In any given year, artificial intelligence company Appen ((APX)) enjoys a ramp-up in customer spending in the December quarter, providing a revenue windfall. Appen had set full (calendar) year guidance on the assumption of history repeating.
The company’s September quarter was a bit slower than hoped, so the December quarter ramp-up was more critical than ever.
It hasn’t happened. Appen has subsequently cut its 2020 underlying earnings guidance by some -15% at the midpoint. Brokers have responded by cutting their forecasts by similar amounts. While the reasons are understandable, the impact has been greater than most expected.
Appen’s Relevance division offers annotated data used in search technology embedded in web, e-commerce, and social engagement for enhancing relevance and accuracy of search engines, social media applications, and e-commerce (Yahoo). Including relevance in advertising, which is why the December quarter is critical. But this year there is a problem.
Wish they weren’t all Californian
Most of Appen’s customers are tech companies located in California. California is currently suffering its third, most deadly, virus wave. A greater part of the state has been put back into lockdown, including Silicon Valley.
Some of Appen’s key customers have responded by deferring planned investment in more mature, ongoing projects and reallocating engineers to to new product development. As these products are in their early phase, data intensity requirement is lower, notes Wilsons (Overweight; target down -27% to $32.11). Management also highlighted the lockdown impact on the capacity for face-to-face sales.
And the rising Aussie dollar is another headwind.
The virus has impacted short-term demand for Appen’s products, but Wilsons still anticipates that over the medium to long terms, the same structural and secular demand drivers will continue to prevail, with the company’s growth to reflect its market-leading position.
While the short term remains uncertain for now, Ord Minnett (Upgrade to Accumulate from Hold; target to $30.00 from $35.00) expects growth momentum to bounce back over 2021-22. Appen remains well positioned, the broker suggests, to benefit from growth in global AI investment.
Outlook Positive
Positive views are supported by management’s upbeat expectations for 2021. Despite the fourth quarter slowdown in mature projects, the number of new project commencements in collaboration with with Appen’s large tech customers is up 32% on the same time last year. These projects are still in their infancy, but Ord Minnett suggests the ability to increase the breadth of its exposure is testament to Appen’s market-leading AI data annotation credentials.
And of course the virus will hopefully prove a temporary setback, now that the first vaccines are being rolled out. UBS (Buy; $44.00 target pending review) believes that while the market will likely wait to see evidence of a recovery, longer term trends remain favourable and 2021 should see a strong rebound in activity as covid disruptions unwind.
Bell Potter (Hold; target down -19% to $27.50) is playing it more cautiously in including a risk factor in its valuation were spending patterns not to completely return to where they were.
Canaccord Genuity (Hold; target to $28.60 from $30.40) notes international advertising agency GroupM recently published a report suggesting a return to double-digit online advertising growth in 2021 following the 2020 slowdown. The experience of the last few years is that Appen’s Relevance revenues grow much faster than digital advertising revenues, the broker points out.
GroupM expects online advertising revenue to slow to high single-digit rates beyond 2021, but Canaccord notes incremental dollar increases remain consistently high.
Canaccord also suggest the stock’s -12.4% share price drop yesterday was not a bad effort under the circumstances, given (a) it is less than the actual guidance downgrade and (b) high growth, high PE multiple stocks tend to be trashed on such guidance disappointment (to paraphrase the broker).
Questions Remain
Despite expectations of a swift recovery for Appen, Credit Suisse (Neutral; target to $26.00 from $30.00) warns the company’s earnings base has become more sizeable, thus making high growth rates and earnings beats harder, and revenue is predominantly non-recurring. The broker is also on the lookout for new entrants to the market.
Until Credit Suisse sees a genuine inflection in ramping revenue from new customers, and particularly given new concerns of customer ability to defer or reduce core relevance spend, the broker is taking a cautious stance.
UBS is yet to review its valuation as the broker would like a few questions answered.
How much of the reprioritising of customer resources seen in the December quarter is a simple lockdown impact and how much is budget restraints in the face of covid? Are lower levels of work on mature projects short term or representative of lower future growth rates? How material is the impact of new customer wins in 2021?
UBS also raises the question of competition, pondering just what the recent acquisition of US company Lionbridge’s AI division by Canadian company Telus might bring.
Five FNArena database brokers cover Appen but only three have to date responded to the guidance downgrade, so to highlight the current database consensus target price would be misleading. The target price changes noted above provide sufficient clue.
