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Given all the hype surrounding generative AI, you’d think that C3.ai (NYSE:AI) would be flourishing. Instead, the company is still facing macro pressures and continues to work through its transition to a consumption-based revenue model. I had previously raised concerns about the ability of management to meet their aggressive guidance for non-GAAP operating profitability by the end of the year, and management has indeed pushed back that milestone into sometime next year. The company maintains a very strong balance sheet highlighted by over $800 million in net cash and is operating very close to breakeven cash flow levels. However, there is little reason to believe in a significant acceleration in top-line growth other than association with generative AI and management guidance – the current valuation appears to already be pricing in a significant acceleration from current levels. Even after a correction in the valuation, I must reiterate my sell rating given my more tempered view on future growth rates.
Earlier this year, AI stock recovered strongly from the lows on the backs of generative AI hype. The stock has since pulled back from recent highs.
I last covered AI in August where I explained why I was downgrading the stock to a sell. Disappointing financial results as well as fears of higher interest rates have pressured the stock price, but I continue to view the valuation as being aggressive.
In its most recent quarter, AI delivered $72.4 million in revenue, representing 10.9% YoY growth and falling short of guidance for $72.5 million. A bright note was that the company lost only $20.7 million in non-GAAP operating income, better than the projected $30 million loss. Free cash flow came in stronger mainly due to interest income earned from the cash balance.
AI saw remaining performance obligations (‘RPOs’) decline to $334.6 million, down from $458.2 million YoY. Current RPOs came in at $170.6 million, down from $186.3 million in the sequential quarter. This was blamed primarily on the company’s ongoing transition to a consumption-based model.
As seen at tech peers, the tough macro environment has greatly impacted deal sizes, though AI is already beginning to lap easier comps in this respect.
AI ended the quarter with $809.6 million of net cash. Looking ahead, management is expecting up to $76.5 million in revenue, representing up to 23% YoY growth. Management maintained full-year guidance for up to $320 million in revenue, representing up to 20% YoY growth, but increased the non-GAAP operating loss expectation from $75 million to up to $100 million.
On the conference call, management did not reiterate expectations for $700 million to be the “bottom” in cash balance this year. Management stated that “the Generative AI opportunity is so massive that we have decided to invest for success.” Management had previously been guiding for non-GAAP operating profitability by the fourth quarter, but has now pushed back that target to “the course of FY’25.” Management did however state expectations to be cash flow positive in the fourth quarter and in the next year. Barring any negative surprises, I still find it likely that the company maintains a net cash balance in excess of $700 million as it is hard to imagine the free cash flow loss swinging from $8.9 million in this past quarter to $50 million in the next two quarters each.
AI has received investor interest in part due to both its artificial intelligence product offerings as well as its stock ticker. The company has unveiled a generative AI offering of its own, with the unique feature being “deterministic responses” that minimize hallucination risk.
It is still too early to determine who will be the winners from generative AI, especially among software names. I have previously stated my belief that competitor Palantir (PLTR) is better positioned than AI in this respect, but a clear argument can be made that it will ultimately be the bricks and shovels companies that benefit most – for example the GPU provider Nvidia (NVDA) and cloud provider Microsoft (MSFT) come to mind. Even after the fall from recent highs, AI was still trading at a premium valuation.
Consensus estimates call for a significant ramp-up in revenue growth. I previously assumed an acceleration to 25% revenue growth, 20% long term net margins, and a 1.5x price to earnings growth ratio (‘PEG ratio’), leading to a potential fair value estimate of 7.5x sales. That is a pretty reasonable baseline assumption and it suggests that the stock may be dead money for a handful of years before growing into its valuation. On the other hand, if growth only accelerates to 15%, that fair value estimate dips to 4.5x sales, and I would question if the stock can ever grow into its valuation. I view it to be difficult to invest in the stock until we get further clarity on what revenue growth will look like when the consumption-based transition is no longer a negating factor – by the company’s own estimates that should happen within 3 quarters. The higher interest rate environment has seen the market reward tech names that can deliver profitability at least on a non-GAAP basis, with many firms delivering an aggressive transition in just a matter of quarters. It is potentially concerning that AI has yet to achieve non-GAAP operating profitability, though it still has a large net cash position to buy it time. Further, it is notable that CEO Thomas Siebel has not sold stock since 2021 when the stock was trading just around $50 per share. The stock is not as egregiously valued as the last time I covered the name, but I am of the view that the quality is not quite here in order to justify many years of accelerating revenue growth. I reiterate my sell rating as investors should search harder for better generative-AI opportunities.
