Stock Story - What Happened: Shares of artificial intelligence (AI) software company C3.ai (NYSE:AI) jumped 10.8% in the morning session, reflecting the broader market's ongoing uptrend, which some may playfully call the Santa Claus rally (a real observed phenomenon where the market tends to drift upwards during the holiday season for reasons such as optimism and year-end tax considerations for funds and investors). All major indices rose, fueled by growing optimism about the Federal Reserve not only concluding its rate hikes but cutting in 2024. Easing inflation has been the catalyst for this change in tone from the Fed.
During the December 2023 Fed meeting, committee members signaled for at least three quarter-point rate cuts in 2024, roughly aligning with market expectations but more accommodative than Fed officials' previous statements. This has set the stage for a soft landing scenario, where inflation comes under control without damage to the economy that could hurt overall consumer demand.
As a reminder, lower rates are good for stock valuations, especially for tech companies where the market needs to discount back cash flows further out in the future. When the math is done to discount these cash flows back to today, a lower assumed discount rate leads to higher present values.
What is the market telling us: C3.ai's shares are very volatile and over the last year have had 74 moves greater than 5%. But moves this big are very rare even for C3.ai and that is indicating to us that this news had a significant impact on the market's perception of the business.
The previous big move we wrote about was 13 days ago, when the stock dropped 10% on the news that the company reported second quarter with revenue falling below Wall Street's estimates. Despite the substantial growth in generative AI demand, the company identified prolonged decision cycles in many instances. Sales execution challenges in Europe were also highlighted. Furthermore, the ongoing transition to a consumption-based pricing model was acknowledged to have a short to medium-term adverse impact on revenue growth.
As a quick recap, consumption-based contracts provide customers with enhanced flexibility. Unlike traditional long-term commitments, customers can scale their consumption of the products and features almost real-time. This means that during good times when demand is high, revenue can grow faster than if the company goes to market with a contract model. On the other hand, though, if times are tough or if competition is increasing, customers can scale down usage, and revenue will see headwinds faster than if the company goes to market with a contract model.
Looking ahead, guidance for next quarter underwhelmed, with its revenue outlook slightly below analysts' estimates and its projected adjusted operating margin missing significantly. Additionally, the company anticipates a long-term drag on RPO (remaining performance obligations, a leading indicator of revenue) due to reduced sales prices and fewer contracts with upfront multiyear commitments stemming from the shift to a consumption model. Overall, this was a weaker quarter for the company, highlighting several challenges.
C3.ai is up 194% since the beginning of the year, but at $32.53 per share it is still trading 29.9% below its 52-week high of $46.37 from June 2023. Investors who bought $1,000 worth of C3.ai's shares at the IPO in December 2020 would now be looking at an investment worth $351.55.
