A report in the SMH today, a few hours old now - not great timing for Appen following a tough for days.
"Australian artificial intelligence company Appen has been hit by claims of racism in its recruitment processes after it asked job candidates to take a “paper bag test” about their skin colour.
A recruiter for Appen contacted Houston based Charné Graham to apply for a role as a social media evaluator at Appen. But after selecting ‘Black or African American’ from a drop down box on the online application she was then asked to select her complexion as Light - pale white, White- fair, Median - white to light brown, Olive - moderate brown, Brown - dark brown or Very dark brown to black."
09-May-2021: I do not hold Appen (APX) shares, as I believe their business model is being undermined and they are becoming less and less relevant now. I also think they are much less of a "tech" company than most people realise. They rely on cheap labour to constantly provide a serious flow of data into their systems, which is not a very automated system at all. Once the data is in they can do plenty of stuff with it, but the data entry itself is very labour-intensive, and they pay peanuts to those people who are doing it. I don't claim to know the business very well, but I know enough to know that I'm not interested on doing further research on them, as they face more headwinds than tailwinds - in my opinion.
That said, to add to the conversation here, as Appen (APX) appears to be a very polarising and popular company to discuss here, I thought I'd include a snapshot of the latest broker views on Appen - see image below. Remember that this is only part of the data available - on FNArena.com - and it could be worth considering a subscription to their service if you want to stay up-to-date with this stuff, or read Rudi's summaries of those brokers' reports and client notes. As a subscriber, you can create a watchlist and every time there is any news or updates on any company on your watchlist, you'll receive an email about it - usually immediately - or at the very least on the same day.
It pays to note however that FNArena only cover 7 brokers:
...so there are limitations there - you have to remember that the consensus views are only a consensus of those 7 brokers, and usually not all 7 of them will cover the company you are interested in, so it's usually a consensus of less than 7. For instance, only 5 of those 7 currently cover Appen. Anyhow, for what it's worth, here is a snapshot - as of today - Sunday 09-May-2021 - of what Macquarie, Citi, Ord Minnett, UBS and Credit Suisse currently think of Appen:
I've seen a two threads of comment about the drop.
1. The negativety of the presentation at the Macquarie conference
2. Facebook's breakthrough for self-supervised learning
From the Macquarie presentation transcript
- there were headwinds for big customers last year as they adapted to COVID and 'regulatory pressures such as anti-trust and data privacy'.
- "The competitive environment for relevance is unchanged with us and Lionbridge AI the key providers."
- 'There’s no systemic change to the demand for relevance data. Our relevance team delivered 90% of our revenue in 2020.'
- "There’s no change in the need for training data. More companies are investing in AI and they all need training data. The high growth in the number of customers we’re winning, including in China, supports that."
- 'We don’t see unusual pressure on pricing.'
- Appen is a project based business. Their customers had to shift priorities last year. That's cyclical not fundamental. More broadly, there is going to be a lot more investment in AI from all sorts of organisations. Governments for sure are slow to adopt but will use it.
- 90% of their business is unchanged with no unusual pressure on pricing
- Facebook's breakthough was for image recognition - ie less than 10% of Appen's revenue. From their last annual report 'Relevant' delivered $538M revenue. 'Speech and Image' delivered $61M.
- China is growing 60% quater on quarter. They have an indepdent setuo of their systems installed in China and another for US Government.
You'll see from my portfolio that I unfortunately bought some at $22 and then some at $15. I bought some more today in my real portfolio.
Many are saying it's over for Appen, I don't care I'm a holder.
Several points/view on the overall Market/Economy and investor sentiment:
1. Rotation out of growth will be short lived
2. People chasing cyclicals after significant moves (are late and will probably get punished.)
3. It will only take confirmation that rates are staying low for the next few years to spark a buying frenzy in growth.
4. I don't see the point investing in any single stock that's returns/growth prospects are less than an index fund @ 10%~ P/A (this is time tested)
5. You can't look around for people to hold your hand and tell you everything is going to be ok in markets.
6. I believe we're heading into a massive Metals Boom and Australia as a whole will do very well out of this with our Nickel/Lithium and Rare Earth projects.
Appen's business model is at severe risk of being disrupted and no longer of any use to their customers.
The CTO of Facebook, Mike Schroepfer, teeted on MAy 1 the following breakthrough:
"Here’s our new computer vision system achieving state of the art results in image segmentation, without needing any labeled training data. This new model was trained on random, unlabeled data, but quickly achieved state-of-the-art results. It’s awesome.
But it gets even more interesting. The model learned to categorize objects in images and organize them into groups based on physical properties — animal species were clearly separated, for example
What’s happening here is one of the defining AI advances of recent years — self-supervised learning — enabling new systems to develop much deeper and more generalized understandings of the data they’re trained on."
HOLDERS CHECK WHAT YOUR INVESTMENT THESIS IS. It may have broken on May 1.
Sorry folks I won't be popular as it seems to be a strawman favourite this company will continue to come under pressure especially as data privacy and anti-trust concerns are impacting developments, possibly with unfavourable consequences for Appen. impacts of an advertising downturn, regulatory factors on customers’ spending and investment priorities appear to have spooked investors.
