Appen (ASX:APX) Is A Global Leader In Machine Learning & Artificial Intelligence

Appen (ASX:APN)

Henry Fung

Henry is a co-founder of MF & Co. Asset Management with over 19 years of experience as a trader, investor and asset manager. Henry is the instructor of the Professional Trading Course, which is a free 5-day course on how to become a profitable trader.

January 4, 2021

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Today, we will look at why we still like Appen shares (ASX:APX) and we’ll discuss our APX share price forecast.

The APX share price plunged more than 16% in a week, due to a downgraded FY20 EBITDA guidance released on 10 December 2020.

Slowing digital ad spending and an appreciation in the AUD/USD exchange rate during Q4 contributed to lower-than-expected revenue growth from its major clients, and hence the downgrade.

The concentration of revenue from major clients and exchange rate risk were not a surprise to us as they were covered comprehensively in our past research.

However, we are still confident in the long-term prospect of artificial intelligence and AI adoption as the technology landscape remains relatively intact under COVID-19.

About Appen Shares (ASX:APX)

Appen is a global leader in the provision of human-annotated data for training artificial intelligence and machine learning algorithms.

Appen specialises in the Relevance and Speech & Image segments that are mostly used for improving internet search accuracy, virtual assistants, and autopilot, among other scenarios.

At the current APX share price, Appen shares have a market cap of $3.1b.

Strategic Overview

Appen is viewed as a workforce management company with high exposure to the technology sector. Appen finds “curated” workers; assigns them with the data processing projects and assures the data quality before sending the processed data to its clients, who are mostly technology leaders like Google, Apple and Microsoft.

Data with a human touch

Appen adds value by giving an additional level of human discernment to raw data. For example, to improve a search engine’s performance, Appen works with humans to rate how good each result is for a particular query.

If you were searching the depth of the Grand Canyon and got two results, one from the US National Park Service and one from a local tour guide.

Most people would trust the US National Park Service more, maybe because it looks more trustworthy, or maybe because the US National Park Service isn’t selling you anything (Source: Appen).

Appen’s evaluators assign human preference and relevance to each query and make search results more relevant. In summary, Appen edits and enhances training data for better machine learning.

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Appen vs Google

Such data processing jobs done by Appen’s crowds are usually laborious, repetitive and non-innovative, such as data/query evaluation, annotation, transcription and translation.

The relationship between Appen and its technology clients (Google, for example) is similar to that between a junior cook and a real chef. Junior cook deals with food, who chops vegetables, meat into eatable pieces, just like Appen prepares the data for Google to process.

Then the chef (Google) puts magic (algorithms) to tomatoes, onions, spice and herbs to turn them into cuisines (better products).

Content relevance vs language resources

Appen provides all sorts of data, but it mainly falls into two categories, content relevance and language resources.

Content relevance data train algorithms to give users more relevant results, such as eCommerce site search, web search and social media feeds.

Language resource data trains algorithms to build virtual assistants, smart home devices, call centre systems and in-car infotainment systems.

Trading Update

On 10/12/2020, Appen (ASX:APX) unexpectedly announced a downgrade to its FY 2020 Underlying EBITDA guidance by 15% from $125M-$130M to $106M-$109M.

This is a drastic decline from its guidance issued on 27 Aug 2020.

As estimated, 77.4% of the fall (AUD$15.48M) in EBITDA guidance is due to slowing growth from top five clients, such as Google and Microsoft who were hit the hardest by COVID-19 restrictions in California.

A stronger AUD /USD exchange rate in Q4 and other factors contribute 10% (AUD$2M) and 12.6% (AUD$2.52M) to the shortfall, respectively.

Appen Shares (ASX:APX) – FY20 – Q3 to Q4 Underlying EBITDA Guidance Shortfall Estimate

Appen (ASX:APX) - EBITDA Guidance Aug-Dec

Source: MF & Co Asset Management Research Estimate

Downgrade Drivers

More concentrated Revenue from online advertising data. APX’s Relevance segment which provides annotated data for clients to target ads has increased its share of the revenue from 61% to 87% FY15-19, and to 89% in H1 2020.

This indicates APX’s greater dependence on the Relevance segment and it also reflects the global trend of data demand in AI and machine learning.

APX – FY20 – FY15-19 Segment Operating Revenue Composition

Appen (ASX:APX) - SEGMENT OPERATING REVENUE

Source: APX Annual Reports, MF & Co Asset Management Research

Decline in Digital Ad Spending. Due to COVID-19, digital advertising spending globally experienced a decline thus affecting revenues of Appen’s major clients such as Google and Facebook, who subsequently spent less on advertising data sourced from Appen.

