Why We’re Not Buying Appen Stock On the Dip
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The difference between confidence and arrogance is whether or not you can walk the walk. Confidence is a highly desirable quality for managers because it’s married to another prized quality – decisiveness. And as a leader, you won’t be very persuasive unless you make decisions with conviction. In the world of investing, we say people with conviction have “strong hands.”
If you’re a confident investor, you’ll put your money where your mouth is. You’ll be less worried about being seen as some market oracle and more concerned about learning how to become a better investor. Investing with conviction means you trust your own judgment. Experienced investors know how important this is for your mental health. You will not sleep well at night if you cannot make a decision and stick with it, even when things appear to be going against you.
Today, we have a decision to make. We’re holding a miniscule amount of Appen (APX.AX) and our position is down -30%. We couldn’t be happier, as we had only just started buying it. (It’s the smallest position we have in our 27-stock portfolio). Before we take advantage of this great opportunity to purchase a growth asset at a 30% discount, we need to decide if this is a stock we want to be holding. The growth is there for sure:
While the business looks extremely healthy, we’ve recently come across some concerns that make this asset much less appealing.
Investing in Appen Stock
The first time we wrote about Appen was in a piece titled Crowdsourced Big Data is Big Business for Appen. We all know about crowdsourcing, getting people to do menial tasks for peanuts. (In some countries it’s meaningful money, so let’s not immediately condemn it.) In Appen’s case, their team of over 1 million people are taking big data and then using it to produce metadata – data about data. It’s all about establishing some context around big data which is being used to train artificial intelligence (AI) algorithms. Appen operates in the following two segments (percentage of 2019 total revenues in italics):
- Speech and Images (13%)
- Relevance (87%)
Let’s start with Speech and Images.
Speech and Images
Does anyone else find it odd that we still can’t figure out what 20% of the world’s population is talking about? We can create synthetic life, yet we’re still unable to translate a simple Chinese newspaper article such that it contains zero Engrish. The inability of humans to master language translation using traditional programming techniques is now being solved with artificial intelligence.
What Appen now calls “Speech and Images” used to be called “Language Resources,” and the name change may be associated with their March 2019 purchase of Figure Eight.
In March of last year, Appen paid $175 million (plus potentially $125 million more) for Figure Eight, a machine learning software platform which uses highly automated annotation tools to transform unstructured text, image, audio, and video data into customized high-quality AI training data. It’s something we wrote about in an article titled Lots of Jobs You Can Work From Anywhere. By purchasing Figure Eight, Appen created more diverse revenue streams and acquired around 200 new clients. That’s a good thing, because language translation will eventually be mastered once and for all.
The Importance of Language Translation
Last year, we spent a month in Jakarta visiting with tech companies and spending some quality time recharging in the world-famous Central Jakarta health spas. During that trip, we found that the most well-funded startups in the country were chatbot solutions focused on Bahasa Indonesia. Many of the big tech players didn’t think it was a priority to teach computers this large lingua franca used to connect people who speak over 700 languages. There’s a reason for that, something the BBC wrote about in a piece titled “Why no-one speaks Indonesia’s language.” The rich complexity of Bahasa Indonesia is a good example of why solving the language-translation problem requires so much nuance that only native speakers can properly articulate it.
Appen has human resources that span 180 languages giving them a powerful advantage in being able to localize data for companies. There’s a big demand for that, which is why Lionbridge went from software localization to data labeling. They knew that offering translation-as-a-service wouldn’t be a thing once AI figures out how to speak any language.
Now that algorithms are learning how to fold proteins, it’s reasonable to think they may soon understand baiju-fueled conversations with Chinese mainlanders. Investing in a company that’s helping other companies to learn other languages only makes sense until the AI becomes clever enough to understand the languages itself. Whether we’re talking language translation or image labeling, what direction will this segment pivot into once the machine learning algorithms no longer need their hands held?
Relevance
As Aspen’s stock took a nosedive on the news of revised guidance, they decided to let investors know everything was kosher in a 57-minute “trading update.” In that call, the CEO talks about how the biggest impact on their performance has been a slowdown in digital ad spending, the dominant source of revenues for Appen’s largest customers, and a good indicator of how these customers spend money with Appen. (With the number of ads media companies vomit onto your browser these days, it’s hard to believe there’s any real estate left for digital ad growth – aside from maybe starting to place ads within ads.)