Appen shares have fallen roughly 75% (crazy huh!) from their peak in August 2020. It is a massive amount and this once market darling is today’s dog.
In 2020 the utilisation of Appen’s services plateaued significantly by most of their major customers, currency headwinds have been felt harshly as well.
Momentum and sentiment are very negative. An investor presentation today for example which reiterated the companies messaging about the headwinds the company is currently facing lead to a 20% drop I suspect the market was taking the no news is bad news approach.
Investors in Appen at this point must all be asking themselves “Am I wrong?”
Do large technology companies actually not require Appen’s data sets?
Are they able to produce them themselves or find cheaper alternatives?
Will margins be compressed due to competition?
Are annotated data sets just a commodity?
Is Appen just a sweat shop for data, easy to reproduce or is there more of a moat in the business?
Maybe AI is more hype than substance and still many years away from being a meaningful part of the economy?
Maybe the AUD will go much higher due to a commodity super cycle?
Management seem to be less and less transparent can I trust their guidance and explanations?
Welcome to uncertainty friend.
Uncertainty is good for a fundamental investor. People don’t like to be uncertain. Uncertainty leads to loss of confidence and loss of confidence leads to selling. Selling leads to depressed prices, negative sentiment and momentum. Falling prices mean a share might drop below its intrinsic value.
I think Appen may represent good value and I think that the more the price falls the less of these questions I have to ask or be able to answer.
I suspect momentum will likely take Appen lower yet. My suggestion, work out your conviction now, look out at the years, rather than the months ahead. There just might be gold in them there hills (or maybe not).
Just did a touch of research around AI in the wake of today's selloff. Thought it was worth sharing.
Venturebeat AI Series (Note: Sponsored by Appen, bias high, but gives some insight into the company's perspective):
This was the flipside, maybe a bit too negative, but I thought it made some good points too: Companies Will Spend $50 Billion On Artificial Intelligence This Year With Little To Show For It
This is probably the more consensus perspective on AI: Tech industry urges $250 million AI budget cash splash
Some of my main takeaways:
[Disc - Added to holding today. 20% drop off the back of information that was the same as their EOY results, seems like a bit of an overreaction. Felt the bet was worth taking, but only a small amount. Still too much uncertainty for high conviction.]
A massive over reaction here, It's times like these that seperate the sheep from the shepherds. When just about everybody is convinced something is not right they're usually spectacularly wrong, I assume this will be no different. I have continued to avg down on this in my real port without any hesitation.
I'm not sure I got any clarity from this. What I think I heard:
Disc - I have a small holding. Have been looking for reasons to top up... Not sure this is it.
I am in total agreement with you Samurai. I'm not as much of a numbers cruncher as I should be, which is why I think the market and analysts are punishing the share price, relying more on intincts, product and addressable market. I think Appen will be rediscovered, as long as the USD conversion stays stable.
Still can't believe how cheap this stock has become sitting around $15~ now I will probably end up adding more to my real portfolio, I think many are misunderstanding this business as a whole and it's opportunity. So AI/Machine and deep learning is a clear mega trend at the early stages of it's S curve and you can see many companies are using these buzz words in their bios and what not to attract investors. Appen provides the data to train/make AI possible, why is this important? Because it's the backbone of getting AI to a level where it's actually usable in real world applications. For AI to exist it needs to have something to learn from so it can recognize what it is whether it's speech/audio/image and then the more it sees the same thing it's able to understand it (this is only achieved with large amounts of data). Appen is clearly a leader in this field and another big S curve lining up with AI is EVs the 2 will go hand in hand. Appen will be an integral part in the EV world with speech and lidar involvement, I remain extremely bullish on this and $100~ price target is a conservative view I'm taking for the long term.
We have seen brokers downgrading the stock except for Citi maintaining a price target greater than $30. I took broker data from 28/8/20 to 16/4/21 to see the downward trend.
The average broker price target on 28/8/20 -> $36.40
The average broker price target on 16/4/21 -> $22.23
The brokers from the chart : Citi, Credit Suisse, Macquarie, Ord Minnett, UBS (taken from FNArena). I couldn't find Mograns or Morgan Stanley.
The share price fall is positively correlated with average broker price target price.
The question remains whether changes in broker ratings are good indicators? From the limited data I took, broker estimates suggest lagging indicators to the actual share price movement. By the time a broker update come out, the market has already made up it's mind.
APX Multiples -- Are They 'Fair'?
Let's start by understanding exactly how Appen is being valued right now versus how it has been treated historically.
Computed below are the key multiples for understanding Appen's valuation over Jun 2017 to April 2021, reported quarterly.
These are: TEV/LTM total revenue, TEV/NTM total revenue, TEV/LTM EBITDA, TEV/NTM EBITDA, TEV/LTM EBIT, TEV/NTM EBIT, P/LTM EPS, P/NTM EPS, P/LTM Normalised EPS, P/BV, P/Tangible BV, P/BV, P/Tangible BV, P/NTM CFPS, TEV/LTM Unlevered FCF and Market Cap/LTM Levered FCF.
Across 2017 to 2021, Appen has traded across a range of:
What does this tell us?
