C3.ai: Path To Profitability May Cannibalize Revenue Growth

seekingalpha11-24 17:16

In 1Q25, C3.ai posted $87 million in revenues, representing a 20.83% year-on-year growth and beating estimates by $270.35k.C3.ai is poised to benefit significantly from the AI revolution, which will ...

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BlackJack3D/iStock via Getty Images  Introduction C3.ai (NYSE:AI) is a provider of enterprise artificial intelligence software based in the United States. The company provides more than 40 turnkey applications and employs approximately 900 full-time employees. As of November 2024, the company's software is utilized by renowned organizations across multiple industries, such as Bank of America, the United States Intelligence Community, Shell, and others. Revenue Mix & Pilot Diversity (Earnings Presentation) Currently, the company reports its revenue through two segments: (1) Subscription Revenue and (2) Professional Services Revenue. It is important to highlight that AI's subscription revenue includes software licenses, SaaS offerings, pilots and trials of applications, and consumption-based revenues which are recognized overtime. Given that we are currently in an accelerated phase of AI adoption, I initially thought that AI might be a good addition to my portfolio. However, upon further investigation, my analysis suggests that it will probably be wise to adopt a 'wait-and-see approach'. Although industry tailwinds are likely to support the company, AI's goal to achieve profitability at the current stage may be at the expense of its growth. More importantly, the valuation of AI is extremely stretched. In this report, I will demonstrate why investors should wait for more data before taking any actions on AI. Latest Developments In 1Q25, AI posted $87 million in revenues, representing a 20.83% year-on-year growth and beating consensus by $270.35k. Overall margins have improved substantially. Gross margin expanded by 283 bps to 59.77% as compared to the same period last year, while operating margin improved to -83.91% from -102.78%. This is the second consecutive quarter that AI generated positive FCF; AI had generated $7.1 million in FCF this quarter after generating $18 million last quarter. 1Q25 Highlights (Earnings Presentation) Looking forward, AI expects revenue for 2Q25 to range between $88.6 million and $93.6 million. For the entire year, the company expects revenue to range between $370 million and $395 million, implying a 19% to 27% growth year-on-year. The company expects to be cash flow positive by 4Q25 and for the entire year of FY2025. Strong Demand Drivers Will Continue To Serve As Tailwinds for C3.ai AI Adoption (McKinsey) Currently, we are seeing a huge acceleration in the adoption of artificial intelligence. According to a recent survey by McKinsey, the adoption of artificial intelligence in at least 1 business function has increased from 55% in 2023 to 72% in 2024. In 2024, more than 50% of the organizations have adopted artificial intelligence in more than two business functions, as compared to less than 25% last year. In fact, data from the survey suggests that we are only at the early stages; more than 65% of the respondents expect their organizations to invest more in artificial intelligence. AI Market Size Outlook (Bain & Co.) By 2027, Bain & Co. expects the market to expand to at least $990 billion, growing at an annual rate of between 40% to 55%. Moreover, the industry is already slowly maturing as companies are already attempting to apply and scale artificial intelligence solutions into real operations. More importantly, we are already seeing the results trickling down into AI's progress. Revenue Growth & Agreements (Historical Earnings Presentation) Since 2023, AI has managed to post consistent revenue growth; this is the sixth consecutive quarter of positive year-on-year revenue growth. In the past six quarters, AI has signed more than 300 enterprise clients; according to the latest earnings presentation, some of these new agreements include heavyweights such as the US Intelligence Community and the US Department of Defense. Investors should be reassured to know that even with the US Intelligence Community's (e.g., NSA, and CIA) advanced technology capabilities, they are still interested in AI's products and services; this is a huge endorsement to AI's capabilities. C3.ai's Path To Profitability May Come At The Expense of Growth Path to Profitability (Earnings Presentation) In the latest earnings call, AI expects to achieve profitability by the end of FY2025 and be cash flow positive for the entire year of FY2025. However, the biggest challenge for AI is to achieve profitability without sacrificing growth. Unfortunately, until today, we have not seen that AI is capable of that. Initially, when revenues were stagnating, the quarters between Oct 2020 and April 2021, the company's operating margin was -40.50% on average. However, after April 2021, in an effort to accelerate growth, operating margins have deteriorated to -95.82% on average due to higher SG&A spending for client acquisition. All of these suggests that AI will have to continue spending aggressively to capture market share; they will not be able to grow organically. My biggest fear is that AI, in an attempt to achieve profitability, will have to give up revenue growth. It is also important to note that as compared to Palantir's (PLTR) revenue dwarfs AI's revenue; AI only has a TTM revenue of about $325 million as compared to PLTR's TTM revenue of $2.6 billion. PLTR also had achieved a 44% year-on-year growth and closed 104 deals recently, beating the latest results of AI (although different quarters). In my opinion, given that the artificial intelligence industry has only recently gained traction and hype, AI should double-down on growth and continue capturing market share; monetization and profitability can come later. C3.ai Must Diversify Away From Baker Hughes and Governments AI's recent bookings suggests that although the concentration of State & Local Governments and Federal, Defense & Aerospace have declined, they still represent a significant proportion. In 1Q25, Federal Defense & Aerospace represent 31% of total bookings, while State & Local Governments represent 11.7% of total bookings. Bookings Diversity (Earnings Presentation) Unfortunately, government contracts can be highly cyclical and dependent on political and budgetary changes. Moreover, government contracts typically have a longer sales cycle, translating to higher acquisition costs; if AI wants to effectively cut costs to achieve profitability while maintaining growth, the company must diversify itself more away from this space (i.e. find a more efficient way to acquire customers). Apart from the above stated issue, more than a third of AI's revenue comes from Baker Hughes (BKR) which is slated to expire on April 2025. Although BKR has worked closely with AI for a long time, there is a still possibility that BKR does not renew its contract; offsetting the potential growth of the company. Full Potential of C3.ai May Have Already Been Priced In Currently, the tech-heavy Nasdaq Composite index trades at a price-to-sales of about 6.3x. If we assume that AI is able to achieve the mid-point of its revenue guidance, AI will generate $383 million for FY2025. Using Nasdaq's price-to-sales multiplied by AI's FY2025 expected revenue, it will imply that AI's market capitalization is merely $2.4 billion. Even if we apply a 50% premium to AI's revenue guidance, it will imply that AI's market capitalization is $3.6 billion. All of these suggests that AI's current market capitalization of $4.7 billion is extremely stretched. Valuation Analysis (Author's Illustration) Closing Remarks Overall, AI is likely to continue to benefit from the industry tailwinds and adoption of artificial intelligence. However, AI's path to profitability may come at an expense of its revenue growth; in my opinion, AI should continue aggressively capture market share and do not waste the current opportunity. Moreover, given the recent surge in share price, the valuation of AI suggests that there is no margin of safety for investors. Any negative news may cause the stock price to plunge significantly; between February 2024 to April 2024, AI's share price fell by more than 40%.  Looking ahead, AI is scheduled to report earnings on 9th December 2024. Investors should monitor AI's customer acquisition costs and revenue growth. If AI can reduce its customer acquisition costs while increasing its revenue growth, it will be a good time to reevaluate the company again. However, if revenue growth falls in-line with customer acquisition costs, then it may be that AI's revenue growth has peaked; which is unfortunate for an artificial intelligence company.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2485769062"}