Three red flags about the future of C3.ai

AI Basics


enterprise software company C3.ai (AI 1.13%) We are benefiting from the recent attention of artificial intelligence (AI). The stock has risen 80% in the last three months, is the hype justified?

C3.ai is a young company with many efforts to become a sustainable business. Investors need to understand the long road ahead before pursuing portfolio stocks. Especially after a recent run. Here are three red flags that investors should be aware of before buying.

1. C3.ai’s business model is complex

C3.ai builds software tools and turnkey applications for the enterprise. The company focuses on the field of artificial intelligence, including being recognized as a leader in his Forrester Wave for AI and Machine Learning Platforms. For example, the company’s software can use machine learning to detect money laundering. In the oil and gas sector, C3.ai’s software monitors the moving parts of the supply chain to keep operations running efficiently. But how do investors measure the value C3.ai brings to their companies?

At first glance, revenue growth doesn’t tell a great story. The company’s sales declined 4% year-on-year in the third quarter of fiscal 2023, which ended January 31. Guided full-year revenue of $265 million is only 5% growth. Management attributed the slow growth to billing moving to a usage-based model, and that growth will accelerate over time as companies use the software more. However, it is a double-edged sword. It can make a business more volatile, thrive in the good times, and hurt when customers tighten their wallets.

Investors should not be in a hurry to give the company the benefit of doubt. its largest customer, baker fuse, still account for about 30% of revenue. Not only does it create concentration risk (Baker Hughes’ contract expires in 2025), but it’s fair to wonder how much traction C3.ai’s products will have without a more established business portfolio. That’s what it is. Today, the company has just 236 customers.

Peter Lynch once said about the simplicity of investing:.“With so many moving parts in the company, it’s hard to know if C3.ai is thriving or surviving.

2. When will C3.ai’s business be profitable?

Many growing businesses lose money – it’s normal. But ideally, you’ll see a clear path to profitability. C3.ai has paved the way for a profitable operating margin at the end of fiscal 2024 (end of April 2024). Management expects operating margin to bottom out at -36% six months ahead of him and then recover strongly. This is due to the expected ramp-up phase of the usage-based billing model.

However, a positive operating margin does not necessarily mean that the company is profitable. Here’s how a business consumes more cash than it generates revenue. Expenses surged through his three quarters of fiscal 2023, led by R&D expenses, which increased him 54% year-to-date to $161,000.

Graph showing C3.ai's R&D expenses and free cash flow have increased and revenue has declined since mid-2020.

AI R&D spending (quarterly) data by YCharts

C3.ai’s operating margin could turn positive, but investors can wait a little longer for free cash flow to become positive. Fortunately, the company has time. With approximately $790 million in liquid assets, including cash and short-term investments, he will be able to raise enough money for three years of operations at the pace C3.ai has spent cash over the past four quarters.

Still, a company on its way to profitability for years is a big question mark. It’s hard to wait for an answer when the economic environment is as volatile as it is now. What if a recession hits and your company’s pay-as-you-go billing works against it? Cash losses can get worse in such a scenario.

3. C3.ai Pays Excessive Stock Compensation

The company’s aggressive use of stock compensation is a major reason why I am concerned about the above financial situation. Paying employees stock is a common way for growing companies to save cash. But too much stock-based compensation can dilute existing equity and hurt shareholders. Below, the company shows he paid $204 million in stock-based compensation over the past year.

In other words, if companies paid full salaries to their employees, cash losses would be much worse than they are today. In my view, it hurts finances because management is pushing that cost onto investors.

Chart showing C3.ai's stock-based compensation has outpaced earnings since mid-2020.

AI Stock Compensation (TTM) Data by YCharts

C3.ai looks like a company that has come up with a marketing strategy, put a lot of money into it, and is diluting its investors with a ton of new stock. That’s a lot going on and not much good for shareholders. Consider waiting until C3.ai puts out much better numbers than today.



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