Another weekend, another “Investor Digest” from the Motley Fool that’s mostly a teaser pitch for one of their higher-end portfolio services… this time it’s about an artificial intelligence (AI) stock, and it’s a tease for the recently renamed Rule Breakers: Artificial Intelligence product ($1,399 for the first year, no refunds), which recommends a portfolio of AI-related stocks, and they drop hints about one of those recommendations. They don’t list a particular person or team as the “editors” for this newsletter.
Here’s a little taste of the ad:
“Our analysts believe there’s one undervalued AI stock in particular that’s poised for 38x revenue growth in the coming years.
“And after releasing their latest results this month, it’s suddenly popping up on many forward-thinking investors’ radar….
“Its proprietary AI platform is able to process a mind-boggling amount of data… 3500x faster than Amazon!
“Processing data at this scale just hasn’t been possible until now.”
So what’s the company? These are the clues we get:
It’s primarily a subscription business, which is always attractive.
They had $183 million in revenue in FY 2021.
And, perhaps most interestingly, they have a new partnership…
“The company just entered into a strategic alliance with Google… thereby turning a potential competitor into a partner that’s now co-selling their platform for them!”
Dinging any bells in the back of your mind? It’s that last bit that intrigues me, since selling and building up the customer base has been their biggest challenge recently, but this is a tease for the relatively recent IPO C3.ai (AI).
C3.ai is a fascinating company, it’s been around for more than a decade and has its roots in the energy management business, with founder Tom Siebel (of Siebel Systems) starting it up as an enterprise software company providing AI tools for predicting and managing energy use. They have expanded well beyond that now, adding predictive tools for managing things like maintenance, inventory and fraud detection, though part of the reason for the weakness in the share price this year is their continued over-reliance on a few big customers, most of whom are in the energy business.
And that’s the biggest risk: This is not a company that has thousands of customers paying a few thousand dollars to use the platform, this is a company that’s still very reliant on a few dozen customers spending millions of dollars to use the platform. If it works and they keep those customers, that’s fine, but it leads to a very volatile business year to year and quarter to quarter if those major customer relationships change.
Which they have this year, to some degree… leading AI to see much lower growth than had been expected in the past couple quarters. Like many companies, it seems like they exaggerated their financial progress before the IPO, getting their operating expenses down to $33 million for their last quarter before they went public and coming close to showing a profit on $40 million of revenue. In the most recent quarter, so now a year after the pre-IPO quarter, they posted revenue growth of 29% and operating expense growth of 127%. The top-line growth is impressive, but that ballooning of costs is worrisome.
And that’s probably the main reason that the shares, which were priced in the IPO at $42 but opened trading at $92 and got well above $150 for a while, have fallen precipitously since February and have mostly been back in the $45-50 range over the past couple months, very close to the IPO price. You can’t justify a wild valuation of 60-70X sales, which is what C3.ai carried in January and February, if you’re growing revenue at only 20-30% and have to more than double your operating expenses just to get that level of revenue growth.
Since this is a subscription business and should be expected to have fairly good retention, we can think of it this way: That means they spent almost $4 in new overhead costs, with more than half of that being selling and marketing expenses, to bring in each $1 in sales over the past year.
You can still spin this story with some hope, of course — it’s still a high-retention subscription business, in an extremely fast-growing and fast-changing industry, and they tell a good story about how excellent their software is compared to other AI processing tools. They still have very strong revenue growth, it’s just not as high as folks imagined it would be a year ago — analysts think they’ll have $246 million in sales this year (their 2022 fiscal year started in May), which is 34% growth on the top line, and they also believe sales will grow 33% in the next year after that. And they’re still pretty small, with a market cap around $5 billion.
There is no expectation that they will get to break-even or become profitable in the forecastable future, but if they can keep the revenue growth that high investors will probably be pretty patient, particularly if management continues to show some traction with its evolving strategy to go beyond just serving a couple dozen huge customers. Particularly because they have about a billion dollars in cash from the IPO, so AI can easily fund their money-losing gr