In their 2019 Annual Report, Appen tells us their largest customers – the ones who rely on ad spending for a dominant source of revenues – pretty much have them by the cojones.
During the year ended 31 December 2019 approximately 88.2% (2018: 89.1%) of the Group’s external revenue was derived from sales to five major customers.
Though the Appen Eight acquisition may help with this, Appen’s revenues are extremely concentrated, which presents a great deal of third-party risk. They also derive 87.5% of their revenues from the Americans, and we all know that’s a rather dicey place at the moment.
The big takeaway from senior management is that Appen’s slowdown is temporary. Customers are changing their project prioritizations – benching older mature projects in favor of new projects that address emerging opportunities or threats. This means Appen is expecting a strong year in 2021, and investors have nothing to be worried about. For anyone who believes in the long-term potential of the company, this is just a buying opportunity.
A Buying Opportunity
There seems to be a pattern emerging where people just blatantly ignore the big elephant on the Wall Street trading floor right now – “The Rona.” When the trillion-dollar travel industry – and all the things that go with it – gets decimated by a pandemic that touches every corner of the globe, we’re fully expecting companies will put on the brakes and freeze expenditures. When companies formally announce this to investors, everyone acts completely shocked, and stock prices tank. We’ve seen this happen twice now, and both times opened new positions (Alteryx and Splunk). And now it’s happened with Appen.
Appen’s stock is down -22% this month on news that they adjusted their guidance. Long story short, Appen thought they could sneak by The Rona unscathed, and investors believed them. When things didn’t transpire as planned, Appen adjusted their guidance. Since we couldn’t care less about short term fluctuations, it’s almost non-news. We’re probably more concerned to hear that their client base is concentrated in California, a state that a growing number of tech giants are exiting in search of greener pastures. (Maybe enforcing hiring quotas based on gender wasn’t the best idea?) Today, we just need to decide if we’re going to open a meaningful position in Appen at a 30% discount.
To Buy or Not to Buy
Our recent piece on The Big Business of Big Data Labeling as a Service raised questions about how sustainable these data labeling business models have become. How long will training data be a viable business? If the demand for training data wanes, what takes its place to assure continued growth? Even if growth lasts for a while longer, it’s not what you might consider transformational. It’s a commodity offering that becomes less useful as time goes on.
There’s an opportunity cost associated with any investment you’re holding. Sometimes it’s useful to do relative comparisons. If we looked at every AI stock we’re holding right now, Appen is the least appealing because its value proposition diminishes as artificial intelligence becomes more intelligent. You don’t have to be Quasimodo to see where this whole thing is going.
The relevance of every investing decision comes down to how much skin you have in the game. We don’t have much. Our Appen position sits at about 0.65%. To put that number in perspective, if our total portfolio value was $100,000, then our position in Appen would be worth about $650. The reason our position is so small is because that’s how we approach purchasing stocks in volatile times. We buy small amounts at fixed intervals over extended periods of time.
The decision to make here isn’t whether or not to sell a miniscule holding. We need to decide if Appen is a company we want to hold in the first place. Based on what we’ve discussed today, the answer is no. We are risk-averse investors, and we believe that the ability for AI to teach itself to learn in any language will quickly make this 1-million-strong global workforce obsolete. (Our recent piece on artificial general intelligence shows how quickly algorithms are learning to learn.) We don’t like Appen’s revenue concentration, and feel the company should spend more time on conveying their business strategy and less time droning on about D&I initiatives, some of which are subtracting value from shareholders. If we’re wrong and the stock rises +1,000% over the next decade, we’ll live with our decision, and hopefully learn some lessons during the process.
Conclusion
We’re now actively managing 27 tech stocks in the Nanalyze Disruptive Tech Portfolio and we’re making that process more automated by refining our tech investing methodology to make it more rules-based. The first, and perhaps the most important rule, is not to become vested in a stock where the risks seem to outweigh the rewards relative to other potential opportunities in the same space.
Are we selling Appen? What other five AI stocks are we holding? Find out these answers and more in The Nanalyze Disruptive Tech Portfolio Report, now available for Nanalyze Premium annual subscribers.
