As artificial intelligence (AI) investing moves into the mainstream, one of the first stocks that comes up is C3.ai (AI -0.85%), primarily because it has AI right in its name. But is it one of the top ways to invest in the AI revolution? Or are there better ways to gain exposure to this space? Let's find out.
Heavy concentration is a risk
C3.ai has enterprise AI solutions that include plug-and-play energy management, inventory optimization, and anti-money-laundering programs. These programs can fit into different business software suites, like customer relationship management (CRM) or enterprise resource planning (ERP), and help its clients become more efficient.
While C3.ai has products for multiple industries, they are surprisingly concentrated in one industry: oil and gas. In the third quarter of fiscal 2023, ended Jan. 31, 72% of bookings came from this sector, with the second-largest contributor coming from the federal, aerospace, and defense segment with 16%. This concentration comes from its relationship with Baker Hughes, an oil field servicing company owned by General Electric. However, this could also be considered a risk if Baker Hughes terminated the partnership.
Furthermore, three separate customers accounted for more than half of C3.ai's revenue in fiscal 2022 (ending April 30, 2022), so it does have a heavy concentration risk. But it also opens up another possibility: What if C3.ai could capture hundreds of these customers? Clearly, a few companies have found its products so valuable that they are willing to spend significant resources deploying C3.ai's products.
One of its most recent wins was a $500 million contract from the Department of Defense for the U.S. Missile Defense Agency, which is slated to last five years. As more customers make public commitments with C3.ai, it will help diversify it away from a few customers as its products become more utilized throughout various industries.
However, C3.ai's finances don't back up this rosy outlook.
Revenue is shrinking for a reason
In Q3, revenue fell to $66.7 million from $69.8 million in the year-ago period. While this should raise red flags for every growth investor, it does come with a caveat. C3.ai is in the middle of a business transformation, shifting from a subscription model to a consumption model, where clients are only charged when using the products.
As a result, revenue shrank because existing customers didn't utilize the product enough to offset the higher subscription price. Management believes this transition will lead to customers using the company's products more. However, this is also risky because clients may cut usage during economic downturns.
Still, this transition is something to watch over the next year to see if it begins to affect its finances positively.
C3.ai is a very young company and is rapidly losing money, but that shouldn't surprise investors. The company is attempting to capture part of a large market and is willing to sacrifice near-term profitability for long-term market share.
However, the stock is richly valued for the business's performance.
AI PS Ratio data by YCharts
At nearly 10 times sales, C3.ai is essentially trading on the hope that it can significantly expand its customer base and rapidly grow revenue over the next five years. While I think C3.ai has the tools to do it, it's extremely risky due to its high concentration of three clients.
If you want to purchase some C3.ai shares because of its future, I don't see anything wrong with it, but I'd keep the position size relatively small due to the high risk. However, C3.ai competitor Palantir Technologies looks like a better buy right now, so I'd consider that stock before purchasing C3.ai.
