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Revealed: Fool’s teased “AI stock with 38x growth potential”

What's being teased by Motley Fool Rule Breakers: Artificial Intelligence?

By Travis Johnson, Stock Gumshoe, September 27, 2021

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 growth for at least several more years.

So is it time to jump on board? I’ve thought about the company off and on since back when it had the even more awkward name C3IoT about five years ago, when I saw Tom Siebel speak at a conference and share some really interesting perspectives about the potential of AI, and more recently I’ve been pondering the prospects since the shares fell in the Spring — this is what I said back in May in a Friday File for the Irregulars:

And is it time to start to look at some recent “fallen angels” from the “overpriced IPO” wave from the past year?

C3.ai (AI) is beginning to come down to prices where you could begin to make some rational valuation arguments… but it’s still really tough to justify unless you have a high degree of certainty that they’re going to add some more large clients — their “flagpole” customers are huge, they have only 30 or so customers and have a very concentrated dependence on their biggest customers (Engie and Baker Hughes brought in more than a third of AI’s revenue last year)… which is a challenge if you have a bad couple quarters with no big customer sales or lose a big customer (so there’s also a specific and immediate risk right now, as they’re reportedly renegotiating the Baker Hughes contract).

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Still, they have huge contracts for an enterprise cloud software company, and if they’re as impressive as they believe themselves to be and can inspire other big customer to sign on (the strategy is to sign “lighthouse” customers and use them to impress the rest of the sector and bring on more customers), then they can grow into this valuation eventually. With that kind of customer concentration, though, and with customers where one big renegotiation can dramatically shake up the business, you have to know it really well to buy — and I don’t know C3.ai well enough yet to pay 30X revenues for what is expected to be only 15-20% revenue growth this year. Their lockup period expires in a week or so, it will be interesting to see if there’s a further dip and some big insider selling.

Revenue expectations have actually improved a little bit for AI since I wrote those words, and the price is roughly at the same level it was then (it was just dipping below $50 for the first time in mid-May). The valuation has come down a little, to about 26X trailing sales (or 21X expected current-year sales), which is still objectively expensive if you’re looking at any stock in any era other than a growing Cloud/SaaS company in the 2020s, but compares pretty favorably with some of their more popular near-peers in this wacky era (Datadog at 56X sales, Snowflake at 90X sales, etc. — though, to be fair, those are both much larger companies with better financials).

The biggest negative, I’d say, is that they have not really grown their Remaining Performance Obligations (RPO) in recent quarters, that number was actually lower last quarter than it was in May, and it has grown only 6% year over year. That’s the subscriptions they have booked and in the bag already. So it’s not just that the revenue growth is more tepid than investors had hoped, it’s also that there isn’t some hidden level of future growth built in that just hasn’t shown up in the numbers yet — if they want to grow, they have to sell.

The good news? The customer count continues to grow pretty nicely, they now have 98 customers, a 10% increase from last quarter and a big jump from last year (85%). But the biggest news is the addition of Google Cloud as a partner this past quarter, that means they’re now partnered up with the number two and three players in enterprise cloud computing, following their longstanding partnership with Microsoft, and it adds another sales force that could bring more customers in the door. They’re also pushing their predictive software systems out of the more industrial businesses and into the world of CRM (customer relationship management), which could open up some new markets to them as they integrate with systems like Salesforce and SAP.

And, paradoxically, it might be good news that their average customer deal is getting smaller — they are broadening their sales effort and lowering the prices of some of their applications pretty substantially, it appears, so their average contract value has shrunk from about $12 million last year to $4.5 million now. Less money is bad, of course, but that also represents a more nimble enterprise that can onboard new clients much more quickly, instead of only doing huge projects.

I’m still on the fence with this one, but it is definitely possible to see a bubbling up of potential future growth in all of their product introductions and partnerships, and perhaps a smoothing of that growth as their average deal size gets smaller and their dependence on one or two huge customers shrinks.

