Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on C3.ai, Inc. (NYSE: AI)
NOTE TO EDITORS: The Following Is an Investment Opinion Issued by Spruce Point Capital Management
Highlights Growing Risk of Additional Revenue Deferment or Contract Elimination from Baker Hughes, C3.ai's Largest Customer Accounting for Over 30% of Sales
Observes Financial Reporting and Accounting Issues Related to Baker Hughes Joint Venture Sales Commissions, Accounts Receivables and Gross Margins
Uncovers Significant CFO Turnover at C3.ai, Including Three Different CFOs Since Registering to Go Public in Late 2020
Finds a Pattern of Exaggeration and Irreconcilable Statements Regarding C3.ai’s Customers, Technology Development Cost, Total Addressable Market Size, Pace of Market Growth, Market Share, Alliances and Sales Cycle to Close Deals
Believes Investor Expectations for Revenues Are Too High Given Significant Salesforce Turnover and Recent Restructuring
Raises Corporate Governance Concerns Related to the Board's Objectivity Given Directors' Past and Current Financial Dealings With Chairman and CEO
Sees 40% to 50% Downside Risk to C3.ai’s Share Price and Urges Investors to Visit www.SprucePointCap.com and Follow @SprucePointCap on Twitter for the Latest on $AI
February 16, 2022 09:15 AM Eastern Standard Time
NEW YORK--(BUSINESS WIRE)--Spruce Point Capital Management, LLC (“Spruce Point” or “we” or “us”), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled “Real Intelligence: Sell C3.ai” that outlines why we believe shares of C3.ai, Inc. (NYSE: AI) ("C3.ai" or the "Company") face up to 40% to 50% downside risk, or $12.85 – $15.40 per share. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and important updates.
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Spruce Point Report Overview
Founded in 2009 by Thomas Siebel and certain Siebel Systems business associates, Patricia House and Edward Abbo, we believe C3.ai has since gone through multiple rebrands and a restructuring in search of a sustainable business model. Initially, the Company was named C3 Energy, an energy management software solution, and subsequently became C3 IoT when hype around “Internet of Things” took off.
Currently, the Company positions itself as a leader in the enterprise artificial intelligence (“AI”) platform market. Amid surging interest in technology stocks, C3.ai IPO’ed at $42 per share in December 2020 and peaked at $177 per share. Now with the Federal Reserve projected to raise interest rates and institute tapering, we believe investors will more closely scrutinize the statements made by, and financial prospects of, once high-flying technology stocks such as C3.ai. Key findings from our report on C3.ai include:
- Evidence of a severely challenged partnership with Baker Hughes, a related-party and C3.ai's largest customer. In June 2019, Baker Hughes/GE ("Baker Hughes") purchased equity, which at pre-IPO accounted for approximately 15% of Class A shares, at an implied $460 million valuation, and agreed to both use and resell C3.ai’s product suite to its oil and gas customers with a minimum annual revenue guarantee over three years to reach $170 million by April 2022. Baker Hughes’ Chief Executive Officer Lorenzo Simonelli also joined C3.ai’s Board of Directors (the "Board"). The contract has since been amended three times, most recently in October 2021, resulting in peak purchase commitments being deferred to $125 million by April 2025 and price concessions now being offered to prospective clients. Mr. Simonelli recently resigned from C3.ai’s Board in December 2021. Based on our research, we believe the joint venture is a marriage that simply isn’t working. With more than 30% of C3.ai’s revenues tied to Baker Hughes, and set to expire in April 2025, we see an escalating risk to C3.ai shareholders from continued revenue deferment or early contract termination.
- Signs of problematic financial reporting and accounting regarding the Baker Hughes joint venture and a revolving door in C3.ai's Chief Financial Officer position. C3.ai reports Baker Hughes’ revenue and cost contribution to its financial statements at nearly 100% gross margin, which one former employee we interviewed described as “impossible.” We believe there is a discrepancy in accounts receivables tied to Baker Hughes and a related increase in unbilled receivables, which suggest that C3.ai may be aggressively recognizing revenues from Baker Hughes. Furthermore, C3.ai has been accruing and paying Baker Hughes sales commissions in excess of what we believe appears reasonable given the joint venture’s challenges selling. In addition, sales commissions are being amortized as an expense to the income statement at a slower pace compared to actual cash payments which have recently been made. Since its IPO registration in September 2020, C3.ai has employed three different CFOs. We believe C3.ai’s current CFO Adeel Manzoor is a problematic choice given his aggressive background, which includes a domestic violence charge, and a material weakness and financial restatement in his prior CFO and CAO leadership role at Telenav, Inc.
