Stocks In Focus: Appen, May 21 2025

0:10G'day, fools, and welcome to Motley Fool Stocks in Focus. Now, whether you're listening to this on the Motley Fool Money podcast or watching it on the Motley Fool YouTube channel, thanks for spending a little bit of time with us where we break down one of the ASX companies that are in the news, topical, widely owned, or simply worth talking about. Now, as I said, if you're on the podcast, that's awesome. We really appreciate it. Now, please hit the subscribe button on that podcast. If this is the episode you picked up because you looked to the company, you found it, that's great. Please subscribe.

0:37If you're on YouTube, do all the usual things that all the YouTubers have to say, right? Like the video for us. It helps, frankly, good for our egos. but helps it get around a bit and get, I hope it find it basically is what we're trying to do. But also subscribe and hit the notification bell so that you can be notified next time one of these great pieces of content drops. And I say great pieces of content, not because I'm doing it, but because he's here with me. He, of course, is Ryan Newman, the Motley Falls Director of Research. Mate, g'day. G'day, Scott. Thanks for having me. Mate, always a pleasure.

1:05Fun doing these things, particularly on the podcast and the YouTube. So if you like the sound of our voice, maybe use the podcast. If you don't want to see me, you do the podcast. Otherwise, jump on the YouTube channel as well. I'll do both those things for me. Mate, we're going to talk about a company that hasn't been in the news for a while, but had been, and it's definitely worth talking about. That company is Appen. APX is the ASX code. Let's start the usual way we do. Tell us what the company does. Man, was it ever in the news? Back in the day, I just realized it was actually part of the old WAX acronym, wasn't it?

1:34It was. That's all right. One of the aid within the WAX. That's right. We've got longer and longer over time, as I recall. It did. It very much did. Look, it's fallen a long way since then. Back then, it was all the rage. It was one of Australia's hottest tech stocks. And it's really come a long way back since then. And I think for pretty good reason. I'll get into what it does first. So basically, what Appen does, it provides training data for machine learning and also artificial intelligence models. We know that those sort of models really rely on data to function and huge amounts of data at that.

2:11So let's use a virtual assistant as an example. So maybe a Siri or an Alexa, something like that. What they really need to do is to be trained on data about how to respond, what the user is really asking for when they say a phrase. They're really looking to hone in on that, but there's so much more to it as well. It's not just a phrase. It's also a phrase that might be specific to Australia or a phrase that might even be specific to Sydney within Australia. So it requires huge amounts of data and bespoke data at that to function. Another good example would be autonomous vehicles. They obviously need to know what a sign might look like.

2:50If it's a stop sign, what does that actually mean? How should the car interpret that information to actually function how it's meant to function? So as I mentioned, huge, huge amounts of data are required for this. And basically, Appen actually provides a lot of that data. In terms of what kind, we're talking text, audio, video, images, and how it does that. It actually, Appen has a crowded network, so more than a million contractors. They can actually farm this work out too. It basically gives them a task and tells them, this is what we need, provide the data for us, and then they pay the contractors to do that.

3:28That's very, very cool. Make sure you remember when you use Alexa or Ramble or something, you kind of think, well, that's easy. That's simple. The computer's on all that work, but you kind of don't see what's happening in the background. So much behind the scenes. Right, which may answer my next question. So maybe if it does, that's okay. Why would a customer choose to use Apple? What's in it for them? Yeah, look, there's a few different parts here. So first of all, I mentioned bespoke data. Really, you know, you could look anywhere on the internet and find data, but Apple is providing bespoke data.

3:56It actually goes in there, it consults with the company, the customer, and basically says, what do you need? What do you need to succeed? It will then go away and devise a project, which can then farm out to those contractors. As I mentioned, more than a million contractors around the world, but they're not all located in one spot. They're not all American. Some might be in Brazil, others in America, others in Australia. So it can really get that bespoke data that those customers need. I'll give you an example. An autonomous vehicle creator might want data to help its fleet of vehicles to drive autonomously on the streets of Los Angeles, say.

4:36Now, the signs in Los Angeles are going to be different than what they are in London, what they are in Sydney, et cetera. So they're really going to be specifically targeting data that is applicable to the Los Angeles market. Another good example here would be a virtual assistant that is looking for improvements with the Australian dialect. Maybe they don't quite understand how to converse with ordinary Australians with the slang that we use sometimes. So they might use Appen to actually farm out that project to basically say, hey, we need people from Sydney or from Australia to give us the data to help us interpret how to help that customer.

