A wave of selling has pounded growth stocks, and C3.ai (NYSE:AI) stock has been among the biggest victims. Shares are down some two-thirds from February highs.
There are some explanations. C3.ai was one of the hottest initial public offerings (IPOs) of 2020, which is saying something. AI stock rose 140% just on the first day of trading. At those February highs, it had more than quadrupled.
So a correction probably was needed. Earnings didn’t help, either.
With fiscal third quarter results released on Mar. 1, C3.ai gave what was seen as light guidance for revenue in Q4 (though the outlook topped Wall Street consensus).
And, again, we’ve seen high-multiple growth stocks take a beating of late. It might be a rotation into the “reopening trade.” Or it might just be some profit-taking.
Whatever the cause, in the case of AI stock the plunge looks like an opportunity. This is one of the better growth stories in the market. But it’s no longer priced that way.
The Valuation Shift in AI Stock
The steep decline has materially changed the valuation of AI stock relative to the market.
Based on its guidance, C3.ai should do about $182 million in revenue in FY2021. At the highs in February, the company had a market capitalization nearing $17 billion.
That’s a price-to-revenue multiple above 90x. Excluding some early stage public companies (like pre-revenue electric vehicle manufacturers), that was one of the highest valuations in the entire market.
I think the C3.ai story is compelling enough to at least consider that kind of valuation. But it’s harder to make a compelling case for that story when the market is pricing it as one of the best out there.
Look at where we are now, though. With C3.ai’s market cap below $6 million, the same price-to-revenue multiple now sits at about 30x.
That’s not cheap, obviously. C3.ai remains a ways from profitability as well. But the multiple now is at least in the neighborhood of other SaaS (software as a service) plays. And that makes AI stock more attractive.
Still Too Expensive?
Now, you could see the selloff as big — but not big enough. Again, 30x revenue isn’t cheap. C3.ai is years away from profitability. A skeptic could argue that the stock still is in a bubble — simply a smaller one.
But let’s understand what C3.ai is. It’s an artificial intelligence play. It’s also a company that’s closer to being a startup than a mature business.
The C3 AI Suite allows large enterprises to build out their own artificial intelligence applications. The product is only about a decade old.
And that raises a couple of problems for near-term performance.
First, the market simply isn’t that big at the moment. Even major corporations still are considering their broader use of AI and its applications. Smaller companies, meanwhile, simply don’t have a use case yet.
Second, the company still is building out the suite with new features and improved functionality. That costs money. So does attracting new customers to the platform.
Put simply, C3.ai shouldn’t be profitable right now, or all that big. Yet it’s still expecting revenue over $180 million in FY2021, and should easily clear $200 million next year. Those numbers aren’t huge — hence the high multiple to revenue — but they’re solid considering where C3.ai is in its growth curve.
The Long-Term Case
Meanwhile, as always, investors need to take the long view.
And the long view for C3.ai is quite promising. We don’t know exactly what the artificial intelligence market will look like in a decade, but without question it will be larger. Most likely, it will post exponential growth.
C3.ai has a big chance to be a big part of that massive market. Right now, there’s basically no competition. Some large enterprises are building their own applications in-house, but that’s expensive, time-consuming and risky.
Obviously, competitors will rise. But the head start C3.ai has built in going from zero to nearly $200 million in sales will provide a key competitive advantage.
It’s an advantage that not too many other SaaS companies have. Those that do have the same seemingly high valuations that AI stock has … sometimes even higher.
Most of those companies have earned those valuations. I expect C3.ai will do the same.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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