C3.ai (AI 0.91%) and Upstart (UPST -0.58%) have both been divisive stocks among growth-oriented investors. C3 initially dazzled the bulls with its rapid growth, catchy ticker symbol, and the disruptive potential of its AI algorithms -- which can be integrated into an organization's existing software to automate tasks, optimize spending, and detect fraud.
Upstart is an AI-powered online lending marketplace that approves loans based on a person's education, standardized test scores, work history, and other non-traditional data points. That unique approach enables its lending partners -- which include banks, credit unions, and auto dealerships -- to serve a broader range of customers with limited credit histories.
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But today, C3 trades nearly 50% below its IPO price and almost 90% below its all-time high from Dec. 2020. Upstart has plummeted about 95% below its record high, which it reached in Oct. 2021, and trades slightly below its IPO price.
Both stocks lost their luster as their growth decelerated, they racked up steep losses, and rising interest rates popped their bubbly valuations. But should investors buy either of these out-of-favor growth stocks as a turnaround play?
C3 faces existential challenges
C3 recently gained a lot of attention during the recent buying frenzy in AI-related stocks, but its underlying business has three glaring problems. First, it generates about 30% of its revenue through a joint venture with the energy giant Baker Hughes (BKR 1.24%), and there's no guarantee that the shaky partnership will be renewed when it expires in 2025.
Second, C3 abruptly switched from a subscription-based model to a usage-based one -- which only charges fees when its algorithms are accessed -- last year. C3 claims that a usage-based billing model will be more appealing to thrifty customers in this tough macro environment, but it's also a lot less sticky than recurring subscriptions.
Lastly, C3's growth has slowed to a crawl. Its revenue rose 38% in fiscal 2022, but it only expects 5% to 6% growth in fiscal 2023 (which ended this April). It mainly blames that slowdown on the macro headwinds, but it also faces intense competition from Amazon Web Services (AWS), Microsoft's Azure, and other leading cloud platforms that already integrate similar AI algorithms into their sprawling ecosystems.
That slowdown wouldn't be too worrisome if C3 were profitable. Unfortunately, it's still bleeding red ink by both generally accepted accounting principles (GAAP) and non-GAAP measures, and it still can't be considered cheap, with an enterprise value worth six times its projected revenues for fiscal 2024. Simply put, C3 faces a lot of existential threats -- and its stock could easily be cut in half again once the hype regarding AI-related stocks dies down.
Upstart faces cyclical challenges
As an online marketplace for third-party loans, Upstart flourishes in a low-interest-rate environment, which encourages lenders to approve more loans and consumers to borrow more money. That's why its revenue surged 264% in 2021.
But it wasn't built to withstand the shock of higher interest rates, which caused its lending activity to grind to a halt in 2022 as its revenue dipped by 1%. Inflation also discouraged consumers from taking out fresh loans to fund big-ticket purchases.
As Upstart's third-party lenders provided fewer loans, the company started funding some of its marketplace loans with its own balance sheet last year. That drastic measure boosted its own debt levels, which made it an even less appealing investment as rising interest rates drove investors away from unprofitable and highly leveraged companies. More recently, though, it has found outside investors willing to provide billions in funding for such loans.
Upstart was profitable on a GAAP basis in 2021, but it turned unprofitable in 2022 as it approved fewer loans. Its non-GAAP net income also plummeted by 91%. For 2023, analysts expect its revenue to decline another 36% as it turns in a non-GAAP net loss. That slowdown is painful, but it seems to be mainly caused by cyclical headwinds instead of existential challenges.
If we look past those near-term issues, Upstart's business model still seems disruptive, its stock looks reasonably valued at less than three times this year's sales, and it could quickly recover once the macroeconomic environment improves.
The obvious winner: Upstart
I personally wouldn't chase either of these beaten-down growth stocks right now. But if I had to choose one over the other, I'd definitely pick Upstart because its stock is cheaper, and it arguably has an easier path toward a cyclical recovery than C3. Meanwhile, C3 can't be considered a viable investment until it resolves its customer concentration issues, demonstrates its usage-based strategy is actually effective, and meaningfully narrows its GAAP and non-GAAP losses.
