Short-seller reports can be dangerous because they can quickly send a stock crashing if they highlight big holes in a company's operations. That's what happened to artificial intelligence company C3.ai (AI 1.58%) earlier this month, when Kerrisdale Capital sent a report to the company's auditors claiming there were "serious accounting and disclosure issues." But before you decide whether to buy or sell the stock, here are the three most important takeaways from the short-seller report.
1. Days sales outstanding are high
The one part of the short-seller report I think was the most valid was that C3.ai's aged receivables are indeed high, with days of sales outstanding at 163 days. And it has been trending in the wrong direction.
AI Days Sales Outstanding (Quarterly) data by YCharts.
This is something investors should undoubtedly keep a close eye on. But at the same time, it could be a handful of receivables that are causing the damage and the company may be due to collect on them in the near future.
It's problematic, but this is also a challenging time amid inflation for businesses trying to cut back on spending in preparation for a possible downturn in the economy. It's not inconceivable that some businesses may be paying slower nowadays. And it's certainly not necessarily a sign of fraud or anything that C3.ai is doing wrong. This is a metric investors should watch for in future quarters, however.
2. Gross margins are high, but not unreasonably so
Another claim the short-seller report made was that the company's gross margins were exceedingly high. It said "common sense" suggested that the company was reclassifying expenses from cost of goods sold to research and development. That's a mighty big assumption to be making, especially since C3.ai's margins aren't all that high compared to other tech companies that generate revenue from recurring services they provide, such as Palantir Technologies and Adobe:
AI Gross Profit Margin (Quarterly) data by YCharts.
C3.ai's gross profit margins are actually considerably lower than both of those companies. A near-67% gross margin is by no means high for a business that relies heavily on subscriptions -- approximately 90% of C3.ai's top line comes from subscription revenue.
3. The CFO is not a novice, as the report would have you to believe
The claim I found most ridiculous was that the company has hired an inexperienced CFO for the sake of signing off on questionable financial statements, and that having many CFOs in a short time span is concerning. But turnover can happen often, even at the CFO level. Last year, COVID-19 vaccine maker Moderna had a CFO depart after just one day on the job.
Kerrisdale suggests that an inexperienced CFO wouldn't have to worry about "ruining their reputation" by approving C3.ai's financials. But current CFO Juho Parkkinen is not only a designated accountant but also has eight years of experience working for a top accounting firm, Ernst & Young, LLP. This is a person who knows accounting rules, and is by no means unqualified or a novice just because he hasn't previously held a CFO position.
Investors should always be careful with short-seller reports
Kerrisdale discloses on its report that it is short shares of C3.ai, and so from the very beginning, investors should take its allegations with a grain of salt; the company has a lot to gain by scaring investors into selling the tech stock. And with C3.ai's stock nosediving following the release of the report, Kerrisdale likely made some great profits by publishing it.
While the high receivables balance is a bit of a concern, that's the only item that investors should be worried about -- and that may end up being a temporary issue. C3.ai is a company with a lot of potential, and it does have some risk. But you should make your decision based on its fundamentals and the outlook for the business, not what a biased short-seller report says about the company.
