Everyone is talking about artificial intelligence (AI) these days. Thanks to the breakthrough of ChatGPT, tech CEOs and pundits alike are convinced that artificial intelligence, in particular generative AI, will be the next major computing platform.
Unfortunately for investors, pure-play AI stocks are hard to come by on the stock market, making it hard to know how to capitalize on this opportunity. That's a major reason why C3.ai (AI 0.09%) has attracted so much attention on Wall Street. It's one of the few AI stocks available to investors with a model using a software-as-a-service platform to deliver AI for enterprise solutions for customers.
As a result of that surge of interest in artificial intelligence, C3.ai stock nearly tripled through the first three months of the year. Before you jump on the bandwagon with the high-flying AI stock, you should be aware of the drawbacks it's facing. Here are three reasons to avoid the stock at the moment.
Image source: Getty Images.
1. C3.ai isn't the high-growth stock you think it is
The hype around AI and the attention on C3.ai, in particular, might make you think that this is a fast-growing software company, but its recent results show that's anything but the case.
C3.ai reported a decline in revenue in the fiscal third quarter, its most recent period, showing it's facing the same kind of challenges as most of the tech sector. In Q3, revenue fell 4.4% year over year to $66.7 million. This was partly due to the company's decision to change its business model from subscription-based to consumption-based, which has created some noise in the results.
Revenue is expected to decline slightly in the current quarter as well. But management said revenue growth would accelerate in fiscal 2024 due to drivers like the launch of its generative AI platform, increased interest in the consumption-based model, and new and expanded partnerships with businesses like Alphabet's Google Cloud.
C3.ai is also losing money. It's on track for an adjusted operating loss of $69 million to $73 million this year, but management expects the company to be cash flow positive and profitable on an adjusted basis by the end of 2024.
Those are big promises from a company that has struggled with execution, including the business model issue. And given the macroeconomic climate, investors shouldn't assume it will hit that guidance.
2. C3.ai customer concentration is a problem
Most software companies tend to receive a range of interest across multiple industries, but C3.ai has struggled with diversifying its revenue sources.
In fiscal 2022, 31% of its revenue came from Baker Hughes, the oilfield services company with which it has a strategic partnership, and its top three customers last year accounted for 57% of accounts receivables, a proxy for revenue.
In its most recent quarter, 72% of its bookings came from the oil and gas sector. That makes it particularly vulnerable to a crash in oil prices, which is likely in a global recession as oil prices are highly cyclical.
The company has a "lighthouse" strategy of tapping into new industries by landing a flagship customer in that sector and then expanding to other customers in that industry from there. But while C3.ai also serves industries like banking, utilities, defense, and manufacturing, that revenue hasn't been sufficient to diversify the business away from oil and gas.
The company finished its most recent quarter with 236 customers, though it's hopeful the consumption-based model can bring in more smaller accounts.
3. C3.ai's valuation is based on hype
The stock's tripling in the first quarter was based almost entirely on hype around artificial intelligence rather than any improvement in the fundamentals. Shares also got a boost at the end of January after C3.ai announced its new generative AI product suite, though it doesn't appear to be generally available yet.
However, after the current run-up in the price, the stock now trades at a price-to-sales ratio of 15. Through the first three quarters of the fiscal year, the company's lost $217 million on $174 million in revenue, indicating it's a long way from being profitable on a generally accepted accounting principles (GAAP) basis.
Given those financials, investors seem to be bidding the stock higher on nothing more than the company's growth promises and vague notions about the transformative potential of AI.
At this point, a bet on C3.ai seems like more of a lottery ticket on artificial intelligence rather than a rational investment in a company whose future cash flows justify its current price.
After the collapse in tech stocks over the last year, investors should know better.
