C3.ai's (AI 0.12%) stock price plunged 12% on Sept. 7 after the enterprise AI software company posted its latest earnings report. For the first quarter of fiscal 2024, which ended on July 31, its revenue rose 11% year over year to $72 million and surpassed analysts' estimates by $1 million. It narrowed its adjusted net loss from $13 million to $11 million, or $0.09 per share, which exceeded the consensus forecast by $0.08 per share.
C3.ai's headline numbers cleared Wall Street's low bar, but a closer look reveals a few bright red flags. Can it overcome those challenges over the next 12 months?
What happened to C3.ai over the past year?
C3.ai's AI algorithms can be plugged into an organization's existing software infrastructure to automate tasks, detect fraudulent transactions, and improve employee safety. It mainly serves large enterprise and government customers.
C3.ai's revenue rose 17% in fiscal 2021 (which ended in April 2021), and it grew another 38% in fiscal 2022. But in fiscal 2023, its revenue only climbed 6% to $267 million as it faced two major challenges.
First, macro headwinds drove many companies to rein in their spending. Second, C3.ai switched from a subscription-based model to a usage-based one that only charges customers for the services they use. That change reduced its revenue and the stickiness of its ecosystem, but the company insists it was necessary to attract more customers in this challenging market.
C3.ai's revenue growth has been sluggish over the past year. Its remaining performance obligations (RPO), or the remaining value of its contracts that have yet to be recognized as revenue, also dropped year over year for five consecutive quarters.
Metric |
Q1 2023 |
Q2 2023 |
Q3 2023 |
Q4 2023 |
Q1 2024 |
---|---|---|---|---|---|
Revenue growth (YOY) |
25% |
7% |
(4%) |
0% |
11% |
RPO* growth (YOY) |
(37%) |
(10%) |
(14%) |
(61%) |
(27%) |
C3.ai's declining RPO reveals the impact of its aforementioned switch from stickier subscriptions to more flexible usage-based deals. The company also still generates more than 30% of its revenue from a joint venture with the energy giant Baker Hughes. That crucial deal is set to expire in fiscal 2025 and hasn't been renewed yet.
On the bright side, C3.ai expects its revenue to increase 15%-23% year over year in the second quarter and 11%-20% for the full year. That outlook implies its top-line growth will accelerate as the macro environment stabilizes. It also expects the rollout of its new C3 Generative AI Suite -- which features 28 generative AI solutions for various industries -- to boost its near-term sales.
But C3.ai's margins are still shriveling
C3.ai's near-term sales growth is stabilizing, but its margins are still shriveling. Its adjusted gross margin dropped from 79% in fiscal 2022 to 77% in fiscal 2023, then tumbled to 69% in the first quarter of fiscal 2024.
During the Q1 conference call, CFO Juho Parkkinen blamed that "short-term pressure" on a "higher mix of pilots," which "carry a higher cost of revenue." In other words, a lot of C3.ai's recent sales growth comes from loss-leading pilot programs -- but there's no guarantee those customers will stick around because it isn't locking them in with subscriptions.
C3.ai's adjusted operating margin had slightly improved from negative 32% in fiscal 2022 to negative 26% in fiscal 2023, but it dropped back to negative 29% in the first quarter of fiscal 2024.
Based on the midpoints of C3.ai's guidance, it expects to post negative operating margins of 45% in the second quarter and 28% for the full year as it ramps up its marketing investments in its generative AI solutions. As a result, it withdrew its previous outlook for turning profitable on a non-GAAP (generally accepted accounting principles) basis by the end of fiscal 2024. That sudden guidance cut was likely the main catalyst for C3.ai's post-earnings sell-off.
Its stock is still overvalued
C3.ai trades at a 30% discount to its IPO price, but its enterprise value (EV) of $3 billion is still 10 times higher than its projected sales for fiscal 2024. That EV/revenue ratio is arguably too steep for a company that expects 11%-20% revenue growth.
Salesforce, which is expected to increase revenue 11% this year, trades at 6 times that forecast. UiPath, which is expected to grow its top line by 20% this year, also trades at 6 times that estimate.
Therefore, I believe the market hype for everything AI is still inflating C3.ai's valuation -- and its management is trying to keep that fire alive by mentioning "generative AI" more than 60 times during its latest conference call. But if we tune out that near-term noise, we'll notice its business isn't that impressive, its customer concentration issues are worrisome, and its valuation is too high. Based on those simple facts, I believe C3.ai's stock will likely underperform the market over the next 12 months.