Firstly, Appen currently trades at the bottom end of these historical valuation-multiple ranges. In other words, sentiment towards the stock is very low relative to historical levels.
Secondly, anything that affects the (perceived) timing, likelihood or duration of future cash flows will affect these valuation multiples. Thus, I don't think the situation we find ourselves in is as simple as classifying Appen as a cyclical v growth v high-growth stock.
Ultimately, there are a large set of factors such as competitive dynamics, pricing power, the nature of revenue (% recurring revenue), management, etc. that are all influencing broker estimates of future growth rates, margins and subsequently cash flow. This is reflected in the valuation multiples.
But, what valuation multiple is 'fair'?
I consider Altium & Wisetech the closest comparators to Appen on the ASX, albeit they are very different businesses. (The best comparator to Appen globally is Lionbridge AI).
These two businesses trade at enormously higher valuation multiples. Currently, they trade 340% (ALU) to 540% (WTC) higher on a revenue multiple basis and 55% (ALU) to 194% (WTC) higher on an EBITDA multiple basis.
There a few factors that dictate why Altium and Wisetech are being rewarded with higher multiples. The multiple premium afforded to Altium and Wisetech is significantly higher than that of Appen's primarily because of two main factors. 1) Earnings quality and 2) earnings reliability.
1) Earnings quality is reflected below in the operating statistics of ALU v WTC v APX, across gross margin (%) and EBITDA margin.
ALU has a gross margin approximately 1.9x higher than APX. WTC's gross margin is 3.3x higher than APX's. The EBITDA margin premium over Appen is between 2.2x (WTC) and 2.9x% (ALU).
2) On the other hand, earnings reliability can be reflected in the percentage of revenue that is recurring:
What could cause a re-rate in Appen's valuation multiples?
As discussed previously, analyst growth rate expectations are currently rock bottom and well below Appen's guidance. Confirmation from Appen that their long term earnings growth trajectory is sound (probably towards the end of this year with CY2022 earnings guidance) will lead to a normalisation of future growth rate expectations by analysts -- this will lead to broker upgrades and a rising share price. This alone should lead to a 50%-100% increase in share price if the valuation multiples return to APX's average historical levels across 2017 to 2021.
Long term, could Appen reach valuations as lofty as Altium's or Wisetech's?
Possibly. They might not be able to reach 15-20x revenue (which is extreme), but they are making important steps towards transitioning to a higher quality SaaS-based business model. There is one key chart to watch. The percentage of Appen's revenue that is recurring.
In 2H20, Appen reported a 343% increase in committed revenue versus 2H2019. This $92M of committed revenue in 2H20 is 31% of the total, up from $36M in 1H20 (12% of the total). In my opinion, this has been underestimated by the investment community.
Appen's acquisition of Figure8 was a game-changer for the company strategically. Figure Eight materially increases the quality of Appen's revenues and the breadth of its customer base via high growth, high-gross margin recurring revenue from annual platform subscription fees (SaaS model) earned from its ~200 customers.
The acquisition combined the scale, quality and language expertise of Appen's leading global crowd, supported by its efficient crowd management platform, with Figure Eight's innovative data annotation platform, to create a unique end to end solution.
We are only beginning to see the fruits of this acquisition. Accounting for differences in gross margin, EBITDA margin and recurring revenue, it is my view that Appen deserves to trade on at least half of Altium's revenue multiple -- which would be a revenue multiple of ~7x (versus ALU at 14.6x). On 2020 revenue of $600m that suggests Appen currently deserves a valuation of circa $3.5 billion AUD -- for a share price of $28.
If Appen could reach ALU's 65% recurring revenue threshold, continue growth at a materially higher pace compared to ALU and increase EBITDA margin to close the gap towards ALU's 34% margin, it would be reasonable to expect that Appen too could trade on 10x+ revenue for a market capitalisation north of $6 billion AUD ($50+ share price).
Appen remains the largest holding in my portfolio -- I am grateful that Mr Market has provided me with a chance to enter at this level.
Time will tell if I am right.
General Notes/Neutral outcome:
Has the thesis been broken?
A variety of factors are conspiring against Appen at the moment (and may continue to over the coming handful of months/quarters):
Personally, I believe all of the 8 factors above are temporarily and not long-term structural trends that are here to stay (with the exception of maybe #1). So, in these moments, I like to remind myself of 2 of WB's favourite quotes:
To have confidence that Appen will return to its long term growth trajectory (in line with the industry growth rate), one needs to have confidence on all (or at least most) of the 8 points above. In terms of #3, all indications suggest to me that Appen has entrenched itself into the new emerging projects that the tech giants are now beginning to grow. These will take time to mature but Appen will be a trusted partner of the tech giants as they pursue new AI products, I simply doubt Appen will get left behind as the tech giants change their product focus (away from advertising - in the light of increasing regulatory pressures.)
Appen has grown into a fairly complex company over the last few years and the results take a bit of time to wade through, digest and contextualise. This is exacerbated by the extremities presented in 2020 making extrapolation of results in that year nigh impossible.
