C3.ai Stock: This Is One To Watch (NYSE:AI)

Thesis

We have viewed C3.ai’s (NYSE:AI) fundamentals as being far too risky for its entire life as a public company, but at current levels things start to get interesting. We believe that C3.ai could outperform the market’s expectations and that the current valuation potentially makes them a buyout target. Investors with a high risk tolerance may want to consider taking a closer look.

C3.ai’s Potential to Beat Expectations

C3.ai reported a decent Q2 with subscription revenue growing 26% year over year. Overall revenue grew by a more disappointing 7%.

C3.ai guided for just $63.0 – $65.0 million in revenue for the next quarter. Compared to $62.4 million in revenue for their most recently reported quarter this guidance isn’t great. The poor guidance is mostly due to a shift in their business model.

C3.ai has decided to switch to a consumption based pricing model. This change has hurt results in the short term but will likely bring long-term benefits to the company.

C3.ai used to focus on landing large subscription contracts. The current economic environment made that challenging. It’s difficult for a manager to justify signing a multimillion dollar software agreement if their company is laying people off or financially struggling. On the other hand, if a company can start using the software without making a large financial commitment, they can have a better idea of the benefits it provides their company and scale usage accordingly. With the new pricing model, C3.ai could end up earning the same amount from each customer and the optics are much better. Customer acquisition will likely be much easier and less costly going forward.

The bull case for C3.ai is that they can successfully transition their business and return to growth. The company is trading at a bargain price and if they can turn their business around the market will reward them accordingly.

Price Action

C3.ai stock has faced steep declines for a while now. Most of that is due to the hype that was injected into the stock after its IPO. Its 2020 IPO price was $42 a share, but the stock ran up all the way to the $180 range before coming back to Earth ever since. While C3.ai has been obscenely expensive the entire time it has been a public company, now may finally be the time for investors to take a serious look here.

Valuation

On a valuation basis, C3.ai is trading at levels that are somewhat of a rarity in the software space. The company is trading at just 1.36x book, 1.54x cash, and 4.76x sales. This is usually a sign that investors have soured on the business and no longer believe that they will achieve profitability or generate significant value going forward. We can see that C3.ai traded at a nosebleed valuation of over 75x sales at one point before declining ever since. This rapid multiple compression may finally be over.

A company could buy C3.ai and get a large part of their purchase back in cash. For this reason, C3.ai could be an attractive purchase to private equity firms as well as other tech companies. While this type of speculation isn’t a reason to make an investment on its own, it can provide somewhat of a floor to the stock price as well as optionality.

Risks

Some risks to C3.ai are:

The company might never be able to operate their business profitably.

The transition to a consumption based pricing model might not be a smooth one and their projections could be too optimistic.

They could get outcompeted and be unable to thrive in their end markets.

For a loss-making tech company, these risks are substantial. Investors will want to make sure that they have a high risk tolerance and long-term time horizon before even thinking about buying shares, even at these depressed prices.

Key Takeaway

C3.ai is a company that is being questioned by the market. If it can successfully pilot the transition to a usage based pricing model, the market will reward the company. If it is unable to improve its value proposition, the stock will continue to struggle. At these levels, the company is starting to look attractive to potential acquirers. For investors with a high risk tolerance and a long-term time horizon, it might be time to take a closer look here.