C3.ai Stock: Bear vs. Bull

C3.ai (AI -0.67%) was one of the hottest tech initial public offerings (IPOs) of 2020. The enterprise AI software company was founded and led by Thomas Siebel, who previously founded and sold Siebel Systems to Oracle.

C3.ai's growth rates initially looked impressive and its artificial intelligence (AI) algorithms -- which helped large organizations optimize and streamline their operations -- seemed promising. Its catchy ticker symbol also attracted a lot of attention.

The company went public at $42 per share in December 2020. Its shares opened at $100 and skyrocketed to an all-time high of $177.47 later that month, but subsequently tumbled all the way back to the low $20s. Let's see why the bears pounced on C3.ai -- and if the bulls can ever stage a comeback.

Image source: Getty Images.

What the bears will tell you about C3.ai

C3.ai initially dazzled investors with its 71% revenue growth in fiscal 2020, which ended in April of the calendar year. But in fiscal 2021, its revenue rose just 17% to $183 million as the pandemic disrupted its orders to the energy and industrial markets.

That slowdown also highlighted C3.ai's overwhelming dependence on its joint venture (JV) with the energy giant Baker Hughes, which accounted for nearly 31% of its revenue during the year. That percentage rose to 39% in the first nine months of fiscal 2022. The customer concentration is worrisome because Baker Hughes might not stick around.

C3.ai and Baker Hughes established their joint venture in 2019, but Baker Hughes subsequently reduced its peak annual revenue commitments in two amendments in 2020 and 2021. Baker also sold off 15% of its equity stake in C3.ai between last April and June, when the company was still valued at about $6.5 billion. Today, it has a market cap of just $2.5 billion.

Baker Hughes also subsequently invested in Augury -- a software company that provides similar services as C3.ai -- which hints at an eventual exit from the JV when its current contract expires at the end of fiscal 2025.

C3.ai has also gone through three CFOs since its IPO, and several of its key growth metrics -- including its customer count -- keep changing. For example, it started to separate its "customer-entities" (large organizations) from its total "customers" (smaller groups within customer-entities) last quarter.

However, that confusing change also revealed that it was actually losing customer-entities on a sequential basis -- which is bad news when it needs to gain more customer-entities to reduce its dependence on Baker Hughes:

Data source: C3.ai.

Lastly, C3.ai is still drowning in red ink. Its net loss narrowed slightly from $69 million in 2020 to $56 million in fiscal 2021 but widened to a whopping $134 million in the first nine months of fiscal 2022 as it ramped up its investments and attempted to gain new customers.

All those challenges suggest that C3.ai was built to be sold, just like Siebel Systems, and not set up to actually generate sustainable growth.

What the bulls will tell you about C3.ai

The bulls believe that C3.ai's recent contracts -- which include a new five-year deal with the U.S. Department of Defense worth $500 million -- will gradually fix its customer concentration issues. They also believe those big contracts complement C3.ai's "lighthouse" strategy -- wherein it secures deals with large enterprise or government customers to attract new clients.

C3.ai also expects its revenue to grow 38% to about $252 million in fiscal 2022. Analysts expect its revenue to rise another 33% to $334 million in fiscal 2023. Those estimates suggest that the company's slowdown in fiscal 2021 was transitory and that it might continue to generate more than 30% revenue growth over the next few years.

Based on those expectations, C3.ai's stock trades at just 10 times this year's sales and seven times next year's sales. Those price-to-sales ratios are reasonable relative to other companies with comparable growth rates. For example, the data-mining company Palantir Technologies -- expects to generate at least 30% annual revenue growth through 2025 -- trades at 16 times this year's sales and 13 times next year's sales.

C3.ai might not generate a profit anytime soon, but its adjusted gross margin expanded from 75% in fiscal 2020 to 76% in fiscal 2021, then rose to 78% in the first nine months of fiscal 2022. That ongoing margin expansion suggests it still has pricing power in its niche market. The reversal of a costly sales team reorganization in the second quarter should also stabilize its net losses throughout the second half of the year.

Lastly, the company still held $1 billion in cash, cash equivalents, and short-term investments at the end of the third quarter with a low debt-to-equity ratio of 0.16. That stable liquidity and low debt indicate it can still afford to rack up some more losses as it expands.

Which argument makes more sense?

C3.ai still has a lot to prove. It isn't doomed yet, but it needs to gradually decouple its business from Baker Hughes, gain more customers, and stabilize its losses before it can be considered a stable investment.