In general, when you’re dealing with a growth stock in fast-growing industry you don’t want the reason for buying to be, “the stock fell sharply and is stagnating” — that tells you the market is not excited about it, and if the market isn’t excited, then why would it pay 20X revenues for a company that’s losing tons of money, has falling margins, and lacks a glamorous revenue forecast? It’s fallen to a level where if you have great confidence in the value of their product you may be getting a great opportunity to buy at a time when it’s misunderstood, but you really need to have a good picture of the company here to like a stock that is somewhat broken. I’m beginning to get there, and I was encouraged by their last earnings call, but I don’t understand their product well enough to disagree with the market at this point or start pounding the table in excitement.

But I will go in with a small speculation on the options side, while I’m continuing to ponder whether the equity is worth adding to my portfolio… mostly just because I think the shift to smaller deals and easier sales onboarding and the emphasis on making some future deals in CRM could lead to some substantial surprise growth over the next few quarters (particularly given Siebel’s history in that area, since CRM was the focus of Siebel Systems before he sold to Oracle about 15 years ago). Optimism is pretty limited for this stock, which brings down the cost of leverage, so I opened a small options position for June of 2022 ($75 calls).

The company isn’t expected to report again until early December, so absent other big announcements from AI it looks like we should have plenty of time to think this one over… and we may well see continuing insider selling as some early backers and partners like TPG and Baker Hughes reduce their stakes, along with other insiders, so it’s certainly not without risk (there has never been any insider buying in AI, though that’s not at all unusual for a recent IPO). I’ll keep the Irregulars up to date if my opinion changes on this one, but digging into that last earnings call was enough to convince me to risk a little.

That’s just what I’m doing with my money, though — with your money, it’s your opinion that matters — do you see Tom Siebel building another great company here, or did they sell themselves to investors just as the company started its decline? Let us know with a comment below… thanks for reading!

Disclosure: Of the companies mentioned above, I own shares of and/or call options on Google parent Alphabet, Matterport, Advanced Micro Devices, and now C3.ai. I will not trade in any covered stock for three days, per Stock Gumshoe’s trading rules.

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youwannabet
youwannabet
September 27, 2021 4:33 pm

$AI is a new “Cloud Contenders” rec in the MF Cloud Disruptors service but not a rec in Rule Breakers service.

Last edited 2 years ago by youwannabet
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youwannabet
youwannabet
September 27, 2021 5:07 pm

OK, yes. I don’t have the MF Artificial Intelligence service but, $AI is a new rec in the MF Cloud Disruptors service, too. I do not own $AI yet for similar reasons as yours – I have enough exposure to cloud stocks.

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ronwill
September 27, 2021 7:16 pm
Reply to  youwannabet

It was actually recommended in their AI service about a month before the Cloud Contenders. APR and MAY respectively

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barton
September 27, 2021 4:43 pm

This is the same one just released last week by Jeff Brown in his $12.3 trillion FLIP.

Did some DD and purchased

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Walter Pisary
Member
Walter Pisary
September 27, 2021 5:31 pm
Reply to  barton

So did I, not in small part influenced by Tom Siebel’s record.

aoraccounts
aoraccounts
September 27, 2021 5:02 pm

On September 4, 2020, Leo Sun wrote an article on the Fool.com website about this same stock saying, “I didn’t like C3 when it was hovering near its all-time highs last December, and I still don’t like it now.”

Things change quickly apparently!!

Also, today, Sep. 27, Anthony Di Pizio wrote an article on the Fool.com website saying that C3 is one of the 2 stocks you can buy at a huge discount right now. The other stock was Zillow.

And, 100% of the 4,000 Fools who voted, expect that C3 will outperform the market.

Thanks for your expert analysis Travis! Gumshoe is my favorite.

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ironmac
Irregular
ironmac
September 28, 2021 4:07 am

I don’t know how much stock (no pun intended) in what those writers put out.

Anyways, i do have AI and am terribly underwater with it. Holding for now given that I usually give a stock a couple of years to prove itself.

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quincy adams
Guest
quincy adams
October 3, 2021 11:47 am

I noticed that Sun repeated his somewhat negative view on C3 in a September 28 blog, claiming the current valuation well exceeds his expected growth rate for the company. I think he writes mostly for the much lower-priced Stock Advisor team…it’s not currently recommended there. I suspect TMF’s philosophy is that if you can afford to pay $1,399 for the premium AI service, you can certainly afford to take a flier on their more risky picks.

dunnydame
dunnydame
September 28, 2021 9:29 pm
Reply to  aoraccounts

Just now on the Wed night online discussion, the Stansberry guys recommended selling $Zillow ASAP. They didn’t like the recent move the company has made in buying houses itself to hold for a profit – conflicts with the revenue they earn from brokers who use their site.

