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Date : 13/01/2021

Appen Limited

ASX :

APX

Market Cap : $2.87 Billion

Dividend Per Share : $0.04

Dividend Yield : 0.42 %

Buy

52 Week Range : $15.70 - $43.66

Share Price : $22.54

A very good long-term growth stock that is supported by industry tailwinds and a 'must-have' product.

Company Analysis

Appen Limited (ASX: APX) is a very important player in the artificial intelligence industry. They offer data sets that can be bought and used to train systems for machine learning (ML) and improved artificial intelligence (AI). In order to build successful and accurate ML and AI models that deliver results like when humans are operating the systems, very large volumes of data are required to train the model prior to seeing accurate results. Appen supplies this much needed training data. The data is categorized by humans and is of high quality that is ready to be applied by customers in order to build AI systems.

On slicing and dicing the data, we see Appen’s revenues being segmented into 2 categories by product – Relevance and Speech & Image, and geographically, most of the revenues being generated is coming from the USA.

The Relevance segment derives its revenue from data sets that are used in search technologies such as search engines, social media search results, ecommerce websites, etc. Given how high-growth and in-demand each of these industries are, Appen’s product has grown incredibly over the past few years. The most recent financials show that Appen’s Relevance segment has once again held up high growth rates – 34% as of June 30th, 2020. As people have stayed home, growth in social media usage and ecommerce usage has soared through the roof. A number of new platforms have been launched and Appen has benefitted with organic growth in the product. Appen has stated that existing customers have also increased in demand for their products during this time. The long-term growth strategy here looks to be in place, and we expect it to continue to deliver as we see more widespread applications of AI and ML.

The Speech & Image segment is not as large as the Search Relevance. This is due to the high level of sophisticated products that are at play in this vertical. For instance, Apple, Google, and Amazon have smart speakers that require these data sets. The competition here is not as high as the Relevance segment when it comes to AI and ML applications. During the half year results, revenues from Speech & Image has dipped compared to the previous corresponding year. However, it is still in line to match 2019’s revenues from this segment come final year results. Over the past few years, the second half of the year has always outperformed the first in the Speech & Image segment. This revenue cyclicality is largely due to the timing and size of the projects.

Appen has seen strong demand from its existing customers for its products and they have underpinned the consistent revenue growth. In addition to this, Appen has reported that they have added several new businesses to further diversify their revenue base.

Geographically, Appen draws about 11% of its revenues from Australia. But the majority of their revenues comes from the Tech savvy USA that is home to the biggest and the best bleeding edge technology heavyweights and start-ups in the world. The USA makes up about 87% of its revenues.

Company Updates


Source: Tradingview.com

The Appen stock price began its recovery from the March 2020 market crash very quickly. Tech firms that have capital light business models were rewarded by markets very early and APX sky-rocketed to an all time high of $43.66 in August. However, it has been a rocky ride since. The first shock experienced was due to investors expecting a growth of over 25% during the 1H FY2020 performance. The revenues from Speech & Image which we explained in the previous section of this report turned out to be an underperformance in the hence, the stock came under massive selling pressure as investors sold-off. This can be explained from the above chart where we can see large spikes in selling volumes.

In December, we saw a similar pattern as investors once again added selling pressure to APX as Appen released an announcement that they continued to experience challenges when navigating through the pandemic. There has been a slowdown in:

  • Digital ad spending
  • Reduction in IT/digital spending
  • Cancellations from the smallest customers
  • Interruption in global hardware supply chains
  • Suspension of f2f projects that are required for audio data collection.

Appen confirmed that their Q3 revenues were below expectations due to the above reasons. However, the all-important Q4 that generally accounts for 30% of Appen’s annual revenues has gotten off to a good start according to the firm.

Industry Analysis

The Artificial Intelligence industry is one of the top 5 high-growth spaces globally. Digital Assistants, chatbots, etc are taking shape everywhere. All these systems require their AI to be trained using very large volumes of data. Data that Appen provides by employing over 1 million contractors to do the work of collating and segregating the data. Hence, Appen finds itself and its business as a ‘need to have’ for its customers, rather than a ‘want to have’. This is a very strong tailwind for sustainable long-term growth.

AI and deep learning adoption have increased considerably over the last couple of years. We have moved on from AI being a very nascent object that people, and corporations are wrapping their heads around to leveraging it to create products/services. McKinsey recently reported that in a survey conducted among global organisations, 50% responders report that their company in whatever industry they are operating use AI in at least one business function. This trend is growing very quickly.

