Shares of C3.ai (NYSE:AI) are moving sharply lower this week after a short report by hedge fund Kerrisdale Capital triggered a selloff.
The short seller has alleged "serious accounting and disclosure issues." This marked the biggest one-day stock price drop for the artificial intelligence (AI) software maker since its initial public offering (IPO) in 2020.
C3.ai has allegedly used "highly aggressive accounting to inflate its income statement metrics in order to meet sell-side analyst estimates for revenue and certain profit metrics, and to conceal significant deterioration in its underlying operations", the short seller wrote in a letter to C3.ai's auditor, Deloitte & Touche.
AI shares closed at $24.95 on Tuesday following the massive selloff, which also spilled over to Wednesday with shares trading about 10% lower. Still, the AI stock remains about 120% up year-to-date amid unprecedented interest in generative AI technology and chatbots such as ChatGPT.
Short Report Triggers Selloff
Kerrisdale also alleged that C3.ai accounts for costs concerning the development of its software as research and development (R&D) instead of cost-of-revenue, for the purpose of increasing margins.
By doing this, C3.ai presents itself as a high-margin, software-as-a-service (SaaS) business, Kerrisdale wrote in the letter. Furthermore, the short seller also raised issues relating to a surge in unbilled receivables from one of C3.ai’s clients.
"In the letter, we discuss the highly conspicuous growth in unbilled receivables to levels we've never before seen in software companies. Opaque, confusing and highly concerning disclosures and financials related to the company's related party and very large customer, Baker Hughes (BKR)."
The letter also noted a "significant turnover" among chief financial officers at C3.ai, as four different people have held the position in the past four years.
C3.ai issued a statement in response to Kerrisdale's allegations, describing the letter as a "highly creative and transparent attempt" to reduce the company's stock price. The AI software maker also said Kerrisdale's accusations regarding Baker Hughes suggest "a fundamental misunderstanding of US GAAP accounting practices and principles."
In addition, the accounting reports and financial statements mentioned in the letter have been examined by C3.ai's independent audit firm, the company's spokesperson said.
On March 06, Kerrisdale said it is short AI shares as the run-up in stock is based on "the misconception that its self-proclaimed "AI leadership" somehow positions it to benefit from Silicon Valley's current tech theme du jour: generative AI as represented by media obsession ChatGPT."
"We believe these speculative flames won't burn bright much longer, as the realities of C3's poor customer traction, failing sales partnerships, and financial pressures will catalyze what is likely to be a painful reality check," the short seller said.
Solid Earnings but Management Commentary More Important
Last month, C3.ai issued a strong earnings outlook, prompting a significant jump in AI stocks and adding to optimism in the sector driven by the launch of OpenAI's remarkable ChatGPT. C3.ai's profit and revenue expectations for the fourth quarter and fiscal 2023 beat consensus estimates, resulting in a notable jump in the company's shares.
Wedbush analyst Daniel Ives said C3.ai is gaining momentum in developing unique enterprise opportunities thanks to its range of innovative enterprise AI products. On the other hand, he noted the company could face some bumps in the road, particularly when it comes to the monetization strategy for its popular generative AI suite which fundamentally alters the human interface for enterprise applications.
The company reported an adjusted loss of $0.06 per share, better than the estimated loss of $0.22 per share, according to FactSet. Revenue came in at $66.7 million, topping the consensus projection of $64.2 million, though below the year-ago revenue of $69.8 million.
Ives said C3.ai is currently "walking the walk" when it comes to reporting better-than-anticipated financial results. The analyst nearly doubled the stock's price target from $13 to $24 per share, while maintaining the rating at Neutral.
C3.ai said it expects Q4 2023 revenue to be in the range of $70 million to $72 million, while analysts were estimating slightly more than $70 million. More importantly, it is the CEO's comments that sent shares sharply higher.
"The overall business sentiment appears to be improving. This is a dramatic change from what we experienced in mid-2022," said C3.ai CEO Thomas Siebel.
He added that the recent boom in innovation and availability of big language models and generative free trading transformers are directly compatible with the company's platform, allowing it to further boost the utility of its applications.
In addition to strong revenue and profit, the company also said it aims to become cash positive by the end of the fiscal year 2024, though Ives thinks that achieving these goals is essential for regaining investors' confidence.
Retail investors have turned to smaller companies developing AI solutions after ChatGPT's unprecedented success left tech giants such as Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOGL) scrambling to ramp up their own AI efforts. ChatGPT's popularity grew even further after Microsoft invested $10 billion into the chatbot earlier this year.
Other AI stocks that saw their share price rise last month include BigBear.ai, SoundHound AI, and Guardforce AI, among others. Some of these stocks notched up whopping gains of more than 200% since the start of the year.
"AI could become the new gold rush on Wall Street," said Adam Sarhan, CEO of Florida-based 50 Park Investment. "But it still needs some more time to mature a bit, better price action, and prove that it can generate profits for investors."
Summary
C3.ai shares are trading sharply lower this week after short seller Kerrisdale sent a letter to the AI company’s auditor alleging serious accounting issues. This way, a massive rally in AI stock has come to a halt after it generated strong investor attention amid the ongoing ChatGPT frenzy.
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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.