Why C3.ai Is a Top Tech Stock to Watch in 2022

CE.ai (AI 4.10%) is doing exciting things in the fast-growing artificial intelligence space, but its dependence on its biggest customer is a cause for concern. In this Backstage Pass clip from "The AI/ML Show" recorded on Jan. 5, Motley Fool contributors Toby Bordelon, Danny Vena, and Jose Najarro discuss why this risky play is one to watch. 

Toby Bordelon: Let's look at C3.ai. I want to just go through this quickly. We've talked about this before. I think on this show a little bit to some extent, and trying to find my slides, here we go. I did a deep dive on this company about two months ago with Brian Feroldi and Brian Withers, so check out in the replay if you want a deeper look at what this company does and what they are for sure. But essentially, what C3 is, we have a question for me about this, we ask for thoughts on C3.ai.

Here we go, we give some right now. Enterprise AI software right here, software so AI-as-a-service, I think that's the easiest, quickest way to think about them. Software as-a-service focused on AI applications. They are focused on enterprises, what they want to do is allow enterprises to deploy artificial intelligence applications at scale. They create the platform and the software to do that, and so here just, you see just quickly this is from one of their presentations. Their software is making over a billion predictions a day, 4.8 million modular process, 620 million sensors, touching all kinds of stuff, that's just quickly what they do.

Here's some of the partners they have, their applications that are quite a lot of cloud platforms, they partner with some of these basically if say we wanted to deploy some mere applications. We use [Microsoft's] Azure, they can run there, we use Amazon Web Services, put it on that cloud. They've partnered with all the major cloud platforms or if you want to host in your own servers that you can do that too. There's a lot of options as to how you want to run this software.

They have a couple of different things that they work with, so they have the AI Suite, which is, they call this their core technology. This is their development platform that allows you too you can use their tools to design your own applications, and they can help you do that. They have pre-built applications, so you can use tools to design your own or you can have these out of the box applications that they can help you tailor too, but it's more immediate that you don't have to think too much about it yourself. This is a great option for a lot of companies. You can think about this and the software-as-a-service area. The difference might be, do I want to use some tools that someone provides me to build my own? Or do I want to use say Shopify's tools to build my own store or do I want to just have an out-of-the-box solution where someone just gives me the package pre-built? That's difference in the AI universe.

They have analytics, you can apply, you can analyze AI based analytics to analyze your data and help you make better decisions, that's a part of what they do. More data vision, they worked with CRM software to use AI to enhance your existing implementations so they can enhance we've already got going on, really a lot of options to use here. You see the big picture of all this put together, you've got your C3.ai applications over here. The customer-built applications you might use our tools to build, all feeding into this you can put on in any one of these clouds you want with any of these partners, really good stuff.

If you are familiar with software as a service, you're looking at this new thing, this looks like a lot of software as a service companies, except that it's using AI as their focus. I think that's the best way to think about what they do in a nutshell. Here are some of just a big-picture of some of the industries that are utilizing their tools. You see a broad range here, oil and gas, I think probably their biggest one, but they're all over the place manufacturing, telecommunications retail. They run the gamut, the point being you can take these tools and put them pretty much into any industry you want.

Subscription, we think software as a service company guys, you probably think subscription business, you should, that's how these things typically run, you can subscribe to the AI suite, you can subscribe to their applications. They also had some usage fees basis there they do the professional services, which is typical professional services being the part of the business, where if you need help getting set up, they'll come and do that. It's like a consulting business basically, but that's not really where they want to be. They do that so that they can sell you the subscription to their higher-margin services, like any other SaaS company would do.

Here's the picture of the founder Tom Siebel he's been around for a while. He founded a previous company, Siebel Systems, he's worked for Oracle. Spent a lot of time there, he's is a pretty good pedigree, written a couple of books. He's the real deal, he's been in this field for a while, he's has been thinking about it for a while solid leadership, solid guy, Brian talks a little bit more about him and the team in our deep dives we want to dig into a little more.

I want to take a look at this, so when you think about who they're competing with, because this is really why I wanted to talk about them here. When you think about top companies for 2022, this is one I think you watch because they're competing with internal solutions. If you're a company like say Nvidia, maybe you're developing these applications on your own, or if you are a larger company to give any company that you want, I don't know a big manufacturer John Deere using AI, developing stuff internally. Then you've got Microsoft, Alphabet and Amazon, who are your big cloud platform providers. But they also have AI software packages that are integrated with our systems they provide, you can subscribe to those as well. So you're seeing some competition from the internal stuff and from the larger players who are competing in this field as well.

That I think is the issue, for this company. When you look at their last earnings report, so one of the things we looked at in the deep dive was that they had a high degree of customer concentration within a few companies, within a few of their customers. Or two customers accounted for more than 10 percent of revenue in 2020 and 2021. In the first quarter of 2021, two customers accounted for 23 percent and 13 percent of revenue, respectively. Three customers had 23 percent, 17 percent, and 15 percent of accounts receivable. That's big concentration, and almost reminds me of the line, you owe the banker $1,000, you have a problem. You owe bank a million dollars, the bank has a problem. If you have three companies comprising over 50 percent of your accounts receivable, you might have a problem at some point. What happens to one of them for whatever, is oops we're either not paying or we can't pay. You can see the risks involved in that.