- Challenges in product adoption and significant salesforce turnover make it unlikely that C3.ai will meet aggressive analyst estimates. Former employees have commented that C3.ai is “literally invisible” in the market, despite its marketing and promotional efforts. While described as a company with good technology, employees have also called C3.ai “complex,” “too technical for consumption” and said, “it was a tough sell because [C3.ai] uses a huge number of 3rd party products.” Despite C3.ai's CEO recently claiming the Company's sales cycle is 4.5 months and decreasing every month, our research indicates that the sales cycle is closer to 18 months to two years. With C3.ai recently discussing a global sales salesforce reorganization on its last quarterly earnings call, we believe the Company will struggle to meet aggressive analyst revenue expectations, which have increased in recent months. Excluding revenue from Baker Hughes, analysts are implying 40% growth from all other customers, which is nearly 2x the historical growth rate. Our analysis of C3.ai’s non-cancellable backlog from all other non-Baker Hughes customers suggests it has largely been flat over the past few quarters.
- Evidence of exaggerated or irreconcilable claims made by C3.ai. We find numerous discrepancies on matters such as the value of and cumulative investment made by C3.ai in its technology, description of its customers, its total addressable market (“TAM”), the pace of its market growth and the scale of alliances with companies such as Microsoft, Hewlett Packard Enterprises, Google Cloud, Intel and Amazon Web Services. To illustrate, C3.ai changed the size of its TAM from $170 to $271 billion during its IPO process, with no evident change in its business mix or offering. C3.ai claims it’s a leader in its industry but given the Company’s current revenue run rate, its implied market share is just 0.12%. This suggests its TAM is too large – or C3.ai is not as relevant to the industry as it claims. In forming a new Digital Technology Institute, C3.ai ascribed a value of $60 million to its technology. However, its top two customers only spend an average of $28 million, and when we asked a former salesperson what the theoretical value for unlimited use of C3.ai would be, the answer was approximately $25 million. C3.ai has suggested that it has spent $1 billion on its product development since inception, but other statements suggest $500 - $785 million. Lastly, C3.ai has changed its definition of customers and entities. At one point, it stated a buying entity needed to only have “an enterprise agreement to deploy or establish the governing terms should we contract to deploy the C3 AI suite or one or more C3 AI Applications to different customers within the Entity.” Loose language like this could open the door for customer count overstatement.
- Worrisome corporate governance practices and insider enrichment. Spruce Point warns public retail investors that they have little ability to effect change at the Company given the CEO and Chairman’s 95% control over the Class B 50x super-voting shares. The dual class share structure also limits C3.ai’s stock from index inclusion and institutional buying. Furthermore, we question multiple directors’ ability to objectively consider shareholders' best interests. We note that directors Condoleezza Rice and “Independent Lead Director” Michael McCaffery are associated with Makena Capital Management, which according to recent IRS filings, has managed financial assets for C3.ai's CEO’s family foundation. Ms. Rice fails to include in her biography her director role at Kior, an alternative energy technology company charged with fraud by the U.S. Securities and Exchange Commission. C3.ai director Patricia House, who fails to put on her biography that she served as a director at Shutterfly – which revealed a non-reliance opinion and financial restatement – is also a long-time ally of C3.ai's CEO and served on his holding company’s Board. We estimate CEO Siebel and CTO Abbo have sold $640 million of C3.ai stock at advantageous prices in the $60s, while C3.ai’s share price languishes 40% below its IPO price.
- We conservatively estimate 40% - 50% downside risk to C3.ai’s share price. Despite C3.ai’s abysmal post-IPO performance, analysts are still split on the Company's outlook, with nearly half saying “Buy” and one analyst dangling a price target of more than $100 per share (the current average price target is $53.50 per share). Retail investors appear to be the biggest shareholders being baited by these optimistic targets. We cannot find a single AI thematic ETF that holds C3.ai as a top 10 position in its fund. We value C3.ai as a run-off of its existing Baker Hughes revenue commitments and believe the partnership will cease to exist in FY '25 at best – or at worst, be modified with even lower revenue or canceled prior to FY '25. We build in additional cash burn over the next 12 months and additional stock dilution. We adjust C3.ai’s balance sheet for newly created operating lease commitments and cash liabilities to the Digital Transformation Institute. We believe the stock has 40% – 50% downside risk over the next 12 months. As an additional reference point, we note that C3.ai’s recently departed CFO forfeited options to buy more than 900,000 shares at $17.10 per share – 30% lower than the Company's current price – which had an intrinsic value of approximately $20 million when he resigned.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
