C3.ai (AI -0.72%) was one of the hottest tech debuts of 2020. But today, the enterprise artificial intelligence (AI) software company's stock trades nearly 70% below its initial public offering (IPO) price. C3.ai lost its luster as investors fretted over its slowing growth, ongoing losses, and high valuations. Rising interest rates exacerbated that pain. But could this out-of-favor stock recover over the next three years?
What are C3.ai's biggest problems?
C3.ai only expects its revenue to rise 1% to 7% in fiscal 2023, which ends next April. That would represent a severe slowdown from its 38% growth in fiscal 2022 and 17% growth in fiscal 2021.
The company mainly attributes that slowdown to macroeconomic headwinds. That's because it provides most of its AI algorithms, which can be integrated into an organization's existing software infrastructure or sold as stand-alone services, to large customers in the macro-sensitive energy and industrial sectors.
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However, C3.ai also generates a large portion of its revenue from a joint venture (JV) with energy giant Baker Hughes. Approximately a third of C3.ai's revenue through fiscal 2025 will still likely come from Baker Hughes, based on Wall Street's top-line expectations and the current terms of the joint venture. This deal, which was renegotiated to be extended for an extra year last October, will expire in fiscal 2025.
Three troubling hints indicate this partnership could be in trouble: Baker Hughes already renegotiated lower revenue commitments to extend the agreement last year, it divested its own equity stake in C3.ai, and it invested in C3.ai's competitor Augury instead. If Baker Hughes walks away from the JV, C3.ai's revenue will plummet.
To diversify away from Baker Hughes and other large customers, C3.ai is aggressively pursuing smaller contracts from smaller customers. It also recently announced it would pivot away from subscriptions toward a usage-based model that only charges customers whenever they access its services.
However, that strategic shift raised eyebrows because enterprise software companies generally prefer to pursue larger customers, which generate higher revenue, and lock them in with sticky subscriptions. C3.ai has also gone through three CFOs since its IPO, and each CFO has slightly modified its customer counting methods and other key growth metrics.
C3.ai's slowing growth, customer concentration, management issues, mixed strategies, and ongoing losses all convinced investors that its stock didn't deserve a premium valuation. At its peak in late 2020, C3.ai was valued at $17 billion, or 93 times the sales it would actually generate in fiscal 2021. Today, it's worth just $1.4 billion, or five times this year's sales.
What does C3.ai believe will happen over the long term?
During C3.ai's latest conference call in late August, CEO Tom Siebel warned that its customers "appear to be expecting a recession" as they reined in their orders. Siebel also warned that the potential downturn "could be significant" and throttle its near-term growth.
Siebel believes that after rising just 1% to 7% in fiscal 2023, C3.ai's revenue will "revert to historical annual growth rates" of more than 30% in fiscal 2024 "and beyond." CFO Juho Parkkinen, who took the position in February, claims that its shift toward smaller usage-based contracts will stabilize its long-term growth. A recent expansion of its partnership with Alphabet's Google Cloud, which bundles C3.ai's AI services with the tech giant's cloud services, could also boost its sales.
Yet analysts aren't as optimistic. They expect C3.ai's revenue to rise 3% in fiscal 2023, 21% in fiscal 2024, and 19% in fiscal 2025. Those growth rates are still robust relative to its current price-to-sales ratio, but its sales could still drop off a cliff in fiscal 2026 if Baker Hughes ends its closely watched partnership.
Where will C3.ai's stock be in three years?
Assuming that C3.ai matches analysts' expectations for $376 million in revenue in fiscal 2025, and it's still trading at about five times sales by then, it could be worth about $1.9 billion in three years -- which would represent a gain of nearly 40% from its current price but remain well below its IPO valuation of about $4 billion.
C3.ai's stock could rise even higher if investors are willing to pay a higher premium again, but I don't see that happening until it renews its deal with Baker Hughes, significantly reduces the energy giant's weight on its top line, stops switching CFOs and reporting methods, and proves that its pursuit of smaller usage-based customers actually makes sense.
