Appen: falling knife or window of opportunity?

Nicholas Plessas

Livewire Markets

Since hitting its all-time high of $43 in August, data giant Appen has run into difficulty after difficulty. After a slump in Q4 2020 earnings and a rising Aussie dollar, investors hoped to have their fears quelled and their pockets filled going into the February reporting season. But the stock is down near 30% from January. And today's result may have just added fuel to the fire.

True, Appen, which was your ninth-most tipped large-cap list for 2021 Livewire's annual reader survey did highlight exciting growth in China and a strong uptick in recurring revenue. But it was the uncertain outlook and what could be construed as an exchange-rate bungle that took the attention of the market.

To make sense of this news, I sat down with Ausbil Investment Management's Mason Willoughby-Thomas to discuss the key highlights from today, what attracts him to Appen, and why he believes now might be a window of opportunity. The Q&A below is an extract of our discussion.

Can you provide some background as to the functions of Appen?

Appen provides annotated data which is essential for machine learning processes that produce artificial intelligence applications.

The data is used to train or ‘tune’ machine learning algorithms whose goal is to make accurate predictions based on a set of data inputs. Machine learning algorithms require vast volumes of accurately annotated data. Appen has emerged as a global leader in the supply of annotated data to many of the world’s largest technology companies because of its ability to deliver the data at scale, on a timely basis with relatively few annotation errors and at low cost.

What attracts you to the company?

The sheer scale of the opportunity to develop innovative AI applications implies a very large addressable market for Appen which should support healthy levels of organic growth for Appen for many years yet. Data has become an extremely valuable intangible asset for a growing number of commercial organisations, but it takes innovative data science to monetise the asset and Appen is a key contributor to that process.

Appen generates good margins in the high teens %, capital requirements are light and incremental return on invested capital is high (noting that headline ROIC is diluted by growth in goodwill from acquisitions).

What were the key points of this result?

The key points today were:

  • Uncertain outlook for the near term
  • A downgrade relative to consensus 2021 EBITDA expectations
  • Growth in new customers
  • Strong growth of recurring or committed revenue vs project growth
  • Attractive growth in China. A small percentage of revenues but may become a real opportunity in the future.
  • Their debts have been repaid and have an excess of cash

In December, Appen updated the market with a downgrade to their 2020 full-year guidance and their results today were largely consistent with that. Overall, the result was consistent with the December guidance with underlying EBITDA coming in at $108.6m which was towards the upper end of the $106m-$109m.

There were a number of notable positives in the release: 

  • an increase in customer numbers; 
  • solid growth in project wins with existing customers; 
  • a rise in the level of recurring or committed revenue as a proportion of total revenue;
  • continued growth in China (off a small base); 
  • strong balance sheet reporting a healthy net cash position after borrowings were repaid during the year; and 
  • strong cash generation supported by seasonal working capital unwind.

Can you give some colour to the situation that caused the earnings slowdown?

Guidance provided in early December last year indicated, amongst other things, that the usual fourth-quarter surge in customer demand had not materialised. With the final quarter of the year typically accounting for 30% of full-year revenue, the impact on the full year was material.

In addition, COVID disruptions over the course of the year meant that customers reprioritised new project areas over existing core relevance products, sales and marketing activities were restricted by an inability to conduct face-to-face meetings and the growing currency headwind brought by a rising Australian dollar compounded Appen’s troubles.  

Were these results within your expectations?

The result itself was consistent with expectations for the 2020 year, as discussed before, however, the outlook did little to soothe the bears or give confidence that the business is turning the corner after a COVID disrupted year in 2020. The challenging operating environment experienced in 2020 is expected to persist into the first half of 2021. If we do see a recovery in earnings it is likely to occur in the latter half of the year.

Quantitative guidance was provided which is admirable in such an uncertain operating environment, however it fell well short of consensus expectations. Guidance for 2021 EBITDA of between $120 million and $130 million was made on a currency assumption of an Australian dollar value of 69 cents US.

The current local spot rate of 78 cents against the US-dollar translates to guidance of between $106 million and $115 million, or $110 million at the midpoint. This divergence of figures results in an implied downgrade of approximately 20% relative to FY21 consensus expectations, providing ample fodder for the naysayers. That said, if we ignore the currency headwind that is largely outside of the company’s control, Appen is still looking to grow its EBITDA 17%-27% in constant currency terms in a challenging operating environment

Appen's share price was down around 11% today; what sentiment is causing the sell-off?

It's all in the outlook. I don't think the outlook did anything to soothe the company. The two main reasons would be:

    • Downgrade to FY21 consensus expectations exacerbated by a rising A$, and

    • The persistence of challenging operating conditions in the first half of 2021 with any recovery in 2021 likely to be back-ended.

Management flagged an 11% dividend rise on last year. Is that something you like to see or would you prefer earnings are reinvested in the company?