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Normally Dubious
Guest
Normally Dubious
September 29, 2021 1:33 pm
Reply to  dunnydame

Is Z what they teased as the Most Dangerous stock to own?
I missed that part of the presentation but Stansberry’s Trade 360 sounds like what Chaikin Analytics offers.

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dunnydame
dunnydame
September 30, 2021 4:46 pm

Yes, $Z was it.

SoGiAm
September 28, 2021 7:16 am

Grabbed some C3 to go with my POAI. Now looking for R2D2; where did he get off to?
Still have some $SDGR . Best to ALL!

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kruffin
September 28, 2021 4:40 pm
Reply to  SoGiAm

Remember you from the old KISS days! Hope all is well.

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frankw17
September 29, 2021 8:18 pm
Reply to  SoGiAm

Glad to see you still have your sense of humor Ben.
Regards,
Frank

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Tony Ren
Guest
Tony Ren
September 28, 2021 3:16 pm

OK so Motley Fool, Banyan Hill, Cathy Wood and everyone else is plugging and watching C3 AI so I suppose it will be bidded up when the time comes. I bought a bit and got out as it started sliding. Now Im waiting for the September swoon to end so I can get back in at a better price. If it delivers in the long run, what happens now doesnt really matter. Just want to maximise the potential.

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evanevan6
Member
evanevan6
September 30, 2021 4:59 pm

The Volatility of a Low Customer base is something to avoid. I learned my lesson thru a chip stock that was making all of Apples chips for their devices.. and then Apple changed the design and/or got a new supplier and their revenues were less than half of what they were. (and the same happened to their stock price.)
Phooey on one-horse companies.

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avatar
October 3, 2021 4:19 am

I am unconvinced that many major companies will sign up for C3. There are dozens of lower-priced alternatives. Some of these already have a strong footprint in Global 2000 companies. More startups and early-stagers are competing to win clients. Add to this – Oracle, SAP, Salesforce, Microsoft and others offer AI and/or analytics at low prices or for free as add ons to their main offerings.

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Carburo
Member
Carburo
October 4, 2021 5:54 am

I mainly invest on fundamentals. One of the things that I watch carefully is the insider dealing.
After the first drop to $120 C3 AI showed a very clear insider trading pattern that suggested that the bearish trend would not stop. In fact, massive sales by the CEO and the TPG and Baker Hughes funds, but also by top managers with amount of stocks sold much greater than the options exercised (at zero or almost no cost) were worrying.
In more recent months, sales of funds have ceased, those of managers have mostly concerned the options exercised and those of the CEO have slowed down. This might suggest that the insader’s view may be in favor of the end of the decline of the stock price.
Hope my English is not too bad.

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Acebravo
Member
Acebravo
October 8, 2021 4:10 pm

Can’t find it on the site, was Fool’s #1 Canadian Stock for the New-Age Space Race tackled already by Travis?

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Acebravo
Member
Acebravo
October 8, 2021 6:00 pm

Yeah I know, all I could see in their click bait as I’m not a subscriber to any of their services, after talking about SpaceX being private can’t invest in it:
“Fortunately for you, our team of diligent analysts at Motley Fool Stock Advisor Canada has identified one little-known public company founded right here in Canada that’s at the cutting-edge of the space industry and recently completed an acquisition that the CEO believes could “supercharge” the business…

All while making a handsome profit in the process.

Oh, and Elon Musk’s SpaceX? They count on this tiny yet absolutely critical company to make their missions a success!”

Not sure MAXAR is a $2B American company and they are pitching a tiny Canadian company.

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Acebravo
Member
Acebravo
October 8, 2021 10:24 pm

MDA is $1.93B CAD so not really tiny and was actually acquired itself from Maxar by Northern Private Capital. I think it’s Magellan Aerospace (MAL), it’s only $589M CAD and its recent acquisition was in late 2019 and secured multi-year contract with Airbus. Don’t know about SpaceX counting on them but they produces aeroengines and aerostructure assemblies for space markets in North America, Europe, and Asia.

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