Some points are raised that are worth considering…
Appen have said that online advertising spend softened in 2020. Are we supposed to believe this given the record shift to online and a US election thrown in? While some are rightfully sceptical I think that it is possible as uncertainty leads companies to preserve cash and even if customers were spending more on advertising online APX is several steps removed from this direct spend and it is entirely possible that their customers delayed or reduced R&D and non-essential spending in their AI projects that require these data sets.
Currency had a wild year with the AUD swinging between mid 50 cents to mid 70 cents USD. Appen have given projections with the rough average of the exchange rate last year to allow them to “contextualise” the numbers. While that sounds reasonable unfortunately the AUD has rocketed up to almost 80 cents now so is going to be a significant headwind unless there is a reversal back down. Of course it could even move higher. That said the important thing is being aware of this. I try to construct my portfolio in a way to diversify across large currency movements. If you are like me and earn AUD it can also be worth remembering that although this hurts Appen your global buying power is rising so I don’t hate this kind of exposure. I certainly wasn’t complaining when the FX provided a free kick in the other direction.
When you look at the revenue by customer of the five largest 1 had good growth two reduced spending and two stayed roughly the same. Something to watch.
China growth is currently +60% quarter on quarter from a low base while it won’t continue at this rate it implies it could have revenue from $15 – 90million in just two years time (probably lower end). While speculative and currently immaterial if this was a separate listed entity on the ASX it would probably trade for $200+ mil valuation.
New customer acquisition is accelerating as they learn how to sell to smaller entities. This will help to mitigate the significant customer concentration risk.
Competition still not a major issue with essentially a competitive duopoly in place between Appen and Lionbridge.
No concerns raised invalidate my thesis for Appen and my expectation is medium to strong sustainable growth for at least the next five years. No view on the AUD.
I would recommend listening to the call to get some extra explanation of the presented numbers from the company that can be found here.
24 February 2021
Appen Maintains Solid Growth
Appen Limited (Appen) (ASX:APX) a global leader in the development of high-quality, human annotated datasets for machine learning and artificial intelligence(AI), has today announced its results for the full year ended 31 December 2020
Jan 15 By Tyler Galagher
Wisdom From The Women Leading The AI Industry, With Dr. Judith Bishop of Appen
Can you tell our readers about the most interesting projects you are working on now?
There are no uninteresting projects in AI, and while I can’t give specifics, we’ve started to move into multimodal data creation and product evaluation projects that require a new focus on time and timing — for example, how the visual output of the AI engine, such as an avatar face or face and body, aligns in time with the synthesized speech. Human beings are super keyed into timing. It’s usually at a subliminal level, but as you know from watching poorly dubbed movies, any slight misalignment between channels can really make the experience challenging.
What are the 5 things that most excite you about the AI industry? Why?
What excites me most about AI is that it’s aimed both at mimicking and exceeding human capabilities of reasoning, perception and communication. The knowledge we’ll gain about ourselves through developing AI — how we interact with each other and with the world — will be so deep. Linguists will be critical to this process because we’ll have to unpack how we communicate in order to help machines learn what we do and how we understand the world.
Another exciting area of development is that, with COVID-19, contactless services will continue to be important to all types of service providers. As we look to convert any situation where you currently have to walk into a room and talk with someone into a contactless service, we’ll continue to look at ways that AI can power chatbots, virtual assistants and the like. In healthcare, for example, there’s tremendous interest in developing AI-powered healthcare assistants that can perform triage to provide more options that eliminate the need for patients who are feeling ill to travel to see a doctor. This type of benefit will be replicated across many industries.
What are the 5 things that concern you about the AI industry? Why?
I would bucket my concerns into two main categories. First is the fact that policy and regulation are lagging far behind AI development. There’s a very real possibility that AI will leave people vulnerable in ways they’ve never been before. AI-powered insights into how we communicate and what we’re expressing and the emotions we’re expressing it with — things most people will want to keep hidden — will be stored in systems and devices. This can create opportunities for abuse.
It’s also a possibility that we could fail to ensure that AI technology is fair in terms of diversity and inclusivity. Whether intentionally or unintentionally, if we use biased training data for AI systems, we could end up replicating existing human bias in powerful AI projects that treat people unfairly on a huge scale. Systemic bias in automated systems for mortgage and credit applications, insurance rates, and even hiring come immediately to mind.
Full text can be found here: https://medium.com/authority-magazine/wisdom-from-the-women-leading-the-ai-industry-with-dr-judith-bishop-of-appen-f285e24cd63a
In a world where data is the new oil Appen is the leading refinery. Raw unannotated data is about as useful as crude in your family car.
- Content relevance currently requires constant human annotated data to stay relevant (repeat business)
- Upside to language services due to big tech selling into a global market
- Computer vision + text and speech recognition requires lots of high quality annotated data as does machine learning
- 8/10 top global companies using Appen - What other company has this spread of top quality companies on its books? Also use is still increasing rather than decreasing.
- Substantial free cash flow leading to acquisitions and revenue diversification
- High customer concentration (loss of one major would be substantial impairment)
- Big tech automating data collection through machine learning making Appen's services redundant (unlikely to happen quickly)
- Acquisition integration issues
- Competition (Lionsbridge)
- AUD strength
Appen worked closely with Microsoft on the recent addition of Inuktitut text transalation to Microsoft Translator.