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As illustrated below, global digital advertising spending has seen much slower growth in 2020 than in 2019, 2.4% compared to 15.9%.

However, digital ad spending is expected to grow at 17%, reaching $389.29 billion in 2021.

Forecasted growth in digital ad expenditure in 2021 is indicative of a recovery in Appen’s Relevance revenue.

Appen Shares (ASX:APX) – FY20 – FY19-24E Global Digital Advertising Spending

Appen (ASX:APX) - Global Digital AD spending

Source: Emarketer

High concentration of customer base. As APX stopped disclosing their top clients in 2017, we pick Facebook, Google, and Microsoft and compare their online advertising revenue growth to APX’s relevant revenue growth.

As illustrated, there is a strong correlation between Tech giants’ digital ad revenue & APX’s Relevance revenue.

Therefore, apart from a high concentration in the types of projects (90% revenue from Relevance in 2020 H1), Appen still has a high concentration of customer base like three years ago.

Appen (ASX:APX) - Correlation of revenue growth rate

Source: APX Annual Reports, 10Q reports of Facebook, Alphabet and Microsoft, MF & Co Asset Management Research

COVID-19 Impacts on Appen Shares (ASX:APX)

The resurgence of COVID-19 in the U.S, where 87% of its revenue was generated in FY19 has negatively impacted APX’s revenue growth.

Furthermore, as California sees the highest total number of cases and the strictest restrictions on business activities, it is not surprising that Google, Microsoft, and other tech giants who contribute an estimate of 88% to revenue are reallocating resources and reducing expenditure and hence a lower revenue growth for Appen shares.

Moreover, given that Appen shares’ revenue is generated from the individual case-by-case projects rather than long-term contracts, an impact on face-to-face sales and customer engagement practices especially in California where major customers are located would have a significant impact on revenues for Q4 2020.

This impact on revenue was reflected by the pressure on the APX share price.

However, the recent emergency authorisation of the Pfizer COVID-19 vaccine could result in the loosening of lockdown laws in the U.S which would directly improve Appen’s operating conditions.

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Appen Shares (ASX:APX) – FY20 – FY16-19 Revenue by Geography

Appen (ASX:APX) - Revenue by Geography

Source: APX Annual Reports

Increased USD Proportion of Income, Appreciation of the AUD in H1 2020, and Underhedged Position Led to Negative Currency Impact.

As illustrated, US contribution to APX’s total revenue increased from 67% to 87.5% FY15-19, while the Australian income proportion declined from 33% to 11% in the same period.

AUD has strengthened against USD, from the trough of 0.5743 on 13 March 2020 to around 0.75 in December 2020.

Moreover, the hedged USD position (measured by the notional value of APX’s foreign exchange instruments) as a percentage of US revenue and of total revenue, has declined from 12.8% to 2.4%, and from 8.5% to 2.1%, respectively, as represented by the blue line and orange line below.

Uncertain AUD/USD Prospect Hinges on US-China Trade war and AU-CN Relationship. Iron ore composes of 65% of Australian export to China, our biggest trade partner, and improving economic conditions in China may increase Australian iron ore export in 2021, whose price has increased 48% in the last six months due to the vaccine news.

However, the deteriorating diplomatic relationship, substantiated by the recently placed trade restrictions on Australia by China may add uncertainty to the long term export landscape and the AUD exchange rate with USD.

Appen Shares (ASX:APX)– FY15-19 – Revenue Distribution and Hedging Strategies

Appen (ASX:APX) - Revenue Distribution

Source: MF & Co Asset Management Research

APX – FY19-20 – AUD/USD Spot Rate

Appen (ASX:APX) - FY19-20-AUD

Source: Yahoo Finance

Conclusion

The recent 15% fall of APX share price was a direct result of downgraded guidance, underpinned by unresolved concentrated customer risk and exchange rate risk.

However, we are still confident in the long-term prospect of artificial intelligence and AI adoption as the technology landscape remains relatively intact under COVID-19.

Moreover, the forecasted industry trend of spending on Digital Advertising and current analyst forecast on APX’s key customers are all pointing to a strong rebound in FY21.

Even though there will likely be some short term pain for the APX share price, Appen shares continue to show strong potential upside for its high market share in AI data annotation and the long-term growth of the AI market.

 

Are you looking for more stocks to buy? In our opinion, buying the right stock at the right time is just half the battle – knowing how to manage the position and risk is just as, if not more important. Take our free 5-day trade like a professional course, it give you the foundational knowledge required to become a profitable trader.

This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.

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