C3.ai (AI 0.60%) was one of the hottest tech IPOs of 2020. The enterprise artificial intelligence company priced its IPO at $42 a share on Dec. 8, but the stock opened at $100 the following day and subsequently surged to about $140.
C3.ai raised $651 million in its IPO, and it now has a market cap of about $13.4 billion, or 85 times its fiscal 2020 revenue. That frothy valuation indicates investors are still thrilled about C3.ai's growth prospects -- but the bulls are ignoring some obvious weaknesses, and pricing too much growth into this high-flying stock.
What does C3.ai do?
C3.ai's founder and CEO is Thomas Siebel, who previously co-founded Siebel Systems, the enterprise software company Oracle (ORCL -0.54%) acquired for $5.85 billion in 2006.
Siebel founded C3.ai in 2009. The company initially offered its cloud-based AI tools to energy companies, but it now serves a wide range of organizations across the commercial, industrial, and government sectors.
C3.ai's top customers include the machinery maker Caterpillar, the oil and gas services giant Baker Hughes (BKR -3.55%), and the European energy company Engie (ENGIY 0.92%). It notably generated 36% of its revenue from Baker Hughes and Engie in fiscal 2020, which ended in April.
These organizations all use C3.ai's software to streamline their operations, cut costs, and make data-driven decisions. Its software helps Caterpillar optimize its inventories, Baker Hughes streamline its maintenance routines, and Engie modernize its energy infrastructure.
C3.ai expands via a "lighthouse" strategy, in which it secures a top "lighthouse" customer in a sector to attract its industry peers. These lighthouse customers include 3M, Royal Dutch Shell, and the U.S. Air Force.
How fast is C3.ai growing?
C3.ai generated 86% of its revenue from subscriptions and the rest from professional services last year. Its revenue rose 88% in 2018, 48% in 2019, and another 71% to $157 million in fiscal 2020. But in the first quarter of 2021, its revenue only rose 16% year over year to $40.5 million as COVID-19 disruptions throttled its growth.
C3.ai says it generates "uncommonly high" contract values, thanks to the "high-value outcomes" its AI tools produce. As a result, its average contract was worth $12.1 million in fiscal 2020, which the company calls a "high-water mark for the applications software industry."
C3.ai tries to grow its revenue per customer with a "land and expand" strategy, wherein it locks in customers with a smaller contract, then signs them onto additional contracts. Its initial contract is worth about $13 million, but it believes it can boost that figure to $39 million via additional contracts. Its average contract lasts for about three years.
But like many other cloud service companies, C3.ai is unprofitable. Its net losses widened over the past three years, and it ended 2020 with a net loss of $69.4 million -- compared to a loss of $33.3 million in 2019. It generated a slim profit of $150,000 in the first quarter of 2021, due to lower operating costs during the pandemic, but it probably won't stay in the black for the rest of the year.
C3.ai's customer concentration is a major risk, and it could still face competition from public cloud leaders like Amazon (AMZN 0.71%) Web Services (AWS) and Microsoft (MSFT 0.73%) Azure, even though it classifies these tech giants as technological partners.
C3.ai's AI services run on top of AWS, Azure, and other cloud platforms -- but AWS and Azure also offer their own integrated AI services. C3.ai claims its services are cheaper, more efficient, and more customizable than those integrated AI solutions, but Amazon and Microsoft could still develop new AI services to compete against C3.ai in the future.
Don't pay the wrong price for the right company
C3.ai has a promising business model, and it could have plenty of room to grow. It estimates the total addressable market for AI tools will grow from $174 billion in 2020 to $271 billion in 2024 -- and its "land and expand" strategy could boost the average values of its contracts as that market grows.
Unfortunately, C3.ai's stock is simply too hot to handle at 85 times last year's sales. Even if it doubles its revenue this year, it would still be pricier than other bubbly tech stocks like Palantir and JFrog -- which both trade at roughly 30 times next year's sales.
I'd consider buying C3.ai's stock if a market crash cuts its price in half, but there's far too much optimism baked in at these prices. The market's near-term momentum might carry it slightly higher, but I'm not interested in paying the wrong price for the right company.