Traditional Data Annotation Will Decline As Advanced AI Expands

Key Takeaways

• Advances in AI and in-house solutions by major firms threaten to make Appen's traditional services obsolete, jeopardizing future revenue and margins.
  
• Rising competition, open-source tools, and regulatory pressures are increasing costs, intensifying pricing challenges, and undermining long-term profitability.
  
• Strong AI expertise, robust China growth, operational efficiencies, proprietary platforms, and major project wins position Appen for improved profitability and more stable long-term revenue.

Catalysts

Operates as an AI lifecycle company that provides data sourcing, data annotation, and model evaluation solutions in Australia, the United States, and internationally.

• The acceleration of advanced AI models that require less human-labeled data is likely to make Appen's traditional data annotation services less relevant, putting the company's future revenue streams at severe risk as the addressable market contracts.
  
• There is a growing trend of enterprises, especially large technology firms, bringing AI development and data labeling in-house, which significantly reduces Appen's ability to win major new contracts and threatens sustained revenue declines and margin erosion.
  
• The proliferation of open-source and synthetic data generation tools is rapidly reducing external dependence on manual data annotation, threatening to render Appen's core business obsolete and dramatically shrink long-term revenue potential.
  
• Intensifying competition from both well-capitalized global rivals and lower-cost entrants is likely to result in further margin compression and potential ongoing losses, particularly as price competition escalates and the company struggles to differentiate in a commoditizing market.
  
• Increasing regulatory scrutiny and tightening data privacy requirements globally will drive up compliance costs and complicate service delivery, increasing operating expenses and undermining prospects for future earnings growth.

Appen Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Appen compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Appen's revenue will grow by 5.9% annually over the next 3 years.
• The bearish analysts are not forecasting that Appen will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Appen's profit margin will increase from -9.6% to the average AU IT industry of 4.5% in 3 years.
• If Appen's profit margin were to converge on the industry average, you could expect earnings to reach $12.1 million (and earnings per share of $0.04) by about August 2028, up from $-21.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.9x on those 2028 earnings, up from -7.0x today. This future PE is lower than the current PE for the AU IT industry at 34.7x.
• Analysts expect the number of shares outstanding to grow by 1.6% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.41%, as per the Simply Wall St company report.

Appen Future Earnings Per Share Growth

Risks

• Strong momentum in China, with revenue growing 67% year-on-year and sustained positive EBITDA for five consecutive quarters, provides a diversified and growing profit stream that may bolster overall group earnings and cash flow.
  
• Appen's deep expertise and continued success in supporting foundation model builders and large-scale multilingual AI projects position the company to capture rising demand from rapid AI adoption, which could lead to higher, more stable revenue.
  
• Significant operational efficiencies and cost management, with $10 million in annualized cost savings plus an additional $4 million from winding back U.S. government operations, are set to improve net margins and move the company towards sustainable EBITDA positivity.
  
• Proprietary, AI-enabled platforms (such as Mercury, ADAP, MatrixGo, and CrowdGen) improve efficiency, scalability, and product differentiation, potentially reinforcing Appen's competitive advantage and supporting better long-term profitability.
  
• Recent major project wins, including a U.S.-based generative AI engagement with annual revenue potential exceeding $10 million, as well as a healthy pipeline and re-engagement with large enterprise and LLM customers, could drive top-line growth and strengthen future revenue visibility.

Valuation

• The assumed bearish price target for Appen is A$0.52, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Appen's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$1.65, and the most bearish reporting a price target of just A$0.52.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $267.0 million, earnings will come to $12.1 million, and it would be trading on a PE ratio of 9.9x, assuming you use a discount rate of 8.4%.
  
• Given the current share price of A$0.86, the bearish analyst price target of A$0.52 is 66.3% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.