"Inuktitut, a dialect of the Inuit language Inuktut, is spoken across Inuit Nunangat, the Inuit homeland in Canada, and is the mother tongue of about forty thousand Inuit in Canada ", Microsoft.
Appen at current prices appears to be a great opportunity with strong tailwinds behind it for at least the next 10 years. AI is one of Ark Invest's 5 innovative disruptive technologies. However, the investment case requires continual growth at 25%+ which will taper down to 20% by 2030. These are large numbers for a company already creating $500+ million in revenue.
Appen has a nice segment of the market. I found a figure that projects AI data will be 10% of all AI spending. Given Appen only has one other major competitor that I can find this gives Appen the opportunity to realise the revenue figures quoted above.
Customer value proposition:
Appen's value proposition to it's customers is the removal of project risks and provides price certainty. AI requires large and accurate datasets to train AI. For the customer to collect, process and use the data this expands the internal scope of the project. Questions customers have to ask themselves is: how many people to hire, who are the experts and how to hire them short time, what to do with them after collecting the data if it is a short project, how many working hours are required, do we have the correct systems to create and store the data, will we do this right? By purchasing the AI training data from Appen, all of these risks are removed and the cost is known at the start. The time saving alone could be well worth it in the fast moving tech world. To use the popular jargon I see Appen as an "AI data/training as a service or AI data/training on demand" company.
When to get out:
I see Appen as a strong "value" growth buy. I have been sitting on the fence due to the weak EBITDA expectation. Why only release the expected EBITDA figure? Are the revenue and profit figures worse? I understand the companies explanation. At a granular level my guess is teams are all working from home in the US and its probably getting to the point where teamwork is dropping off and new projects are less important than keeping to your known strengths.
I will be looking to buy in small chucks to build a position given the current outlook but don't won't hold off if others start to realise the value I see here.
I would be very interested in a forum conversation with anyone who would like to point out what I have got wrong with this thesis! As mentioned I couldn't find many negatives...
My predictions for the upcoming annual results are as follows:
The low end of the range assumes 24% growth in EBITDA YoY. The high end of the range assumes 32% growth in EBITDA YoY. Astute observers will note that this is a +/- 4% range from APX's guidance around growing earnings in line with industry growth (28% p.a.)
Anyone who is expecting more than $140M AUD for CY2021 EBITDA is perhaps a bit too optimistic. Or perhaps I am being conservative by discounting the power of operating leverage and expanding margins. Regardless, in my eyes, anything above $140M EBITDA for CY2021 would be a spectacular performance (that would be up 32%+ YoY).
If the midpoint of the above EBITDA ranges are hit, on current prices, APX would be trading on 19x CY21 EV/EBITDA and 15x CY22 EV/EBITDA (noting $126M in cash as at 30th June 2020 and a market cap as it stands today at $2.8 billion AUD).
Is that too high? Perhaps. Historically, across the markets as a whole, the general rule of thumb is that EV/EBITDA under 10x is attractive and undervalued. However, that is for the market as a whole, not the tech sector, which commands higher multiples due to stronger growth.
Worldwide, the average value of EV/EBITDA in the technology & telecommunications sector as of 2020 was a multiple of approximately 21.1x, an increase from 15.1x in 2019.
Today, there are some examples of eye-watering high levels of EV/EBITDA in the tech sector, but APX, at current prices, is not one of them.
“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.”
– Peter Lynch
Appen: An Aussie Star on the World Stage
From the 5 golden Aussie technology stocks (the ‘WAAAX’), at current prices, we like the look of Appen most. Given our investing style and Appen’s recent fall from grace, the smallest member of the 5 WAAAX giants is looking particularly alluring right now. In this research note we will evaluate why, but first, let us lay out the context:
Appen collects and labels images, text, speech, audio, video, and other data used to build and continuously improve the world’s most innovative artificial intelligence systems.
Appen’s competitive moat includes having a global crowd of over 1 million skilled contractors who speak over 180 languages and dialects, in over 70,000 locations and 130 countries, and the industry’s most advanced AI-assisted data annotation platform.
It is this reliable and cost-effective training data that gives leaders in technology, automotive, financial services, retail, healthcare, and governments the confidence to deploy world-class AI products.
The companies utilising Appen to deploy AI products are the real deal. We are talking about the BIG end of town. Although Appen does not disclose their customer’s identity, they do reveal that they work with 8 of the 10 largest Western AI technology companies on Planet Earth.
We believe those customers to be Microsoft (Azure), Google (Google Cloud), Facebook, Twitter, Mozilla, IBM (Watson), VMware and American Express, in addition to smaller AI application developers. Not bad for a somewhat little Aussie company that was founded in 1996.
Working with the giants of the tech world has propelled Appen’s growth. Since 2015, the share price is up an astonishing 1368%. Indeed, Afterpay is the only member of the WAAAX that has outperformed Appen across the past half-decade.
The top line is up 546% across 2015-19, from $83M to $536M. Moreover, with the underlying EBITDA margin holding in a range between 16% and 20%, EBITDA is up 622% over the same 5-year period from $14M to $101M AUD. Over this 5-year period, the PE multiple has ranged from 44 to 114, reflecting its status as a high growth firm.