5:15So as I mentioned, bespoke data, but there's really that variety in dialects, accents, interpretations that they can get from that huge network of contractors. Another good reason why they would use Appen is the custom technology. So Appen has, what, a two-decade head start in this. They really have the technology and the know-how to actually do this, which allows for faster project setups, improved quality outcomes, and that really is the key for a lot of these customers. The other thing too, I'll just mention as well, and I think this has probably become a little bit less relevant over time.

5:54And certainly back in the day when I really followed this closely, I'm talking five or six years ago, the real reason why customers would really want to use Affen was because it would provide the real training data. And that's often been perceived as higher quality compared to synthetic training data. And I'll just go into the difference there. Real training data would come from my voice or your voice saying phrases, actual human input. Synthetic training data might be artificially intelligence-created inputs and data. I think that's getting a lot better over time. And I think that's a real inflection point, whichever way it goes for Appen.

6:40is there. But yeah, historically, one of the key reasons why customers would have used it is because of that real training data that it provides. Nice, mate. That makes perfect sense. Before we go into the pros and cons of an investment, let me just let our listeners and viewers know, the multiple provides general advice only. We can't give you personal advice. We can't tell you what you personally should do. So Ryan's going to give us some pros and cons of an investment in Appen, but that's the company. That's not your circumstance. You've got to work out what fits. Last thing I'll tell you is just remember, we're recording this in the middle of May 2025.

7:09If you're watching this, listening to this at any point after that, just know that circumstances could have changed. Ryan's view might have changed, the company might have changed, competition, price, anything could have changed. So please just bear in mind that while we are long-term investors at The Motley Fool, frankly, this is not a formal recommendation. The other thing I probably should tell you, this is just Ryan's thoughts and very valuable thoughts, by the way, but they're not formal Motley Fool recommendations. And again, that can change at any point in time. So just keep that in mind.

7:33Mate, with that said, let's get to the investment case. Let's try and lay out both the pros and the cons, as I say, why would our listeners and viewers consider an investment in Appen? I'm going to start with the cons, Scott, because I think that could actually provide a little bit of context to some of the pros. Okay. So look, first of all, customer concentration, this has always been a trait of Appen. Certainly when I did start following it, I want to say about 10 years or so ago, the company had heavy, heavy concentration and it It particularly relied on Microsoft. So it was supplying Microsoft with a hell of a lot of data.

8:12Ideally, I wanted that concentration to reduce over time. I think, if anything, it's actually probably increased, maybe stayed around the same. But 67 % of its revenue came from the top five customers in FY24. That's a lot of concentration. And look, those kind of customer relationships can be very handy. but when things go astray, not so good. And back in March, 2024, so a little over 12 months ago, the company actually lost Google as a major customer. That was a$70 million hit in US dollars as well, mind you, for the FY24 year. So going forward, no revenue from Google. And you don't need me to tell you what happens if they lose another one of those top five customers.

8:57That's a big dent in revenue. So that's one of the major, major cons, I think, of investing in Appen. It is also loss-making. It reported a$20 million loss in 2024. And again, these are in US dollars as well. Negative operating cash flow, negative free cash flow. They were big, big improvements on the previous year, mind you, so I will preface that by saying that. But there is still a way to go. And look, ideally, at this stage of the company's life, I would really like it to be profitable and generating some solid cash. Part of the reason, I suppose, as well, that results can be hit and miss is the projects themselves can be quite lumpy and sometimes one-off in nature.

9:40You never quite know for sure if they're going to get a good project come through or if some of that spending is going to be pulled back a little bit by some of those major customers. And I mentioned this one as well before, the competition factor. The biggest one that I'm worried about, though, is synthetic data or potentially also companies like Google generating all of that data internally themselves rather than having to fork out$100 million to a company like Appen. Those are the two big, big risks that I'd be watching, the synthetic data and internally generated data that could threaten its relationship with those concentrated customers that it has.

10:27Having done the cons, showing my entire script to play down, let's get to the pros. So risks to the business. What about the positives? What would you consider investing in Appen? Yeah, look, and the reason I wanted to say the cons first is because excluding Google, the company has actually started generating growth again. So revenue was actually up 16 % in the 2024 financial year when you exclude Google. It's also expected to increase again in FY25. And I think a lot of that is probably coming from the opportunity that it has in generative AI. Now, when I talk about generative AI, people are most probably familiar with like chat GPT, so large language models.