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While Scale AI highlights its revenue doubling in the past year, Appen’s revenue had only increased 12% for the full year ended 31 December 2020.
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So obviously Appen will have to demonstrate in 2021 much higher revenue growth than 12% for its price to recover.
Thank you for pointing out that metric. The biggest concern is what they synthetic data companies do once the algos have been trained – or become smart enough to train themselves.
To me it looks like Appen reached the bottom now. The valuation is so low I can’t see it going much lower (unless there is a larger market crash).
Calling a bottom is tough. Catching a falling knife or a value play? We’re avoiding value plays because we have enough of them in our dividend growth portfolio.
Mark Brayan, Chief Executive Officer, Appen Limited Remarks at Macquarie Australia Conference – 6 May 2021
Revenue of $599.9M in 2020 was up 12% on the prior year, and underlying EBITDA of $108.6M
up 8% on 2019.
This is solid growth on any measure but not to our usual standards for a few reasons:
• The AUD strengthened through 2H 2020, dampening translated revenue.
• COVID impacted our face to face selling motion but this appears to be in the past now
given the uptick in wins we saw in Q4 last year.
• COVID interrupted many businesses last year and that in turn reduced their digital ad
spend for a period. This impacted our major customers’ sources of revenue, and
although digital ad spend has bounced back nicely, that experience is driving them to
invest in new AI products that are less reliant on advertising.
• Our major customers are also responding to data privacy and anti-trust concerns, as
well as heightened competition amongst each other. These issues are also driving new
AI product developments, ones that rely less on personal data and make them more
independent.
Cheers for that Stan.
Here’s the thing about Appen. We sold the stock because the bigger picture wasn’t compelling. We sold around 25 or so, which means we avoided the massive psychological dilemma that happens when you’re down 60% on a stock. We’re just not interested in this one. The CEO is doing his job. He seems to have his finger on the pulse. But we’re off to hunt other animals.
Now the stock is much lower: $12.260 (-5% today). So overall the stock lost more than 2/3 of its value. Earlier it was one of the hottests stocks in Australia, now it is unloved.
To me Appen looks like a victim of COVID-19 – with key projects delayed because of it.
Current metrics: Market Cap: $1.59B, P/E = 30, Dividend Yield: ~1%
Analysts avg price target $14.9 : +21% upside.
Analysts expect EPS to grow in 2022 and 2023 on average by over 20% per year.
Key projects that were delayed in late 2020 are returning with a skew to delivery in 2H21.
So it seems to me the stock should start moving up later this year.
The bigger question is what this company plans to do when the AI algorithms are able to train themselves?
Appen has 5 big clients that contribute about 93% of its revenue.
In 2020 due to COVID those customers were delaying projects that they were planning on using Appen’s data.
If that’s the case then customer concentration risk is yet another reason to avoid the stock.
MF: “The Appen share price was out of form and dropped 9% last week. This decline appears to have been caused by news that a major shareholder has been selling down its holding shortly after building it up. According to a ceasing to be a substantial holder notice, the Capital Group Companies has been selling a significant number of shares just a month after buying them. Its most recent sale involved 583,170 shares for just a touch over $8 million on 1 July.”
When we sell a stock we don’t revisit the thesis, we move on. We believe there is a fundamental problem here where AI algorithms will soon be able to train themselves and Appen will need to do a massive pivot. We happened to exit our position at the right time which was pure luck but of course we won’t mention that and just attribute it to our incredible investing acumen.
I just found Appen big customers are: Facebook, Google and Amazon. So they are one of the biggest tech companies.
See Sydney Morning Herald article: “Appen hit as tech giants pivot to new AI projects” from December 2020.
This is some pretty interesting info Stan. Wonder what the revenue concentration looks like. That’s the problem when you’re a vendor for some big tech outfit. They’ll pull the rug out from under you with zero notice.
“Within the next three or so years, Brayan (Appen CEO) wants to have created a system in which
humans can look at the first 10,000 of 1 million images, and then a machine learningbased computer program would tag the rest of the street signs. This will speed up processes dramatically, allowing Appen to offer a cheaper price for its services, and
free up the time of its crowd so the company can take on more projects.”
See Sydney Morning Herald article: “Appen hit as tech giants pivot to new AI projects” from December 2020. 😉
Sounds like the crowd is already freed up to take on more projects. And what will those be?
