Could Competition Shake Up Appen?

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Could competition be stalking Appen as a result of an increasing number of smaller projects on offer? Several brokers suspect this may be the case

-Sizeable earnings base makes growth rates harder
-Pricing, amid smaller contracts, may prove critical
-Appen still well-placed to capitalise on AI trends
 

By Eva Brocklehurst

Machine learning software leader Appen ((APX)) has carved out a niche and, while still ahead of the field, competition could catch up if the size of projects is any indication. Credit Suisse suspects historical patterns cannot be relied on any more. Appen's earnings base has become sizeable and this makes beating previous growth rates harder.

Revenue is predominantly not recurring and this raises the alert signal for any impact new entrants are having in the market. So far the industry is "ok” and Credit Suisse asserts it is simply "following the money".

Along with renewed concerns that customers may still prefer to defer or reduce capital expenditure the broker takes a cautious stance and reduces estimates substantially for 2021-23, involving a combination of updated AUD/USD and lower growth forecasts following updated guidance.

Even so, Credit Suisse acknowledges there is a risk to estimates given assumptions that growth will still accelerate. The operating earnings guidance range is $120-130m at constant currency, which was US$0.69 in 2019, Bell Potter points out.

This assumes an average Australian dollar exchange rate of US$0.70. As a result, Bell Potter downgrades 2021 and 2022 forecasts by -23% and -26%, respectively. The main competitive advantage,the broker observes, is the long-standing relationships with customers.

Wilsons agrees Appen has faced, and still faces, headwinds such as lower growth in demand for its services and an appreciating Australian dollar, along with the risk of removal from the ASX100. A more stable register could reduce the volatility in 2021 but elevated currency may drive downgrades nonetheless.

Pricing For Competition

Pricing, as Macquarie points out, may prove critical. Appen still generates most of its revenue from purchase orders rather than recurring subscription platform fees and these can be unpredictable and lumpy. Furthermore, The broker notes that, while Appen signed up 136 new customers in 2020, on a constant currency basis guidance is signalling operating earnings growth of 15% in 2021.

This leads Macquarie to suspect new projects are smaller in nature. With this in mind, and the scale of the workforce being the company's main buffer to competition, the smaller projects could present difficulties. The broker flagged this prospect just a week ago and the results have borne out its suspicions.

Pricing is yet to emerge as a competitive lever but this could occur with smaller project sizes in the future. The company expects the first half of 2021 will remain weak and did not provide guidance for the first/second half split. This is another area where Macquarie is cautious, given a lack of detail.

The broker notes the stock has underperformed the ASX 100 by -22% over the past week and -46% in the last three months and, with the limited visibility, envisages scope for further weakness before value support is reached.

UBS remembers that, at the December downgrade, the company had noted key clients were prioritising resources away from mature projects and towards new products.

The broker suspects this was a significant development and underscored the decision to downgrade guidance. Concerns have not been alleviated with the actual results and challenges such as a stronger Australian dollar, uncertain pandemic trends and an evolving regulatory environment remains heightened.

UBS resets growth expectations for the medium term, although acknowledges these could prove highly conservative if historical growth trends resume. The broker believes future machine-learning applications will continue to require human datasets for many more years and as AI adoption expands exponentially, so too will the volume of training data required.

Appen Still A Winner

Wilsons believes Appen is well-placed to capitalise on the trends in content relevance which require high-quality analysis of vast quantities of data at a reasonable price. Nevertheless, risks centre on high customer concentration and limited revenue visibility.

The broker points out Appen has experienced some traction from increased sales & marketing expenditure, winning 70 customers in the second half and 46 in the fourth quarter alone. Projects with major customers grew by 34% and were driven by the increased use of the company's annotation platform.

Revenue from China grew 60% in the fourth quarter with customers including major Chinese technology operators, while incremental traction has been achieved in the autonomous vehicle segment. In government applications, the pandemic, and the US presidential election, hindered Appen but there still is a growing pipeline of opportunities.

Demand drivers are likely to prevail in the industry Wilsons concludes and, while retaining an Overweight rating, lowers FY21-23 estimates by -15-23%. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, has a $22.83 target.

Bell Potter, also not one of the seven, has a Hold rating and $19.50 target (reduced from $27.50). The database has two Buy ratings (Citi, Ord Minnett yet to comment on the results release), two Hold and one Sell (Macquarie). The consensus target is $23.28, suggesting 36.5% upside to the last share price. This compares with $26.68 ahead of the results. Targets range from $16.00 (Macquarie) to $30.90 (Citi).

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