Appen's Competitive Moat

Once in a while, the market offers up a high quality business at a somewhat-grounded valuation. These opportunities are rare and it's worth asking ourselves whether Appen is one of them.

Its revenue has been growing at a great clip over the past few years:


It seems to lack a key characteristic of a truly high quality business, that being scalability. Its margins have been obstinately static despite that fantastic revenue growth:


In this respect I think it's very similar to a professional services firm. To say it's just a labour hire company misses the point that unlike a labour hire company, it doesn't just clip a ticket on contractor timesheets. The contractors work through Appen's systems and rather like a firm of Lawyers or Engineers, Appen itself will be judged by its customers on the quality of the end product.

If revenue growth returns to even half its previous rate, and even with margins remaining as they were, this is a fantastic investment today. The key question is knowing whether the last year is a short hiccup or evidence of a terminal disruption to the business.

Appen's main advantages over its competitors are said to be:
- A pool of 1 million "skilled contractors" who do the data labelling.
- Artificial intelligence assistance to data annotation.

On the first point, I'm not sure how this is any real competitive advantage. There's really nothing to stop those contractors switching to a competitor, or even working multiple different gigs. They are effectively Uber(/lyft/didi/ola...)-drivers of data annotation.

Few of us have enough understanding of the quality of Appen's IP and its human capital to make a judgement on its AI or a prognosis on whether it can continue to innovate and be a market-leader. But there seems to be no obvious reason a well-resourced competitor couldn't invent something better, a 'winner takes all' scenario that would likely squash Appen.

In the end I thought the risk/reward equation was too uncertain, but very interested to hear other views on what edge Appen has over its competition.