Appen’s sell-off: sizing the opportunity
On the 10th of December 2020, Appen downgraded its FY2020 earnings guidance on the back of its heavyweight US-technology customers confronting new lockdowns in California and shifting their resources to new projects away from data-intensive mature projects in the wake of COVID-19.
Appen is still projecting overall YoY growth in both revenue and earnings, but this growth is now signalled to be slower than was previously indicated – the company noted that it was not experiencing the usual ramp-up in sales that has been experienced historically at this time of year.
Consequently, the EBITDA range for FY20 was downgraded from $125M-$130M to $106-$109M AUD, which includes an FX adjustment (headwind) from US$0.70c to US$0.74c.
The key piece of information for investors to understand is that the earnings update relates to the re-allocation of work by Appen’s customers. Some of Appen’s US tech clients have temporarily shifted resources (engineers) away from major existing projects, which are data-intensive, to focus on new project opportunities (that enhance their long-term resilience and value), which are less data-intensive. The mature projects have not been abandoned completely.
The share price is down circa 43% from the all-time high of $43.50 to $24.66 at the time of writing, for a market capitalisation of circa $3 billion AUD. We have taken this opportunity to add Appen to the TEP Investments portfolio and it is now our largest holding.
“Whether we're talking about stocks or socks, I like buying quality merchandise when it is marked down.” – Warren Buffett
We take a long-term view on value creation, seeking companies that have a disciplined growth strategy, a laser-like focus on their core market and are the leader in their industry. This process gives one the opportunity to look past the short-term valuation metrics and short-term performance if we can have confidence a business has the platform and management team to create a more valuable business on a medium and long-term basis.
What we are looking to identify, is a business that might look expensive on short term valuation metrics (i.e., one year forward PE multiple) or look ‘down and out’ because of a temporary earnings downgrade but offer value in 3 to 5 years on the back of strong compound revenue and profit growth.
Will this earnings downgrade be short-lived or is it the beginning of a structural decline?
For earnings downgrades, if the information released to the market causing the downgrade does not impact your original investment thesis, then your margin of safety has improved, potentially dramatically. For any earnings downgrade with a high-quality company, we consider if the change is a result of cyclical or structural changes.
Our view is that this is not a structural (long term) change in demand for Appen’s products and services. The largest western technology firms who are Appen’s customers (e.g., Microsoft, Google, Amazon) continue to grow at pace. Moreover, Appen has an opportunity to secure blue-chip Asian technology clients in the future, such as Tencent or Alibaba, and we believe this opportunity is not priced into the share price. Appen also has an opportunity to expand into other verticals such as finance and healthcare.
On the Appen earnings update investor call, CEO Mark Brayan highlighted that the company believes this COVID-related development could be positive longer-term in terms of presenting new revenue avenues that could complement a return to growth on their historical programs of work. However, currently, Appen has a lack of visibility on this and their near-term work orders and this is something we are vigilant of as a risk. This is the first time we have seen evidence of Appen’s customers struggling to cope with multiple R&D programs of work. Our view is that ramp ups in engineering, product and software hiring at the US tech giants may indicate that this is a challenge that will be managed through over the next 12 months and beyond and is temporary.
The long-term trends for Appen remain exceptionally favourable. Spending on artificial intelligence is growing rapidly at 28% annually and AI adoption should accelerate in a post pandemic environment according to market observers such as the Boston Consulting Group (BCG). Further, online advertising, a major source of revenue for Appen’s key customers and a reasonable indicator of their spend, is forecast to rebound strongly in 2021 according to analyst forecasts. In the Q&A section of the trading update conference call, Mark Brayan declared that he expects Appen to resume a growth trajectory in 2021 in line with market growth. The structural tailwinds, as well as the strength of the existing pipeline for 2021, support a return to strong growth rates in 2021 in line with industry trends.
Our conclusion is that this is a short-term cyclical earnings impact not a structural headwinds earnings downgrade – AI is here to stay.
How much is Appen worth?
Valuing Appen is notoriously difficult.
The challenge of this task is evidenced by the fact that broker fair-value estimates for Appen i) swing wildly and ii) vary wildly among the sample set. When a single-year earnings downgrade of circa 15% shifts a broker estimate by more than 25% despite the value of the business being the present value of all future cashflows across the lifetime of the business – we have an overreaction.
It implies that buy-side research firms have no real indication as to the length, likelihood, and size of Appen’s future cashflows and are tinkering not just with short term earnings but modifying key long term inputs to their Appen valuation models. Changes to the long-term growth rate or the terminal value of Appen leads to enormous variation in the fair value of the business.
With pessimism and uncertainly clouding investors’ judgement right now, short term fluctuations appear to have crept into long term assumptions. This forms part of our investment thesis and is part of what we aim to take advantage of over the next 12-24 months with the Appen share price as long-term growth assumptions normalise again once Appen proves this current set back is temporary.
We have tested 3 scenarios across the TEP Investments APX discounted cash flow valuation model: i) the bear case, ii) the base case and iii) the bull case and determined a fair value target price using a blended valuation across the 3 scenarios.
Across all 3 scenarios, the following has been held constant:
A corporate tax rate of 30%
A weighted average cost of capital (WACC) of 9.9%.
