C3.ai Inc. (AI, Financial) is a technology company that provides artificial intelligence software solutions to various industries, from manufacturing to health care.
After a splashy public debut at the end of 2020, C3.ai saw its stock value plummet by 90% over the next two years as growth slowed and investors lost their appetite for loss-making companies. However, with the emergence of ChatGPT earlier this year, there has been a rush among investors to buy any stock remotely associated with the broader AI trend.
As such, C3.ai's stock has soared more than 80% year to date, though it remains below its all-time high of $177.47.
One of the primary obstacles the Redwood City, California-based company is currently facing is increasing competition as generative AI gains traction. Moreover, the company's dependence on a single client for a significant portion of its revenue poses a substantial risk to its financial stability.
These factors, combined with the volatile nature of the stock market, create a complex landscape for C3.ai to navigate.
The problem with the business model
C3.ai specializes in developing enterprise-level artificial intelligence solutions that enable its customers to access machine learning and data analysis capabilities. The company generates revenue through a subscription-based model and professional services offered with the software license. In October, C3.ai also started offering its software under a consumption-based model to attract more customers.
The company has formed key partnerships with a number of customers, such as Baker Hughes Co. (BKR, Financial), to promote its solutions to specific industries. However, this has resulted in a strong dependence on these customers.
Despite undergoing multiple name changes, from C3 Energy to C3 IoT and now C3.ai, the company continues to struggle with profitability even as AI technologies increase in popularity. Even with partnerships and free trials, customer acquisition and revenue growth rates have been slow.
Don't put all your eggs in one basket
The company has also become the target of short sellers. Kerrisdale Capital publicly announced its short position on C3.ai on March 6, citing poor products based on outdated AI technology, a dwindling customer portfolio and an underperforming business model compared to the software industry average.
In addition to using outdated technology, C3.ai is struggling to expand its customer base. As of its fiscal third-quarter 2023, Baker Hughes accounted for over 40% of its revenue and the overall oil and gas industry made up 72%. As this industry is highly cyclical, a recession or other significant headwinds would negatively affect C3.ai's already weak business model.
As such, diversification of the company's revenue streams would do a great deal of good, along with improving its technology.
A highly inflated stock price
While investors may believe that many customers will opt to purchase artificial intelligence applications off the shelf rather than developing their own, it is important to note that the already weak adoption of C3.ai's products could result in significant downside risk for the stock. Additionally, the recent surge in the share price has likely been driven by ChatGPT hype over the last three months and may not necessarily reflect the company's true fundamental value.
The company's price-sales ratio has fluctuated significantly over the past several years, with a high of 70.91 and a low of 4.31, indicating instability in its valuation. The median price-sales ratio was 10.43, which is still higher than the industry median of 2.38. Furthermore, C3.ai's price-sales ratio is ranked worse than 83.98% of 2,671 companies in the software industry, indicating investors are paying a significant premium for the stock.
While there may be potential for growth if interest rates drop, investors should carefully consider the potential risks associated with the company's overvaluation and weak adoption of its products.
Takeaway
The bottom line is C3.ai is overvalued. Despite the potential for growth, weak adoption of the company's products could pose a significant downside risk for the stock. Further, investors should consider that the recent surge in the stock's value was likely driven by excitement over ChatGPT and may not necessarily reflect the company's fundamental value.
While investors may believe that customers will opt to purchase its applications rather than develop their own, this may not necessarily translate to success for C3.ai. The company's high price-sales ratio suggests investors are paying a significant premium for the company's revenue, which may not be sustainable in the long term.
It is important to focus on fundamental value rather than hype or speculation and to consider both the potential upside and downside risks associated with the investment. Therefore, investors should approach the stock with caution and carefully weigh the risks associated with it before making a decision.
