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thesis
We saw C3.ai’s (NYSE:AI) very risky fundamentals for its entire life as a public company, but at current levels things are starting to get interesting. We believe that C3.ai can be surpassed Market expectations and current valuation make them a buy target. Investors with a higher risk tolerance may want to consider taking a closer look.
C3.ai’s potential to exceed expectations
C3.ai reported a respectable Q2, with subscription revenue up 26% year over year. Overall revenue grew a more disappointing 7%.
C3.ai Q2 earnings presentation
C3.ai guided for revenue of just $63.0 – $65.0 million in the next quarter. This guidance doesn’t compare well with revenue of $62.4 million in their most recently reported quarter. Poor guidance is due to a change in their business model.
C3.ai decided to switch to a consumption-based pricing model. While this change may hurt short-term results, it will bring long-term benefits to the company.
C3.ai Q2 earnings presentation
C3.ai was focused on landing large subscription contracts. The current economic environment has made it challenging. It’s hard for a manager to justify signing a multimillion-dollar software contract if their company is laying off people or struggling financially. On the other hand, if a company can start using the software without a huge financial commitment, they can have a better understanding of the benefits it brings to their company and scale their use accordingly. With the new pricing model, C3.ai can earn the same amount from each customer and the optics are much better. Customer acquisition can be very easy and cost effective.
C3.ai’s bull case is that they can successfully transform their business and return to growth. The company trades at bargain prices and they are rewarded accordingly if they can move their business in the market.
Price action
C3.ai stock has been on a steep decline for some time now. Much of that is due to the hype injected into the stock after its IPO. Its 2020 IPO price was $42 per share, but the stock rose to the $180 range before coming back down to earth. While C3.ai has been obscenely expensive for as long as it’s been a public company, now may be the time for investors to take a serious look here.
Evaluation
On a valuation basis, C3.ai is trading at levels that are rare in the software sector. The company trades at just 1.36x book, 1.54x cash and 4.76x sales. This is usually a sign that investors are bullish on the business and no longer believe they will make a profit or create significant value going forward. We can see that C3.ai traded at over 75x sales valuation at one point. This rapid multiple compression may eventually come to an end.
A company can purchase C3.ai and get a large portion of their purchase back in cash. For this reason, C3.ai could be an attractive buy for private equity firms and other tech companies. While this type of speculation is not a reason to make an investment on its own, it can provide a measure of stock price and optionality.
Risks
Some of the risks of C3.ai are:
The company may never be able to operate their business profitably.
The transition to a consumption-based pricing model may not be smooth, and their predictions may be overly optimistic.
They can compete and fail to thrive in their end market.
For a loss-making technology company, these risks are huge. Investors will want to make sure they have a high risk tolerance and a long time horizon before even thinking about buying stocks even at these pessimistic prices.
The key takeaway
C3.ai is a market questioning company. If the shift to a usage-based pricing model can be successfully piloted, the market will reward the company. If it can’t improve its value proposition, the stock will continue to struggle. At these levels, the company begins to look attractive to potential acquirers. For investors with a higher risk tolerance and a longer time horizon, it may be time to take a closer look here.
