Artificial intelligence (AI) is arguably Wall Street's most prominent theme in 2023, and enterprise software company C3.ai (AI 0.71%) benefited greatly from that extra attention. Share prices have spiked more than 200% since January but fell back to Earth somewhat in recent weeks.
Is this AI stock taking a breather before trudging higher, or is this a bubble of hype finally bursting? Before buying the dip, long-term investors should consider these three potential concerns that C3.ai's business must address in order to succeed.
1. C3.ai is generating poor revenue growth
C3.ai sells AI applications and software to enterprises. This includes a platform where developers can create AI applications using C3.ai's building blocks or purchase finished applications that can serve specific purposes for a business.
For example, C3.ai offers a law enforcement application that can use data and AI to uncover patterns or trends. Energy companies can use C3.ai's Oil and Gas suite of apps to optimize forecasting and scheduling, comply with regulations, and identify operational risks. In other words, AI is helping users leverage data to work smarter.
One might expect rapid growth from a company with innovative solutions like AI, but the numbers don't seem to show that. As the chart below indicates, C3.ai's quarterly revenue growth hasn't exceeded 42% and has slowed down in recent quarters.
Part of the reason for the recent drop is the company switched its billing method to a consumption-based model. Management expects growth to increase over time as customers use its technology more. On the other hand, why would C3.ai make this change if previous sales efforts were going well?
AI Revenue (Quarterly YoY Growth) data by YCharts
If anything, the stock's surging share price should follow an improvement in growth, not precede it. It seems as though investors are giving management credit for results that haven't come yet, which means disappointing earnings numbers moving forward could result in share prices getting hit hard.
2. C3.ai's profit margins going backward
Growing companies often lose money and work toward profitability as revenue growth outruns expenses. That's called operating leverage and is an excellent sign for a company's future. However, C3.ai hasn't slowed its losses yet; its operating margin has continually deteriorated.
AI Operating Margin (TTM) data by YCharts
Management believes the business will turn a non-GAAP (generally accepted accounting principles) operating profit five quarters from now, but that's still leaving important expenses like stock-based compensation out of the equation. The company could be at least two years from profitability -- and that's if things go according to plan. It's something to watch, especially in light of weak revenue growth.
3. C3.ai has some customer concentration risk
C3.ai doesn't have a vast customer base -- it numbers just 236 as of Jan. 31 -- but that includes some wrinkles. For example, the company counts each distinct division, department, business unit, or group within a customer entity as a customer, potentially overstating the number of separate enterprises that C3.ai does business with.
One customer entity accounted for 45% of revenue in the quarter ending Jan. 31. Two separate customer entities accounted for 36% and 10% of C3.ai's revenue in the prior year's same quarter. In other words, a few enterprises carry water for most of C3.ai's customer base.
What happens if one of these entities, such as Baker Hughes (its largest customer), pulls its business? The company is potentially losing multiple customers (by C3.ai's definition), not just one.
This is a speculative stock
These are some factors to consider when considering C3.ai as a potential investment. The business isn't growing much right now (or is profitable), and losing the wrong customer could be a huge setback. That makes the stock more speculative, and it's not a great idea to chase risks. Investors should probably steer clear until there are a few quarters of better growth and improving margins to hang their hat on.