Then at their last earnings report, one of the things with they announced their biggest customers, Baker Hughes, they announced an expansion of that Baker Hughes contracts, which in one level is good. But on another level, what you want to see with these companies that start with a big customer concentration is you want to see diversity overtime. You want to see them add more customers, add large customers, and have that concentration decrease. What they basically told us, that we're actually putting more of our eggs in this Baker Hughes basket. We're increasing our concentration with Baker Hughes. They signed the contract, the expanded contract with almost 500 million over six years, a little over 350 million guaranteed over 3.5 years, which sounds good, but 100 million a year from Baker Hughes, if you assume it's a straight line out there for the 3.5 years. But then they were guiding for full fiscal-year 22 revenue to be between around 250 million in total. When you look at 250 million a year in revenue, 100 million coming from Baker Hughes, you think, man, that's a little bit of a concern.

They also talked about the remaining performance obligation. The remaining value of contracts yet to be performed. The assortment in the contracts. They said that went up 74 percent in the quarter, but if you back out Baker Hughes, it actually went down 60 percent. What you're seeing is the new business was almost entirely driven by Baker Hughes, and that's my concern.

My concern with this company is I'm not sure that the AI-as-a-service business model as operated by a small SaaS company, a smaller SaaS company like C3.ai, is where we're going in the future. I wonder if it's going to be more of their Microsoft's, Amazon's, Google's and their platforms providing those services, or if we go to the point where you've got a company like CrowdStrike, it does security and now integrating AI into its offerings. If you see more of these SaaS companies, integrating AI into what they're already doing, is this going to be an AI-first service situation, or is it going to be a Software-as-a-Service that starts to be enhanced by AI, by the people already doing it? I don't know how this plays out. I don't know where a C3.ai ultimately fits into the landscape, that's my concern with them.

I would not say this is a top stock to buy, in 2022, I would say this is a top stock to watch, because there's a three billion dollar market cap right now. Well off their highs, well down for the year. If they succeed, there's a huge amount of potential. But it can be also the case that they just can't get a lot of traction with new customers, and other companies just because of their positioning, start doing this better or start winning in this field. I think you watch them. I think you watch companies like them that are newer in the space and try to get a sense this year of where this goes. Who do the people who are in the market for AI services go to for their services. Can C3.ai in the next quarter or two, grow their customer base beyond the dependence on Baker Hughes, or are they going to be stuck in this. We're really a service provider for just a handful of large companies. We can't get much more than that.

Something to watch, a company that I think is very very interesting, but they got some work to do, I think, to prove that they fit in the market, and that the services they're offering are actually valuable right now. We think, is AI the future or is AI right now? If it's right now, they should be succeeding soon. If it's the future, then I don't know that they have the capacity to survive that future. I guess that's my thought. I don't know if you guys quickly, we were running out of time here before, if you have any thoughts on that, or if not this company, other companies that you see in the chat, UiPath or Stem. If you guys follow any of those, if you want to pass some quick thoughts about those, or if you have quick thoughts on C3.

Danny Vena: I don't follow either one of those, but I did cover C3.ai when it IPO-ed and really had some of the same concerns that you mentioned. I actually did the write-up for the most recent earnings report where they covered Baker Hughes. Honestly, the fact that if you backed out that contract from their remaining performance obligation, the fact that it declined sequentially by 16 percent, that raises questions about the effectiveness of the sales team. If they put them all on that Baker Hughes thing and basically left everything else out, are they really doing the job they need to do? I think the next couple of quarters, really watch that remaining performance obligation and see whether or not, are they putting their eggs all in one basket or are they going to try to grow out of that?

Toby Bordelon: At a three billion dollar market cap, it's kind of compelling to me, but I think if I were going to invest in the AI industry, even the AI as a service space, I would absolutely not go all in on C3. I think it's a small piece of a bigger basket. Maybe Nvidia is part of that basket, maybe Microsoft is part of that basket.

Danny Vena: Nvidia is carrying my basket. [laughs]

Toby Bordelon: There you go. I think you size this very carefully. I think it's a risky play. But it could be interesting. Don't ignore it, but certainly not in back of the truck territory for me, it's too many questions right now.

Jose Najarro: I think you've made a great point here, where sometimes you could just research a company, and maybe might not hit your criterias right now, but you put that checklist. Hey, maybe in the next two quarters, if they meet these requirements, if maybe customer base improves, now it looks a little bit more attractive. It's OK that, hey, maybe from right now to when that happens, I might miss out on some of the gains, but I feel more comfortable investing in the company once these metrics are met.

Toby Bordelon: Yeah. I think the benefit here, if you're looking at C3, my biggest concern is customer concentration, whether they can grow beyond where they are right now. I think what you look at in the next quarter, the next two quarters, the next three quarters, is you look and you say, yeah, our customer concentration is going down. The three customers for Q1, 2021 that were over 10 percent of accounts receivable, now we only have one customer who is 10 percent, or Baker Hughes is no longer 25, 30 percent of our revenue, they're 20 percent, they're 15 percent, you start seeing, but not because they're backing out, that's bad. They become a smaller portion of a growing piece of revenue. If you see that happening, you see good trends like that, then maybe you get a lot more interested.