11:10It seems to be getting a lot of project-based work here. These, of course, need huge amounts of data. The revenue that Appen was actually generating from these sources was up more than 600 % in FY24. It accounted for 22 % of revenue compared to 4 % of revenue the previous year. It's actually working with 26 lives language model builders now as well. Look, I think there is still an opportunity here going forward. You know, I did mention that it's still generating some solid growth in that region so far in FY25, and I think that could well continue in the foreseeable future. The other thing as well is I think it is profitable at an operating level.

11:52So I mentioned before, still generating a loss at the net profit level. At the operating level though, it is profitable. I think there is still room for improvement there. I think artificial intelligence could potentially help to make its own model more efficient. I think there's a real opportunity there if it can do that to improve its results at the bottom line. So those are some of the pros that I'll stick with. Nice, mate. I like that. Obviously, the other thing we've got to think about when investing is valuation. So that takes me to my question. Now, again, it's not a formal recommendation.

12:22I'll say that a dozen times. We do, by the way, quick plug, we do Motley Fool Stock of the Month on YouTube. Every month, we give you one actual Motley Fool recommendation. That's a buy recommendation. So if you want one of those, you can get those on our YouTube channel. It's not what I didn't mean as a plug necessarily. I just want to differentiate between stocks in focus, which is, hey, here's a business. What do we think versus one we actually definitely like? I don't say Ryan won't necessarily like this one. I don't know what he's going to I haven't asked him. So I'm going to hear, as you are going to hear, mate, let's take a five-year view, as we tried to do at the Motley Fool.

12:50What do you reckon the odds are that Apple is able to beat the market from here, from the current price, given those pros and cons, over the next five years or so? Scott, this is a really difficult question to answer. And I know you're prone to say, I don't know. That's an answer. I'm going to go the more conservative side, and I'm going to say no. I don't think it's market beating, but I don't know. And the reason is because this industry is just moving so, so fast. And look, historically, I do think that Appen's ability to provide that bespoke, that real training data was a real strength to it.

13:29Now I'm not so sure. Artificial intelligence is becoming a lot better and a lot better equipped to continue training itself. When you've got customers like Google that have left Appen entirely, and I do believe they are generating quite a bit of their data internally now, and I suspect some of that is synthetic in nature, is dangerous for a company like Appen. So yes, the answer is yes, that they can beat the market if they are still relevant in time, especially if they continue to train large language models. And I think that would require continued growth and revenue and also further cost improvements.

14:07but I'm sticking with no because I do think that there is just so much riding outside of Athens' control at the minute that I just wouldn't feel comfortable to be putting my money behind it at the minute. So short answer, no, I don't think it beats the market over the next five years. Nice answer, mate. I like it very much. I mean, think about when we talk about the speed of technology, the speed of AI, it feels like it's been with us forever. Was it a year, two years? And the pace of improvement, if you use those generative models over time and each model is just mind-blowingly better than the last one.

14:36It's a brave person to look at five years and think they know, particularly in this very specific area where it comes to training data, when it comes to the use of AOL, that kind of stuff. It's hard to imagine what the world looks like in five years, let alone whether a company like Appen specifically is going to be a winner or loser. Yeah, look, I also want to preface what I just said. I think there could be some very big swings up or down in that next five-year period. So I don't want to say it's not going to go up or it's going to go down in a straight line, nothing like that. I think the real risk there is the technology advancements that are happening, whether or not that completely cuts up and out of the supply chain altogether.

15:13Very good. There you have it. One of the hot stocks of years past, part of that WAX acronym, as Ryan said, now on the wine. Do you like what I did there, wax and wine? But maybe it's got a future, maybe it doesn't. We'll see how AI progresses and how Appen can adjust its business to what the future holds. Mate, thank you for sharing your expertise with us. Thank you for listening and for watching. Again, Motley Fool Money or the Motley Fool YouTube channel. Come and get more great stuff from the team. It is worth your – well, it's free, right? It's worth the price of admission. Come and join us.

15:42Be part of the journey on social, on YouTube, or on the Motley Fool Money Facebook feed. Motley Fool Money podcast feed. You can find us on the other social. We've got Facebook, we've got Twitter, we've got Insta, all the good things. But until we speak again, Fool on. Fool on. The Motley Fool and people appearing in this program may have positions in the companies mentioned. general advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under financial services license 400691.