This is based upon a cost of debt calculation that reflects i) the risk-free rate, ii) the country risk premium and iii) the sector’s (technology) specific cost of borrowing
Annual inflation rate of 2.40%
An EBITDA multiple method for calculating the terminal value
Assumed total shares on issue remains constant at 122.35M
Assumed the underlying EBITDA margin is 17% in 2020F and rises gradually (linearly) to 21% by 2030F (across 2015-2019, the EBITDA margin has ranged from 16% to 20%)
Assumed the EBIT margin is 11% in 2020F and rises gradually (linearly) to 16% by 2030F (across 2015-2019, the EBIT margin has ranged from 12% to 16%)
The Bear, The Bull & The Human
In the bear case, we assume that Appen is unable to meet its promise of returning to an industry standard growth rate (28% p.a.). We assume Appen’s top-line grows at 20% in 2021F and then gradually declines (linearly) to 12% growth YoY in 2030F. This is a low-growth scenario in which Appen would be underperforming the industry growth rate by a significant margin. We consider it a highly unlikely scenario but find it a useful exercise to determine a likely floor in the share price. In this scenario, we assume a terminal value multiple of 6x 2030F EBITDA to match the assumed low growth trajectory of the business. This scenario leads to a fair value share price estimate of $18.81 per share.
In the base case, we assume that Appen can meet its promise of returning to an industry standard growth rate (28% p.a.). We assume that Appen’s top line grows at 28% in 2021F and then gradually declines (linearly) to a growth rate of 20% YoY in 2030F. This is a moderate growth scenario that tapers off, such that Appen is likely to have underperformed the industry growth rate overall across the forecast period (2020-2030F). We consider this a viable scenario, but, there is a fair chance that the business outperforms this scenario if Appen can match and maintain the industry growth rate. In this scenario, we assume a terminal value multiple of 7x 2030F EBITDA to match the moderate growth trajectory of the business. This scenario leads to a fair value share price estimate of $36.71 per share.
In the bull case, we assume that Appen beats the projected industry growth rate (28% p.a.). We assume Appen’s top line grows at 28% in 2021F and then rises to 36% YoY growth in 2022F buoyed by a bullish post-COVID environment and maturation of new customer projects and/or additional growth from one or more new blue-chip clients (tech giants – Alibaba, Tencent etc.) in China. We then assume that the growth rate gradually declines (linearly) back to a growth rate of 28% by 2030F. This is a high growth scenario that beats the projected industry growth rate and then tapers off in line with the industry growth rate. We consider this a possible scenario. In this scenario, we assume a terminal value multiple of 8x 2030F EBITDA to match the high growth trajectory of the business. This scenario leads to a fair value share price estimate of $66.98 per share.
Finally, reverse engineering the model to arrive at the current share price (circa $25 per share) reveals insights into what the investor community currently collectively believe the growth rate of Appen will be going forward. Using the same margin, WACC, and terminal value assumptions as per the above scenarios, reverse engineering the model reveals that the investor community are collectively pricing in a revenue CAGR of 19% across 2020-2030F for a share price of $25 per share, well below the expected industry growth rate (28% p.a.). This contrasts with the Appen track record of high growth; APX achieved a 54% revenue CAGR across 1H FY2015 to 1H FY2020.
Ultimately, using a blended valuation approach and applying a likelihood of 15% to the base case, 50% to the base case and 35% to the bull case, we arrive at a TEP Investments target price for Appen of $44.62 per share.
The law of entropy & investor psychology
However, unless you have a crystal ball (we do not even get one here at Oxford University, unfortunately), projecting the future growth rate of this high-quality business is a little bit like throwing darts at a dartboard. We can refine our throw with practice, industry insights and objective research. Yet, the law of entropy states that all things in this universe trend towards disorder – there is no guarantee where our dart will land.
Moreover, left unchecked, disorder increases over time. Energy disperses, and systems dissolve into chaos. The more disordered something is, the more entropic we consider it. The Greek root of the word translates to “a turning towards transformation” — with that transformation being chaos.
Entropy is fundamentally a probabilistic idea: For every possible “usefully ordered” state of molecules, there are many, many more possible “disordered” states. Just as energy tends towards a less useful, more disordered state, so do businesses and organizations in general. Rearranging the molecules — or business systems and people — into an “ordered” state and maintaining it requires a continual injection of outside energy.
So, although we cannot hope to predict the world and future business outcomes with high levels of precision, can we still win on the roulette table of life that is the investing world?
I believe so.
There is something more predictable than the future ever could be and this is what the best investors manage to understand and take advantage of – human behaviour. In short, we can predictably assume that human behaviour is unpredictable. Humans are not rational market participants. Humans are irrational market participants.
Humans emotions and investment markets will always continue to swing back and forth along the investment pendulum. Charlie Munger’s ‘Psychology of Human Misjudgment’ speech given at the Harvard Law School in the mid-1990s is in my eyes the finest investment speech ever given. The speech does not directly touch on investments but that tells you something – the most enduring advantages are psychological.