The global AI market was valued at US$ 20 billion in 2018. From 2019 to 2025, this market is forecasted to grow at a CAGR of 35%. Software, hardware, and services are adopting the new technology and it is being led by the biggest companies in the world – the FAANG stocks, most of whom are customers of Appen. The spending towards AI among global companies is estimated to be about US$100 billion by 2023 and the overall AI market is forecasted to be valued at over $200 billion by 2025.

As large companies adopt AI and leverage the technology, the largest organic growth in the industry will be led by the new start-ups that are pushing innovation beyond limits. The IoT’s, ML, AI start-ups all ‘need’ datasets such as the ones that Appen provides. Covid-19 has disrupted the rate at which these start-ups pop-up and grow. In case of the existing start-up, they have definitely felt the cash crunch and are holding back on expenses until the economy is back up and running. This has been the story for Appen’s customers during 2020 and is projected to change as a vaccine rids the world of the virus. There are strong structural tailwinds coming from the AI industry that are backing up Appen for long-term sustainable growth.

Investment Thesis

Appen, like most technology stocks on the ASX are generally overbought or oversold during its ups and downs. The share prices thus reflect a lot of pressure that is being added by either the bulls or bears and the stock is subject to high degrees of volatility and lots of momentum swings.

Behind the scenes of the markets, we see Appen as a very strong company that has consistently had revenue growth of over 30% in the past 5 years. They are a profitable company that has maintained EBITDA margins of an average of 15% over the same period of time. The net income after taxes also has a smooth curve to it – suggesting once again, sustainability in operations and earnings.

Appen delivered a 25% growth in revenues and 6% growth in EBITDA during H1 FY2020. Our crunched numbers suggest that the firm would generate revenues for the full year around the $620 million mark – representing a 15% growth from FY2019. While this is very aggressive for most firms, a 15% growth is a slowdown in performance for Appen and technology firms trading at 50x Price to Equity.

However, the slowdown is expected, and the market seems to have already priced it in and then some more with all the downward pressure that the stock has been put under in the last month. From a long-term investment viewpoint, it is extremely important to look beyond the current troubles that the entire world is experiencing along with Appen and determine whether it would be able to pick itself up once the storm has passed. We certainly think so:

  • Investments have to be made to deliver growth and during the troubled year Appen has not made any investments through the pandemic, and rightly so. It has been uncharted waters for the firm and most of their customers have been affected.
  • Marketing and sales budgets were cut, resulting in reduced growth rates. As the effects of the pandemic continue to decrease, we expect Appen to get back to ways to drive new sales.
  • Appen’s loyal customer base are the biggest technology companies in the world – Facebook, Google, Amazon, etc, and Appen boasts that they have seen a 405% increase in annual contracted value during H1 FY2020. The platform agreements with the existing major customers includes US$80 million annually. This reinforces how critical Appen is to the AI space as a whole. They are a market leader and have immense experience in operations.

Appen reported that its Chinese business is taking off – mainly led by the big Chinese technology companies. The monthly revenues as of July 2020 is estimated to be around $600,000 and is growing very quickly. The APAC region will play a very important role in the growth story of Appen in the next 5 years. While the biggest contracts will continue to come from the USA, the emerging markets of China India, Singapore and South Korea are leading the chase when it comes to innovation and AI levered products and services, and Appen playing a key role here is imminent.

Appen is a technology company whose 1 million plus works-staff is made up of contractors. This indicates that most of their assets are off the balance sheet. As of June 2020, that is, H1 FY2020, Appen reported $126 million in cash and a total debt of $64 million. Accounts receivable is $91 million.

The above graph shows accounts receivables as a percentage of the revenues that Appen generates. The metric basically measures how much of the firm’s revenues are still pending payment. The sudden rise here is attributed towards the customer payment delays that Appen has accepted and deferred during 2020 and is expected to smoothen out over time.

The financial health of Appen is strong. Their liabilities have remained the same since the previous year, and they have a net cash position of $64 million after deducting all debts and leases. The firm is capitalised by equity up to 89% and debt up to 11%.

Cash Flows from operations increased by 77% as of H1 FY2020, and this cash was spent towards tax, dividends, capex, opex payments. Most of the revenue that is generated comes in USD. Therefore, Appen is exposed to forex risk. A weak USD may have a slight impact on earnings during the full year report.

Recommendation

Appen is a market leader in its space and they deliver a “must-have” product in the AI industry. The performance of the firm has been spectacular in the build up to 2020, however, it has witnessed somewhat of a slowdown in growth due to the effects the pandemic has had on Appen’s customers. With 2021 being focussed on the recovery of the pandemic, Appen is a great investment at current price levels. Strong structural tailwinds support the fundamentals of the stock, and we issue long-term investors a “Buy” recommendation as we expect the stock to outperform the benchmark index during 2021.

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