I recommend reading Whitepaper “The State of AI and Machine Learning” available from the Appen web site.
One of our MBAs read that and wasn’t overly thrilled. Isn’t it just a bunch of surveys?
“In the second half of FY20, Appen said that growth moderated due to the strong Australian dollar and COVID-19 impacts.”
Appen recently announced they will start reporting is US dollars. That makes sense as most of their revenue is in USD from US companies. That will make revenue more smooth in their reporting.
MF: “Appen is currently going through a restructuring that will focus on the needs of different customer groups and markets, and to enable the development of differentiated approaches to sales, customer experience and delivery models. A new leadership structure will come with profit and loss responsibility that will increase visibility of, and accountability for, performance across its business units.
There will be restructuring costs, but annualised gross savings are expected to be US$15 million from 2022.
In a May trading update, the company said its year to date revenue plus orders in hand for delivery in FY21 was approximately US$260 million at the end of April 2021.
Underlying earnings before interest, tax, depreciation and amortisation (EBITDA) for the year ending 31 December 2021 is expected to be in the range of US$83 million to US$90 million.
”
APX share price is cheap, as there is some uncertainty related to their restructuring efforts and the main question is: are their problems temporary (C-19 related) or persistent ? I believe their problems are temporary.
Not a lot of detail on how that restructuring will affect their product offering. We’ve moved on from Appen so it’s not something we’re curious about right now.
When you say something is “cheap,” you need to qualify that. According to our simple valuation ratio, Appen’s future revenues growth is cheap at 2.7 (1.578 billion revenues / annualized revenues of 0.584 billion). The question is, what growth is coming? We’ll probably need to wait until the restructuring is over to find out.
It is interesting to compare what is happening with 2 Australian AI stocks:
Appen lost most of its value (price $9.85) and has market cap $1.2B. P/E=28 and is very profitable.
Brainchip (BRN.AX) is at its top valuation (price $1.03) and has market cap $1.7B and has almost no revenues.
So Brainchip with almost no revenues has much higher valuation than Appen (another AI stock) which is very profitable.
Brainchip has nothing to offer until they can show meaningful revenues. Based on all the muppets that come around here to sling mud whenever there’s a new press release, the stock appears to be manipulated as well.
The Appen share price was rocketing today (+29%) after the AI company received a takeover proposal from Telus International.
Appen requested a trading halt following a development relating to the proposal.
Latest share price: $8.27.
And now it’s down 20%. Expect lots of volatility going forward.
Appen now expects full-year underlying EBITDA to be between $13 million and $18 million, down from $78.9 million posted a year earlier. It retained its revenue outlook of $375 million to $395 million, compared with $447.3 million last year.
Plans to increase the use of offshore facilities and cut costs are gathering pace, but the full benefits will not be evident this year, Appen Chief Executive Officer Mark Brayan said.
Share price: $2.57
Top line growth plans are needed as you said before.
The article was right about Appen, while I was over-optimistic about it.
It seems big AI companies do more AI labeling themselves (using better tools), rather than relying on third party (like Appen) manual labeling service.
Probably Appen needs to find larger number of smaller customers and also find them outside US to keep its business going.
They will also need to find other ways to generate revenue. So effectively they will have to reinvent themselves, but that involves risks. They try to gain market share in China, but the problem is Australia – China political relations are strained.
It seems earlier TELUS’s offer to buy Appen for A$9.50 was probably worth taking as current share price is only $2.58.
Thank you for the feedback Stan. Being right is simply having the fact-finding exercise end up matching the outcome. Sometimes it doesn’t, and that’s why investing is a tough game to play. It’s never fun to watch a company struggle and Appen does need to reinvent themselves like many before them.
“In line with our revenue outlook provided on 25 August 2022 we expect FY22 revenue to be in the
range of US$375 million to US$395 million”. Appen current market cap is: $337M, share price: $2.73. So that gives us P/S = 0.9.
Full year results will be end of this month: 27th Feb.
Appen recently announced the official starting of Armughan Ahmad as CEO and President. With over 25 years of experience scaling multi-billion-dollar technology businesses and building strong global teams, Armughan plans to accelerate adoption within the fast-growing enterprise AI market.
Letting investors know what strategy they have outside data labeling might be a good start.