Appen is a growth company with a high return on invested capital so where ever possible I would prefer as much capital to go into the growth opportunities before it. In saying that, cash generation in 2020 was strong with the remaining debt repaid from cash reserves, so as long as the growth opportunities in front of them are fully addressed and funded I would prefer to see those earnings paid out rather than sitting on the balance sheet.

Has your position on the stock changed post result?

The shares have undergone a significant derating since reaching a peak of $43.50 in August last year. Concerns have been raised about the risks to Appen’s business from changing customer priorities, new market entrants and new technologies competing with APX’s largely human-focused approach to data annotation. Today’s result will probably only intensify those concerns.

From our perspective, we remain of the view that the opportunity set available to Appen remains large, that demand for human-annotated data (noting that Appen also has machine annotation capabilities) will remain robust, that Appen remains nimble enough to adapt to changing customer needs or technological evolution and that it’s proven abilities to deliver accurate data, at low cost and at large scale will hold it in good stead as the future of artificial intelligence unfolds. The company continues to grow at a healthy pace (in US$ terms) in a challenging operating environment so after a heavy derating and some of the heat removed from consensus expectations (no longer a consensus long) – now might be a window of opportunity!

How would you wrap up today's results in one sentence?

Appen delivers results in line with expectations, but their outlook remains uncertain with guidance disappointing.

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The information contained in the article is given by Ausbil Investment Management (ABN 2676316473) (AFSL 229722) (Ausbil) and has been prepared for informational and discussion purposes only and does not constitute an offer to sell or solicitation of an offer to purchase any security or financial product or service. Any such offer or solicitation shall be made only pursuant to a Product Disclosure Statement or other offer document (collectively Offer Document) relating to an Ausbil financial product or service. A copy of the relevant Offer Document may be obtained by calling Ausbil on +612 9259 0200 or by visiting www.ausbil.com.au. You should consider the Offer Documents in deciding whether to acquire, or continue to hold, any financial product. Neither this article nor the provision of any Ausbil Offer Document is, and must not be regarded as personal advice or a recommendation or opinion in regards to an Ausbil financial product or service or securities of any other entity including Appen (APX) or that an investment in an Ausbil financial product or securities of any other entity including Appen (APX) is suitable for you or any other person. This article and the information it contains is for general use only and does not take into account your personal investment objectives, financial situation and particular needs. Ausbil strongly recommends that you consider the appropriateness of the information and obtain independent financial, legal and taxation advice before deciding whether to invest in an Ausbil financial product or service or in the securities of any other entity including Appen (APX). The information provided by Ausbil has been done so in good faith and has been derived from sources believed to be accurate at the time of completion. While every care has been taken in preparing this information. Ausbil make no representation or warranty as to the accuracy or completeness of the information provided in this article, except as required by law, or takes any responsibility for any loss or damage suffered as a result or any omission, inadequacy or inaccuracy. Changes in circumstances after the date of publication may impact on the accuracy of the information. Ausbil accepts no responsibility for investment decisions or any other actions taken by any person on the basis of the information included. Past performance is not a reliable indicator of future performance. Ausbil does not guarantee the performance of any Fund or the securities of any other entity including Appen (APX) the repayment of capital or any particular rate of return. The performance of any Fund depends on the performance of its underlying investments which can fall as well as rise and can result in both capital gains and losses. By viewing this article, you agree to be bound by these limitations, terms and conditions set out in the paragraphs above. Unless otherwise specified, any information contained in this publication is current as at the date of this article and is prepared by Ausbil Investment Management Limited (ABN 26 076 316 473 AFSL 229722) (Ausbil). Ausbil is the issuer of the Ausbil MicroCap Fund (ARSN 130 664 872) (Fund). This article contains general information only and the information provided is factual only and does not constitute financial product advice. It does not take account of your individual objectives, financial situation or needs. Before acting on it, you should seek independent financial and tax advice about its appropriateness to your objectives, financial situation and needs. Securities and sectors mentioned in this monthly report are presented to illustrate companies and sectors in which the Fund has invested and should not be considered a recommendation to purchase, sell or hold any particular security. Holdings are subject to change daily. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance. Unless otherwise stated, performance figures are calculated net of fees and assume distributions are reinvested. Due to rounding the figures in the holdings, breakdowns may not add up to 100%. No guarantee or warranty is made as to the accuracy, adequacy or reliability of any statements, estimates, opinions or other information contained herein (any of which may change without notice) and should not be relied upon as a representation express or implied as to any future or current matter. You should consider the Product Disclosure Statement which is available at www.ausbil.com.au before acquiring or investing in the fund.

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Nicholas Plessas
Partnerships Manager
Livewire Markets

Nicholas is a Content Editor at Livewire Markets. He is passionate about equities, the law and basketball.

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