Debunking Kerrisdale Capital's Bearish Take on C3.ai

5 апр. 2023 г.

I'm long on C3 - so I'm as biased as Kerrisdale here, but apparently, that doesn't keep people from taking their word for granted, either. I have a degree in Finance, worked at a big-four accounting firm, in the financial industry (upper management), and am now a business owner (that was too lazy to create a new account for posting this - that's why you'll find me posting all kinds of UE5 stuff, otherwise. My dirty hobby...)

But I'm a hopelessly logical investor, meaning I couldn't figure out why Kerrisdale's letter to Deloitte yesterday moved the markets at all. So I needed to understand the whole situation better and digged deeper.

I went through C3's financials and Kerrisdale's report and looked at their letter to the Auditor, and here are my two cents on their March 6th report and their letter to Deloitte. Apologies for the lengthy post, but it's a complex topic.

It is worth questioning whether Kerrisdale's attempt to undermine C3 serves to manipulate market perceptions, particularly when considering the firm's history of short-selling and ongoing legal scrutiny.

Let's start by shortly going over Kerrisdale's report from March 6th.

Kerrisdale's report conveniently overlooks C3's unique value proposition and casts doubt on the company's competitive advantage. However, this dismissal seems disingenuous, given the distinct position C3 occupies in the AI software market.

Contrary to the report's implications, C3's industry-specific AI solutions set it apart from the likes of IBM, Google, and Amazon. The company's focus on sectors such as energy, manufacturing, and financial services demonstrates its commitment to providing tailored solutions that address the unique challenges faced by these industries.

The report also paints a bleak picture of C3's growth rates, suggesting that they are unsustainable. However, the data and industry trends tell a different story.

AI adoption is in its early stages across a variety of industries, with tremendous potential for growth. The ongoing digitization of industries and the increasing demand for AI-driven solutions are good for C3's prospects.

C3's ability to secure long-term contracts with major clients demonstrates the trust and satisfaction customers have in its products and services. This contradicts Kerrisdale's pessimistic outlook and raises suspicions about the firm's motives. They basically take one of C3's strengths (their ability to build long-term partnerships and client relations) and give it a negative spin.

Kerrisdale's report attempts to pigeonhole C3 as a company reliant on the energy sector, potentially to create uncertainty and fear in the market. But this claim conveniently omits the company's broader diversification strategy.

C3 has made significant strides in expanding into healthcare, manufacturing, and financial services, proving its ability to penetrate new markets and adapt to different industry needs. This diversification not only mitigates the risks associated with dependence on a single sector but also showcases C3's resilience and growth potential.

The report also casts doubt on C3's future competitiveness by highlighting declining R&D spending. This interpretation, however, seems deliberately misleading when considering the broader context of the company's strategy and expertise.

Streamlining R&D spending could be a strategic move by C3 to optimize resources and concentrate on the most promising projects. It is important to recognize that R&D spending is not always directly proportional to innovation or product development success.

Moreover, C3's existing technological expertise and intellectual property provide a strong foundation for future growth. The report's attempt to misrepresent the company's R&D spending is... questionable.

All in all, I'd say that C3's unique competitive advantage, growth potential, diversification strategy, and technological expertise paint a more optimistic outlook for the company's future prospects than Kerrisdale's report suggests. As AI continues to transform industries, C3's targeted offerings are well-positioned to capitalize on these opportunities, in my opinion. Of note to me is their ESG product - ESG will be a really, really big thing in the near future, especially here in the EU, in the near future.

My opinion: investors and market participants should be mindful of the potential for market manipulation and misinformation, especially when considering reports from firms with questionable motives and legal standing.

Let's finally move on to what caused yesterday's market movements. Kerrisdale's letter to the auditor, Deloitte. Keep in mind that this is just my take on it. But I think that my opinion is not entirely unqualified.

TL;DR: Deloitte is the biggest accounting firm in the US, and it basically comes down to this: you either trust a short-seller publishing an open letter going hand-in-hand with a well-timed media campaign at a conspicuously opportune moment (C3 was about to really take off and obliterate their short position), or you trust that C3's financials, on which Deloitte signed off on, are correct. Your call.

Slightly longer version:

Kerrisdale Capital sent a letter to C3's auditor, raising concerns about the company's accounting and disclosure practices. The letter questions the company's revenue recognition methods, particularly for long-term contracts, and the impact on financial results.

C3 has consistently provided transparent financial results, as evidenced by their fiscal Q1, Q2, and Q3 2023 reports. The company has experienced steady revenue growth and diversified its client base, showcasing a strong business model.

C3's financial reports adhere to US Generally Accepted Accounting Principles (US GAAP), ensuring that revenue recognition and other financial practices are in line with industry standards.

As per US GAAP guidelines, companies recognize revenue when the performance obligations under a contract are satisfied. C3's long-term contracts are structured to deliver AI software solutions and services over time, and the company recognizes revenue accordingly.

It is essential to emphasize that C3's revenue recognition practices are compliant with the accounting standards and have been consistently applied across all financial reporting periods.

In their own March 6th report (page 13), Kerrisdale calls out C3 for their long product cycle (6-18 months). Considering C3 is a rapidly growing company that closed bookings of about $650 million in Q3 FY 23, it's hardly surprising that "the company’s accounts receivable have ballooned", according to their letter to the auditor.

With C3.ai's strong bookings performance in Q3, it is reasonable to expect a corresponding increase in unbilled receivables. This growth in receivables is a natural consequence of the company's expanding business and long-term contracts, reflecting the ongoing demand for its AI solutions.

On page 13 of their report, Kerrisdale acknowledges that C3 has a long product cycle, ranging from 6 to 18 months. This admission, coupled with the growth in unbilled receivables, suggests that Kerrisdale's claims are inconsistent and contradictory.

The long product cycle means that C3's revenue recognition is spread across multiple reporting periods, which naturally leads to a growth in unbilled receivables. This growth aligns with US GAAP guidelines.

The contradictory nature of Kerrisdale's claims raises questions about their understanding of US GAAP or their willingness to misrepresent financial information intentionally. It is essential to consider the possibility of malicious intent, particularly in light of the firm's ongoing legal scrutiny and history of short-selling.

The US Department of Justice and the SEC are currently investigating dozens of firms, including Kerrisdale Capital, for potential market manipulation through short-selling schemes. I found relatively little information on this, but little or unsubstantiated information apparently suffices. I quoted one of several articles earlier in this post.

Given this backdrop, Kerrisdale's claims regarding C3's accounting and disclosure practices might be an attempt to manipulate market sentiment and cast doubt on the company's financial integrity.

In light of the transparent financial results provided by C3 and the company's adherence to US GAAP guidelines, Kerrisdale's claims regarding accounting and disclosure issues appear to be unfounded.

In conclusion, C3.ai's growth in unbilled receivables is a plausible outcome of its strong Q3 bookings performance and long product cycle. Kerrisdale's contradictory claims and potential misunderstanding or manipulation of US GAAP guidelines warrant skepticism and caution, IMO.

I expect Deloitte to back up C3 in their FY 23 audit opinion, voiding Kerrisdale's claims. I think the whole thing is a well-executed publicity stunt by a short-seller that was facing serious trouble from the stock being about to take off. I would have done it the same way. Even including the SEC, which is/was investigating Kerrisdale, in their letter is a bold move, but implying regulatory action/fraud, is exactly what Kerrisdale needed to "cover their ass" here and get the much-needed market reaction. Hats off to them, textbook execution.

So that's it. Thanks for reading, if you even made it this far. Make of it what you want, as I'm as biased as Kerrisdale on this.