I can’t stress this enough: it’s time to put your chips on the tech sector again. We’ve seen a sharp reversal from buying everything in the tech sector without regard to fundamentals and valuation in 2020 and 2021, to indiscriminately selling every growth stock because of poor sentiment.
That sharp shift has been more pronounced in recent IPOs like C3.ai (NYSE:AI). Once one of the most popular trades in the tech sector, C3.ai has seen its share price collapse by 40% this year. It’s also trading at less than half of the $42 price level at which it went public, and at a fraction of its all-time (mid-pandemic) highs above $150.
Yes, there are risks in this business – just like in any other smaller-cap growth stock. Yet I think C3.ai has plunged low enough for us to take a gamble on.
I remain bullish on C3.ai, primarily owing to valuation and the fact that the company has just taken a “big bath” quarter to reset expectations lower. If/when overall market sentiment improves, and in the high likelihood that C3.ai manages to muscle past the low targets it has set for itself, I think C3.ai has powerful levers to spark a long-awaited rebound rally.
First – let’s discuss why exactly the stock has been in such doldrums recently. The pessimism is stemming primarily from guidance. For FY23 (which for C3.ai is the year ending next April 2023), the company has issued guidance of $308-$316 million in revenue, representing 22-25% y/y growth – which represents substantial deceleration from the current-quarter growth rate of 38% y/y.
Is this disappointing? Certainly. But there’s also likely a great deal of conservatism in this estimate. This is especially true because the company just received FedRAMP status for the C3.ai Applications Platform, which will supercharge the company’s relationships with federal government entities. The company has also noted strong recent traction with partner-led deals, as well as diversifying beyond the oil and gas industry.
Overall, here are what I believe to be the key bullish drivers for C3.ai:
- C3.ai is still exhibiting hyper growth. In its most recent quarter, the company grew revenue at a ~40% y/y pace. This actually represents acceleration over its growth CAGR since 2019. The company is also scaling from a customer base perspective, and is now at over 220 customers (versus just ~50 at its IPO).
- Industry diversification. AI is a “horizontal” technology, meaning it can be equally applied and benefited from by companies in any industry. Historically, C3.ai has concentrated in heavy manufacturing and oil, due to its relationship with Baker Hughes. More recently, however, the company has expanded applications in production to cover customers in financial services, healthcare, and other expansion industries for C3.ai.
- Star leadership. C3.ai’s CEO, Tom Siebel, is a well-known software industry veteran best known for selling his startup Siebel Systems to Oracle for $5.8 billion.
- Powerful technology. C3.ai is one of the best-recognized names in enterprise AI transformation, which is an area that will only continue to receive more corporate investment as businesses look to modernize and automate their operations.
In spite of the lowered guidance, I believe C3.ai’s dramatically reduced share price more than compensates for the added risk. At current share prices near $19, C3.ai trades at a market cap of just $1.97 billion. After netting off the generous $992.4 million of cash on the company’s most recent balance sheet, C3.ai’s resulting enterprise value is just $978 million.
This puts C3.ai’s valuation at just 3.1x EV/FY23 revenue, which is an incredibly cheap valuation for a company that is still expected to grow at least in the mid-20s next year. In my view, should C3.ai continue to collapse further, there will be interest from acquirers that will intervene to stop the bleeding.
The bottom line here: take advantage of the market’s current edginess on C3.ai to build a position at an incredibly low cost. Be greedy while the market is fearful.
Let’s now discuss C3.ai’s actual Q4 results in greater detail; in spite of the guidance miss, Q4 numbers came in well ahead of expectations. The Q4 earnings summary is shown below:
C3.ai’s revenue in Q4 grew 38% y/y to $72.3 million, beating Wall Street’s expectations of $71.3 million (+36% y/y) by a two-point margin. Revenue largely kept pace with Q3’s 42% y/y growth rate.
Also critical to see in C3.ai’s progression is its continued buildup of customer counts, which was long a weakness spelled out during its IPO. By the end of FY22, the company has hit 223 total customers, up 48% y/y, and adding five net-new customers in the quarter.
The company also noted very robust bookings expansion. Bookings from oil and gas customers grew 95% y/y, while non oil and gas customers grew bookings at a 116% y/y pace. And as previously mentioned, partners and resellers are contributing more and more to C3.ai’s go-to-market results. In Q4, the company launched new partnerships with mega-consulting firms PwC, Ernst & Young, and Accenture (ACN).
And in spite of the pessimism around the guidance growth ranges, CEO Tom Siebel sounded off a note of positivity on the outlook during his prepared remarks on the Q4 earnings call:
Let’s talk about guidance, okay? Okay. As I mentioned, the addressable market opportunity is large and expand. Our pipeline continues to expand. Our customer footprint is growing. Our balance sheet is rock solid. I have never been more optimistic about C3.ai than I am today. We have exceeded revenue guidance for each of the six consecutive quarters that we have been a public company and we are tracking exactly to the long-term plan that we laid out during the IPO roadshow […]
Now in the past few years, as you know, okay, we’ve been making substantial investments in branding and advertising. These investments have contributed substantially to our brand equity and market recognition. I’m confident these were prudent and productive investments, we largely created and not only the market category of enterprise AI. That being said, it’s not lost on us that there’s been a fundamental shift in capital market expectations regarding cash flow. Until recently, the market rewarded rapid growth at any cost. This has clearly changed the market currently demanding sustainable growth combined with free cash flow, with free cash flow. We are confident that we can achieve that goal.”
And in line with that profitability comment from Siebel, the company has illustrated that by FY24 to FY25, it intends to shrink its current -29% pro forma operating loss margin to a 2% profit. This is driven primarily by economies of scaling on marketing and R&D spend:
In 2021, no investor could have fathomed that C3.ai would one day trade at just 3x forward revenue – and yet the day has come. Rather than be quick to judge that the decline was due to a sour turn in the business, take the opportunity to bear additional short-term risk and buy C3.ai for its longer-term merits. This is still a nascent AI company with powerful technology and deep-seated relationships with Fortune 500 clients as well as the federal government – don’t count C3.ai out just yet.