C3.ai (AI -3.78%) has been the source of increased interest thanks to its ticker symbol: AI. With interest in artificial intelligence (AI) stocks ramping up, C3.ai stock was a clear benefactor, as the stock more than tripled at the beginning of 2023. Then, a short report and letter to C3.ai's auditor from Kerrisdale Capital caused the stock to tumble. It now sits roughly 50% down from its 2023 high but is still up an incredible 55% for the year.

Clearly, there's a lot going on with C3.ai's stock. Here are a few things investors should understand before considering a position.

1. A short-seller made some strong accusations

The short report on C3.ai essentially focuses on its relationship with oil services company Baker Hughes (NASDAQ: BKR). Kerrisdale argues that C3.ai has a failing relationship with Baker Hughes, which is a problem because the company accounts for more than 30% of its sales.

When one company accounts for a significant portion of revenue, it's dangerous, as it could quit using C3.ai's product and leave the company in shambles. While management did nothing in its rebuttal release to dispute that its relationship with Baker Hughes was strained, it did point out that it has been upfront with investors that Baker Hughes is a significant portion of its revenue.

There were also allegations of inflated unbilled receivables, which could mean C3.ai is reporting inflated revenue yet not realizing it. Again, management refuted this claim by stating that its accounting practices are standard, based on generally accepted accounting principles (GAAP), and that they're not out of line with those of other software companies.

While some of the short report may have been easily refuted, the concentration with Baker Hughes and other oil giants is troubling.

2. C3.ai has an oil and gas concentration

C3.ai champions its solutions spanning various industries, including financial services, state and local government, and supply chain management. However, it's focused on one area: Oil and gas.

We've already discussed how Baker Hughes makes up a large amount of C3.ai's revenue, but with 72% of sales coming from this sector during the third quarter of fiscal year 2023 (ending Jan. 31), it's also concentrated in one industry. Fortunately, new sales are much more balanced, with various sectors piloting C3.ai's products.

Chart showing C3.ai's revenue diversity.

Image source: C3.ai.

Still, if the balance of new customers is roughly equal, it will do nothing to swing the overall booking makeup in a different direction. C3.ai has only been public since late 2020, so it has been in operation primarily when the oil industry has done quite well for itself. It's unknown how C3.ai would perform if oil prices fell off a cliff, creating a risk for investors.

Plus, with oil and gas slowly being phased out, C3.ai's primary customers will slowly see demand fall over the next 50 years. With this kind of uncertainty built into the stock, it raises some red flags.

3. Management has switched up C3.ai's billing style

Looking at C3.ai's latest earnings release, you may have noticed its revenue falling slightly compared to last year's Q3. That's because C3.ai is switching its billing practice from a subscription style to a consumption-based one.

By only charging clients when they use its products, C3.ai aligns user interest with the company, creating a more positive relationship. As this accounting works out throughout the year (revenue is projected to fall once again in the fourth quarter), investors will need to make sure C3.ai returns to growth mode when it overlaps its billing change that was announced during its Q1 2022 (the three months ending July 31, 2022).

It's possible that this changeup may have been a smoke-and-mirror type change, as Kerrisdale suggests with its accounts billable claim. However, multiple companies use this model, so the transition risk here is likely limited. However, with its remaining performance obligations (RPO) falling (they decreased from $537 million to $436 million year over year), it's a sign some accounts may not be renewed.

That's a lot of risk for a company that hasn't produced any profits to date (its net profit margin in Q4 was an incredible negative 95%). Because of that, I think there are much better companies to invest in if you want to gain AI exposure.

While C3.ai may become a better company after its billing transition is complete, the customer and industry concentration are too great, revenue isn't growing quickly enough, and profits are a long way away.