Ann: 2021 AGM CEO's Presentation, page-18

The tide is slowly turning for beaten-up WAAAX stock Appen thanks to its plans to restructure the business and signs that its artificial intelligence projects delayed by its big tech customers are starting to return.

The artificial intelligence data services stock traded as high as $43.66 in the past 12 months, but thanks to increasing regulatory scrutiny on companies such as Facebook, Microsoft and Google and a reduction in spending on advertising-related AI initiatives, its earnings have been under pressure.

Appen CEO Mark Brayan announced a restructure of the business in May. James Brickwood

From its 12-month high in August, the company has lost almost 70 per cent of its value. In the year to date it is down more than 47 per cent.

Having fetched a market capitalisation of more than $5 billion in August last year, the business is now valued at $1.3 billion.

But in May, Appen experienced a sudden 10 per cent share price surge, with the market buoyed by its plans to restructure the business from its content relevance and search, plus speech and language categories to its new categories of “global” (which encompasses its big US tech company clients), and “new markets” (encompassing enterprise, government and China-based earnings).

The point of the restructure was to change the company to be more product- and customer-centric. It also involves shifting to US dollar reporting, which will remove a lot of the currency fluctuations from Appen’s results, given 90 per cent-plus of its revenue is generated in the US.

Wilsons senior analyst Ross Barrows told The Australian Financial Review the restructure had pleasantly surprised the market.

“I don’t think anyone expected a restructure. This is them taking a step back and looking at what they want to do. They’re taking a product-led strategy and now the cost base will reflect that,” he said.

“I think they’ll be able to service their customers’ needs better ... and they’ll be able to do it faster and cheaper. The breadth of their offering will position it well.”

Appen provides companies with crowd-sourced annotated data that is needed to train AI algorithms, powering voice assistants, image recognition technology and algorithms that dictate search results and advertising placements.

It has a crowd of more than 1 million workers who annotate the data. Traditionally this has been a very manual process, but thanks to the company acquiring Figure Eight in 2019, it has created a tech platform that speeds this up by automating a chunk of the annotation process.

Good value?

At the time of the restructure update, Appen also reaffirmed its full-year guidance of $US83 million ($107.6 million) to $US90 million in earnings before interest, tax, depreciation and amortisation.

This reiteration, RBC Capital Markets lead technology sector analyst Garry Sherriff said, was quite unexpected.

“We decided to upgrade [our recommendation], having been somewhat negative beforehand until the mid-May announcement on reiterating guidance, shifting to US dollar reporting and the restructure,” Mr Sherriff said.

“Our price target is now $20 and we think in the low teens it’s a reasonable buy.”

Many analysts, including Cannacord Genuity’s Conor O’Prey, had been expecting another guidance downgrade from Appen, but the reiteration of guidance suggested AI projects were gearing up again and the second half of 2021 could be a big one for the business.

“An order book of $US260 million shows healthy progress from February’s circa $US185 million and represents the sort of rate required to reach our revenue forecast,” Mr O’Prey said in a note. “Although caution remains in that earnings will be heavily skewed to the second half of the year.”

Restructure savings

Appen is expected to save $US15 million annually through the restructure, but chief executive Mark Brayan emphasised at the time of the announcement that it was not an exercise in cost-cutting.

Completing any restructure comes with a one-off cost, but the company did not go into detail about what this would entail.

The cost most likely centres on redundancy and entitlement payments to any staff who lose their jobs in the restructure.

Although Mr Sherriff now believes Appen’s share price will strengthen, he said investors have been right to sell off the stock based on concerns about Apple changing its privacy settings.

Historically, when someone uses an app on their phone, it may track them across other apps and websites in order to target them with advertising. While advertisers are able to track your internet usage without any personal information being revealed, a new setting Apple is introducing will allow the smartphone user to not just know who is tracking them, but prevent the tracking. Naturally, this has huge consequences for advertisers and their algorithms.

“The change to Apple iOS and privacy prompts was one reason we were quite negative on the stock. We were concerned about the privacy changes and what they would mean for Appen. But now the price has come back in the low teens, that’s factored in,” Mr Sherriff said.

Competition

Appen’s largest competitor, Lionbridge, was acquired by New York Stock Exchange-listed TELUS Corporation in November for $C1.2 billion ($1.3 billion).

It also competes with smaller players such as Scale AI and Labelbox.

These businesses could become acquisition targets for Appen, but Mr Barrows did not believe they posed a competitive threat.

“There are some really sophisticated, well-funded niche players, but they’re niche, so they can’t deliver the breadth and that’s worth pointing out,” Mr Barrows said.

“At the moment [Appen’s] share price is lower, and the valuation of those [possible acquisition] targets is up. But they have done acquisitions like these in the past, so that’s a consideration.”

Ongoing headwinds

Analysts agreed the biggest concern for Appen was still around its revenue visibility, thanks to its reliance on project-based work.

RBC’s Mr Sherriff said the market would be looking for a sign at its full-year results next February about whether the challenges of this past year have been an aberration, or something more permanent.

“The structural demand for search content and algorithms being used by the big tech companies won’t change. What is of interest is how much of this work gets done in house and how much is eaten away by other players in the market,” Mr Sherriff said.

“Those are the medium-term questions. But it still has OK growth for now.”

Although the company’s significant customer concentration and project-based work is considered a headwind, Mr Barrows highlighted that they can also work in Appen’s favour.

“The project work has that ambiguity and lack of visibility, but that’s also what gave it great momentum,” he said.

“There’s no reason it can’t happen again.

“Some people say it’s over, that it’s had its day in the sun. But I don’t share that view.”