Buyer Beware: Morgan Stanley is Bearish on This Popular AI Stock

Artificial intelligence (AI) stocks have been the darlings of the investment community for the better part of two years now. While semiconductor giant Nvidia (NVDA) has been the poster child of this revolutionary movement in technology, established tech titans like Microsoft (MSFT), Amazon (AMZN), and Google (GOOG) have also poured billions into bolstering their AI capabilities. And why not? The market for AI is projected to deliver massive growth over the next decade, with virtually every industry expected to feel the impact. 

However, while the Nvidias, Amazons, and Microsofts of the world might be well-established as leading players in the AI space, plenty of smaller companies are fighting for traction in the competitive industry, too - and some of them even have “AI” in their name to prove it. Here's a closer look at one of these players, and why Morgan Stanley just weighed in cautiously after earnings.

About C3.Ai Stock

Founded in 2009 by veteran Silicon Valley entrepreneur Thomas Siebel, C3.ai (AI) offers an enterprise AI platform that helps businesses leverage technologies like cloud computing, big data, and the Internet of Things (IoT) to gain insights and improve decision-making. The company, which went public in 2020, is currently valued at a market cap of $3.89 billion.

C3.ai stock is up 10.6% on a YTD basis, edging past the 8.7% gain delivered by the S&P 500 Index ($SPX).

The Bull Case for C3.ai

Solid Q3 Results: C3.ai's results for the latest quarter exceeded expectations on both the top line and bottom line - so much so that the stock popped 24.5% after the release.

The company reported total revenues of $78.4 million for the fiscal third quarter ended in January, denoting a yearly growth of 18%. The top-line growth was primarily driven by the 23% YoY increase in Subscription revenues, which form about 90% of the total revenues for the company. 

Over the past 3 years, the company's revenues have expanded at a CAGR of 19.76%. Further, that strong growth is expected to continue, as forward revenue growth is pegged at 13.3% - almost double the sector median of 6.6%.

C3.ai has yet to be profitable, and in the latest quarter, losses more than doubled to $0.13 per share from $0.06 in the prior year. However, the quarterly loss came in narrower than the consensus estimate of a loss of $0.25 per share. Notably, the company's losses have consistently beaten the consensus estimate, which speaks to prudent financial management for a newer company operating in such a capital-intensive domain as AI.

The company closed the quarter with a cash and equivalents balance of $723.3 million.

Diversified Business: C3.ai's operations are diversified across a varied set of industries, with the highest allocation being only at 29% (State and Local Government). Other top contributors to the company's bookings distribution are Federal, Defense and Aerospace (25%), Manufacturing (16%), and Agriculture (16%). Notably, partner-supported bookings rose by an impressive 337% from the previous year.

Moreover, the company's partner network includes top corporations like Amazon's AWS, Google Cloud, Microsoft, T-Mobile (TMUS), and Boston Scientific (BSX), among others. On the Government level, C3.ai has partnerships with the U.S. Department of Defense, San Mateo County, Daly City, and Riverside County in California, to name a few.

With a varied set of partners across industries, corporations and government, C3.Ai remains less vulnerable to headwinds in a particular industry, providing it with revenue stability.

Generative AI: C3.ai is also strengthening its generative AI offerings. In Q3, the company closed 17 C3 Generative AI pilots across a broad range of industries, including Federal, Defense and Aerospace; Agriculture and Forestry; and Food Processing, among others.

This follows on the heels of 36 generative AI pilot deals signed during fiscal Q2, with 21 of those customers having a revenue base above $10 billion.

Moreover, C3.ai has reported solid results from its GenAI customers. Law firm DLA Piper used C3 Generative AI to reduce the attorney time it takes to create 200+ point due diligence analyses of limited partner agreements by 80%, and European firm Holcim - a leader in sustainable building solutions - completed a successful six-month pilot with C3.ai that led to a four-year agreement to scale C3 AI Reliability across its 100+ cement plants.

The Bear Case for C3.ai

Risk from Revenue Strategy Migration: C3.ai is currently in the process of migrating its revenue strategy from a subscription-based service to a more modern, consumption-based service, in which the firm charges per CPU/GPU usage as opposed to a pure subscription service.

This type of migration is gradual and can suffer from many growing pains, as was seen in the SaaS industry almost a decade ago. Notably, management has disclosed that the firm may experience negative revenue growth, followed by flat revenue growth, due to this transition.

Lack of Profitability: C3.ai is not profitable, and that remains a concern for both current and prospective investors alike. Further, stronger peers like Palantir (PLTR) and Salesforce (CRM) operate in industries that overlap with C3.ai, making its path to profitability even trickier.

Steep Valuation: As C3.ai remains unprofitable, some of the traditional earnings valuation metrics do not apply. However, those that do suggest the stock is potentially overvalued at current levels.

The company is trading at a forward price/sales and enterprise value/sales ratio of 12.37 and 10.05, respectively - well above the tech sector median of about 3x, and steeper than AI software stocks like UiPath (PATH).

The Bottom Line on AI Stock

The analyst community also have mixed feelings about C3.ai stock. As a case in point, Morgan Stanley analyst Sanjit Singh poured cold water on the post-earnings rally, weighing in with an “Underweight” rating and a $21 price target. He says the stock’s valuation remains unattractive, at more than 12 times sales, and wrote, “We look to get more constructive should the growth profile of the business accelerate and as underlying profitability begins to flow thru the model.”

On the other hand, Wedbush analyst Dan Ives reiterated his “Outperform” rating, and also upped his target price to $40 from $35. “We view this quarter as a step in the right direction for C3 as the company’s entire product portfolio continues generating unprecedented demand for its AI platform to improve operations, optimize processes, and transform businesses,” he wrote.

The overall analyst community have deemed the stock a “Hold,” with a mean target price of $29.17 - a discount of 8.1% to Thursday's close. Morgan Stanley's price target is a steeper 33.8% discount, while the Street-high target from Ives implies expected upside of 25.9%.

Out of 14 analysts covering the stock, 3 have a “Strong Buy” rating, 7 have a “Hold” rating, 2 have a “Moderate Sell” rating, and 2 have a “Strong Sell” rating.