscal year. That is an arguably aggressive target given that non-GAAP operating margin stood at negative 32.4% in the latest quarter. After taking into account interest income earned on cash balances, the non-GAAP net income number came in at negative $15.2 million. If AI can hit the top end of management guidance of $320 million in revenue, and assuming a back-ended acceleration in revenue growth, then we arrive at around $90 million in fourth quarter revenues. That implies $12 million in incremental gross profits, coming quite close to matching this quarter's net non-GAAP loss. As I discuss later, however, while reaching non-GAAP breakeven might be within the company's reach, it is not enough to justify the current valuation.

Management tried to differentiate their AI offerings by saying that their large language models ('LLMs') have no risk of the same hallucination cited at competitors. While management called this “table stakes for any large commercial or government installation,” I do not share such optimism. One final note regarding guidance was management’s commentary that they “feel comfortable with the expectations that the sell side analysts have set for the coming year and we are not inclined to change those expectations at this time.” Consensus estimates are calling for around 20% growth, implying that management is walking back from its prior guidance for 30% long term growth.

Is AI Stock A Buy, Sell, or Hold?

AI stock has captured the hearts of retail investors amidst growing hype for generative AI.

C3 and Generative AI

FY23 Q4 Presentation

But is there more to this than just the stock ticker? The company still has not adequately addressed the concerns raised in the Kerrisdale short report, and it is not a given that the turnaround will be successful in reigniting accelerating revenue growth rates. While management is guiding for revenue growth to accelerate, it remains to be seen if the company can hit that guidance amidst the tough macro environment. The stock is trading at around 12x sales, right around the multiple seen at higher-quality peer Palantir (PLTR) in spite of consensus estimates looking similar (and not to mention PLTR being GAAP profitable).

consensus estimates

Seeking Alpha

Unlike at PLTR where I expect consensus estimates to prove too conservative, I wouldn’t be surprised if consensus estimates here proved too optimistic. Management continues to guide for at least a 1% non-GAAP operating margin in the fourth quarter of this year and at least 20% non-GAAP operating margins over the long term.

profitability target

FY23 Q4 Presentation

Assuming 20% long term net margins, 25% growth (ahead of consensus), and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see the stock trading at 7.5x sales. Even after accounting for the net cash on the balance sheet, the stock trades at a premium to that estimate. The stock may be “dead money” for many years as it may take 4-5 years before the valuation reaches that multiple, and that is assuming minimal deceleration in growth rates. The high valuation alone is not enough to make for a bearish thesis, but I am of the view that AI was already a lower tier operator in artificial intelligence prior to the rise of ChatGPT (with PLTR being at the top) and now the mega-cap tech titans are new competitors. In my coverage of the tech sector I have seen customers move towards more "name-brand" providers due to the macro environment - this trend should benefit PLTR and hurt AI.

Entering this generative AI craze both PLTR and AI were the main pure-play AI companies, but whereas PLTR was already well-regarded for being able to implement across all industries, AI continues to this day in its efforts to diversify away from its large exposure to the oil industry. This is concerning given AI’s continued high exposure to its largest customer Baker Hughes. AI is not at imminent risk of bankruptcy given the strong balance sheet and modest cash burn. It may take some time before revenue growth turns negative, if ever. My sell rating is based on valuation and the mismatch of investor expectations. I stress that there is great uncertainty as to when the investor fervor may subside, as evidenced by the continued meme-driven overvaluation seen at GameStop (GME) and others. Readers looking for exposure to the growth of artificial intelligence may prefer PLTR for its higher quality product offering and comparable valuation.

Source: seeking alpha