The recent buzz around artificial intelligence (AI) has given C3.ai (AI 1.18%) stock a massive boost in 2023. Shares of this pure-play enterprise AI software provider are up 123% so far this year as investors recognize the growing demand for AI applications. But recent developments suggest that the company's terrific stock market rally may be in danger, at least in the short run.
Short-seller Kerrisdale Capital this week issued a report accusing C3.ai of accounting fraud, and the stock fell significantly on this news. Kerrisdale claims C3.ai inflated its revenue and margin in a bid to appear as a software-as-a-service company while it is actually a consulting services provider. The report claims this allowed C3.ai to enjoy an inflated valuation on the market. Kerrisdale also points out that the company's accounts receivables grew at a much faster pace than revenue, suggesting that C3.ai is inventing revenue to meet Wall Street's expectations.
It remains to be seen if these accusations are credible and investors await a response from C3.ai management as Kerrisdale has levied serious allegations against the company.
What happens if C3.ai ends up exonerated? Should investors consider capitalizing on the recent drop in the share price in anticipation of more gains? Let's find out.
C3.ai stock could face near-term headwinds
Based on C3.ai's financial performance, the stock may have gotten ahead of itself. On March 2, the company released results for its fiscal 2023 third quarter (which ended Jan. 31), reporting revenue of $69.8 million. That was a small improvement over the prior-year period's revenue of $66.7 million.
The company anticipates full-year revenue of $265 million at the midpoint of its guidance range. That would translate into a jump of just 5% over fiscal 2022's revenue of $252.7 million. So C3.ai's growth is not strong enough to justify its current high price-to-sales ratio of 10.
Analysts' share price targets also suggest that C3.ai may not be able to sustain its hot streak. With nine analysts covering it, the stock's median price target is $21 -- 15.8% below its current level.
All this indicates that buying C3.ai stock at its current valuation may not be a good idea. Investors would be paying too much for a company that isn't expected to deliver much growth this fiscal year and needs to clear the air about the accounting irregularities alleged by Kerrisdale. And it's possible that C3.ai could undergo a correction. But if that's indeed the case, savvy investors could get an opportunity to buy this AI play later at a cheaper valuation -- and it would make sense to do so.
Buying the stock on dips will be a good idea
The reason why C3.ai is set to report muted growth in fiscal 2023 is because of a change in the business model. The company has been transitioning to a consumption-based business model from a subscription-based model. Management believes this will help it accelerate the adoption of its enterprise AI software offerings, improve its sales cycle, and boost both revenue and profitability.
The transition means short-term pain for C3.ai, but the company remains confident that the consumption-based pricing model is the right strategy to adopt, as its customers won't be locked up in lengthy contracts. The move will also reduce the need for clients and C3.ai to negotiate on subscription pricing -- customers can simply pay for services based on their needs.
The good part is that the pivot to consumption-based pricing has already started bearing fruit for the company. The number of deals struck in fiscal Q3 increased 35% year over year. And C3.ai struck 20 deals priced at under $1 million last quarter, up from 12 in the prior-year period. This suggests that the company has lowered the barrier to entry for new customers looking to purchase its enterprise AI software, which seems like a smart thing to do given the massive potential in this space.
Mordor Intelligence forecasts that the enterprise AI market will grow at a rapid annualized pace of 52% through 2028. It is also worth noting that C3.ai's total addressable market could hit a whopping $791.5 billion by 2026. In that context, and based on its fiscal 2023 revenue estimate, the company today is only scratching the surface of a huge opportunity.
This also explains why C3.ai's revenue growth is expected to accelerate from fiscal 2024 onward as spending on AI software intensifies and the company's shift to the consumption-based model progresses.
AI Revenue Estimates for Current Fiscal Year. Data by YCharts.
Moreover, C3.ai anticipates that the adoption of the consumption-based pricing model will give its margins a boost and improve its profitability. For example, the company now expects a fiscal 2023 non-GAAP loss of $71 million as compared to the $81 million loss it forecast at the beginning of the year. Looking ahead, C3.ai expects to post a non-GAAP operating margin of 2% in the fourth quarter of fiscal 2024, which would be a big improvement over its negative 23% margin in the previous quarter. The company has a long-term non-GAAP operating margin target of 20%.
This also explains why analysts expect substantial bottom-line improvements from C3.ai compared to last fiscal year's adjusted loss of $0.73 per share.
AI EPS Estimates for Current Fiscal Year data by YCharts.
Even better, C3.ai is expected to deliver earnings growth of 50% annually over the next five years. So investors looking to buy an AI stock for the long run should consider accumulating C3.ai on dips, given the healthy end-market opportunity it is sitting on and the potential bottom-line growth it could deliver through its shift to a consumption-based revenue model. Of course, investors should also keep an eye on C3.ai management's rebuttal against the allegations of accounting fraud.