We do not need to predict the future of Appen with certainty. What we do need to know is that investors are currently viewing Appen with a bearish view of its future growth trajectory – this has been highlighted via the DCF analysis above. The pendulum of investing has swung out towards one of its two endpoints – it is much closer to fear than it is to greed. We also know that a pendulum rarely spends considerable amounts of time at either end of its arc and the further it swings out to an extreme the higher the likelihood that the pendulum will reverse towards the other direction.
With a more positive growth outlook from Appen at the February 2021 full year FY2020 update or with a more positive update at the H1FY2021 update in August 2021, analysts and investors will begin to normalise their view of long term Appen growth rates towards the base case and potentially to towards the bull case. Fair value of this company swings extraordinarily with relatively small shifts in the long-term growth rate.
With the earnings downgrade, the market pendulum has swung to the bears – but just like the inescapable tug of gravity, the reversal of the ‘sentiment pendulum’ is inevitable.
It is almost impossible to predict the future of Appen’s business performance flawlessly, but it is almost a certainty that investor sentiment will swing once more… and with it… the share price.
“We can all observe that stock prices, set in an auction market, are more volatile than business values. Several studies and casual observation reveal that individual prices oscillate widely around a central price year in year out, and for no apparent reason. Certainly, business values do not do this. Over time, this offers the prospect that any business, indeed all businesses, will be meaningfully mispriced.” – Nicholas Sleep
Re APX my read is that anyone who listened to the company's last call would not be too surprised at the downgrade. IMO the last call had quite a few caveats, MD was quite cautious, APX do not have significant visability on sales and although the US stock market is booming C19 is still impacting normal activity. i sold APX a little while ago with the strategy to see if we get a pre xmas downgrade then reass for potential re-entry. i think APX still has a growth pathway, a coupe of brokers still o/w, one upgdraed to o/w on this call. Likely Relevance will be irreleavnt (excuse the pun) one day, but not yet. my best guess at this stage is buy around $24-5. DYOR this is not advice.
Buy the blood!, This company is not going anywhere and is part of a larger macro trend being machine learning/AI which will grow significantly long term time to scale in.
Appen had a conference call regarding their latest update. They got really defensive on revenue growth etc... Especially when it came to how their top 5 customers (Comprising 88% of revenue) have reprioritised their data-intensive projects to other projects concerning vertical integration. They believe it is a "near-term" headwind and those customers will continue with previous projects after Covid.
Their growth plans with the government took a massive hit (pandemic of course) and halted the sales growth there. They are very optimistic about autonomous driving technology and are labelling data on test cars across race tracks.
The market belted the company on reducing the guidance estimates. However, the market is not looking at the longer-term picture with autonomous driving. Tesla will lead and vertically integrate but other car companies will use third party tech for their autonomous vehicle. Appen can be part of the third party tech. Comma Ai is used extensively across GM fleet, as well as Luminar for Volkswagen. Appen should sign up deals with companies like Comma Ai who have the data so that they can label the training data as Comma Ai does not have a large workforce.
I do not know how far away they are with customers in the self-driving space and that was going to be my question on the conference call. The interpreter cut me out lol, most of the wall street guys talking about how it impacts EBITDA for 2HFY20 is not forward-looking. Plus, Appen puts it out there that it will decrease.
What the crisis has told Appen is to diversify your customer base. Autonomous cars are the way, it will have to most data in the next 5 years. The miles driven by Tesla is just a barometer of how big the market can grow. Other car companies are not that sophisticated and do catalogue engineering.
Just saw Dino's straw (WOW) Scale AI already in the space and doing data labelling for autonomous driving cars. Ok, I spoke too soon, competition is big and Scale has the lead. In saying that, more than 1 company could label the data. The datasets are massive.
Significant insider selling in the last few days. Could be nothing but chair, CEO and director all selling large chunks concerns me. In light of this Any downgrade or bad news in the near term would break my thesis in terms of management and quality and would lead to my exit. If i hadn't already bought I would prob have avoided.
Appen released its full year results today and there was a lot to like. Highlights for me include the following:
Core business revenue of 536 million a 47% increase on FY18. They further break this down into: Speech and image 67.7M (+32%) Content relevance 430M (+37%).
Figure 8 ARR of 33.7M (56% CAGR over last 4 years) – Acquisition now performing strongly and expected to positively contribute to EBITDA from second half 2020 but possibly even in current half.
Underlying EBITDA growth of 42% to $101M excludes figure 8 contribution.
EBITDA margin slightly lower from 19.6% to 18.8%. On call stated one large customer had agreed to fixed pricing for next five years which management were happy with stating that it relieved margin pressure although said they would be lower in first half due to investment in sales and marketing before returning to mid to high teens in second half. Interesting according to CEO business efficiencies will be reinvested in the business rather than allowing significant margin expansion.
Very positive commentary regarding growth avenues with two US facilities opening up allowing work with more sensitive US data. China office sounds well set up but low expectations being set for growth there. US government work and LIDAR 3d data set annotation also mentioned as areas for new contracts (lookout Pointerra).
Regarding corona virus seemingly little expected impact so far...
The Company’s full year underlying EBITDA for the year ending Dec 31st 2020 is expected to be in the range $125M - $130M (at A$1 = US$0.70, Feb-Dec 2020)