The rising popularity of artificial intelligence (AI) has caught the attention of just about everybody on Wall Street. Analysts at financial institutions are attending seminars, webinars, and everything in between to try and get a grasp on which companies are making inroads in AI versus those that might be using the new buzzword as a means to attract attention.
While Big Tech firms such as Alphabet, Microsoft, Amazon, and Nvidia are already looking like the leaders of the AI pack, other growth companies, including Palantir, MongoDB, and ServiceNow, should not be overlooked. In the midst of these names sits one tech company that, from my purview, should be left behind: C3.ai (AI 3.02%).
Given its namesake and ticker symbol, C3.ai briefly experienced some meme trading activity during the early days of AI hype. However, after a couple of mundane earnings reports, savvy investors appear to be catching on to the company's lack of prospects. Let's dig in and analyze why it may be time to move on from C3.ai and look elsewhere.
A lackluster operation
C3.ai is a software-as-a-service (SaaS) company that generates revenue from two sources: subscriptions and professional services. Subscriptions represent recurring software licenses, and therefore growth in this category garners more intense scrutiny from investors.
For its fiscal first quarter ended July 31, C3.ai reported $72.4 million in total revenue. While this was at the higher end of the company's previously issued guidance, growth from subscriptions only grew 8% year over year in the quarter.
Moreover, roughly two-thirds of fiscal Q1 bookings stemmed from the Federal Defense and Aerospace sectors. To put this into context, one of C3.ai's biggest competitors is Palantir. One of Wall Street's most bearish stances on Palantir is that the company historically relied on large, lumpy government contracts. However, over the last couple of years, Palantir has showcased its ability to penetrate the private sector.
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The competition is intense
When it comes to AI, I do not believe there is a one-size-fits-all solution. Depending on the needs and use cases of the client, a multi-pronged approach may be best. For example, advertisers who are seeking sophisticated tools to measure the strength of a marketing campaign may find that Alphabet offers a suite of products that can achieve this goal. On the other hand, an enterprise that relies heavily on ChatGPT might find that Microsoft offers the best combination of services for its needs. Whatever the case, Big Tech will likely be a central component of a company's AI roadmap.
On the other hand, some smaller companies are showing just how prolific generative AI capabilities can be. As mentioned above, Palantir is witnessing surging demand fueled by its latest AI tool, released earlier this year. For this reason, the company's stock has experienced some new life and brought it within reasonable valuation levels of other growth equities.
Yet perhaps the biggest beneficiary of AI is Nvidia. The company's data center products and highly coveted semiconductor chips have Nvidia positioned at the nucleus of AI. Moreover, many of these companies generate billions of dollars of positive free cash flow from Big Tech to growth stocks. However, C3.ai is still unprofitable (reporting net losses) on a GAAP basis and is not yet generating free cash flow.
Although C3.ai is growing its top line, it simply is not doing so at a rate that challenges the competition. Moreover, as the company continues to burn cash, the competitive landscape will likely further separate itself as many other AI players can fund growth with existing cash flow.
Image Source: Company Filings and The Motley Fool
Take a look at the stock price action
As of the time of this article, C3.ai stock is up 130% year to date. While this looks like a huge victory, it's a bit misleading.
Since its initial public offering (IPO) in 2020, C3.ai stock is down almost 80%. Furthermore, since reporting earnings earlier this month, this stock is down 14%.
During the latest earnings season, investors got a front-row seat into the AI endeavors of several names in the tech sector. It's become clear that Big Tech is not messing around and that the behemoths are willing to invest billions into this new frontier. Additionally, some smaller players are emerging as potential leaders in the AI arms race and doing so impressively by maintaining profit margins.
From my standpoint, C3.ai sits at the other end of the spectrum. The company's revenue growth is lackluster, and it is struggling to build a profitable operation. Until the company can prove, as Palantir did, that it's more than a glorified government contractor, there is very little to like about this stock.
I suggest staying away from any momentum that may enter the price, as I believe more hype and shenanigans than the underlying fundamentals of the business drive it. If you currently hold the stock, I think now is a good time to exit and prevent yourself from becoming a bag holder. Should you incur a loss, the silver lining is that you can use these for tax harvesting purposes. If you are still looking for AI exposure, any capital you can recoup is likely better off reinvesting in other stocks, such as those mentioned throughout this article.
