Palantir Technologies Inc. builds and deploys software platforms for the intelligence community in the United States to assist in counterterrorism investigations and operations. The company provides palantir gotham, a software platform which enables users to identify patterns hidden deep within datasets, ranging from signals intelligence sources to reports from confidential informants, as well as facilitates the handoff between analysts and operational users, helping operators plan and execute real-world responses to threats that have been identified within the platform. It also offers palantir foundry, a platform that transforms the ways organizations operate by creating a central operating system for their data; and allows individual users to integrate and analyze the data they need in one place. In addition, it provides apollo, a software that enables customers to deploy their own software virtually in any environment. Palantir Technologies Inc. was incorporated in 2003 and is based in Denver, Colorado. The company is publicly listed on NYSE under the ticker “PLTR”.
Our considerations
Palantir Technologies, from now on simply “Palantir” for readability purposes, is an data intelligence company. The business of the company is often compared to that of other AI, data and analytics companies, but it isn’t a good comparison: indeed, while these companies offer a static approach, Palantir’s platform provide a customized, flexible and forward-looking solution that allow the user to turn messy, unstructured and structured data into charts, maps and other forms that enhance visualization by humans across organizations. Since most companies in the world are becoming software companies, willingly or not, Palantir products offer an incredible competitive advantage for organizations and institutions that decide to use them.
There has been a lot of hype around this company last year, mainly attributable on it going viral on subreddits like WallStreetBets and developing a cult-like following. However, regardless of the hype and the incredible software offerings that the company has, we don’t think it’s a great buy and, moreover, we see some important issues in the management of this company.
First of all, the company is not yet profitable. There are several reasons why this, the most important one being that having dealt mainly through government contracts over its life, the company has never had to think too much about costs: the contracts covered them. Indeed, we have to keep in mind that Palantir began to be publicly traded just in 2019, but existed since 2003. It’s not a problem by itself, but considering there are at least two more years with net loss, the fair value of the company has to be severely discounted.
The second main problem has to do with the extreme use of equity financing, also known as “stock dilution”. Palantir’s weighted average shares more than doubled from 979 million at the end of 2020 to 1.923 billion by the end of 2021. Stock-based compensation racked up total expenses of $1.27 billion in 2020 and $778 million in 2021, which represented respectively roughly 116% and 50.4% of total revenues. Obviously, since the value is that high, existing shareholders left the company amid concerns about continuous share dilution. There are some improvements on the way, though: in its latest 10K, Palantir reported $922.4 million of stock-based compensation related to the RSUs outstanding over the next three years and $888.6 million of expenses related to options outstanding over eight years, translating to an average stock-based compensation of $418.47 million annually for the next three years. However, while this number is significantly lower than what we have seen until now, it is still far from being good news to shareholders and we should expect the share price to remain roughly flat those years.
In 2016, Alex Karp, the CEO of the company, noted that Palantir was profitable already since 2014, but they decided to defer profitability as a result of the rapid growth in its core business. Stock-based compensation is surely a good way to incentivize employees and align interests with value creation, nevertheless if the dilution rate grows faster than the company’s equity growth, shareholders might have a real problem.
Other than these two key issues, there are several risks and uncertainties tied to being a shareholders of this company. First of all, there is the concentration risk: by having a few large customers accounting for a significant part of the revenue, the company is exposed to credit risk and revenue risk. In 2021 the top three customers accounted for 18% of total revenue, improving from the 25% seen in 2020. However, as the customer base grows, the company should be able to mitigate this risk. The second important risk is regarding the revenue growth, as any material revenue miss below the 30% annual growth rate guidance provided through 2025 can significantly affect, in a negative way, the share price movement. It’s impossible to predict whether top customers will renew and expand their contracts, which might distort the growth outlook in a significant way. Then there are the ideological risks, since the company is clearly politically aligned. As the company discloses in its SEC filings, “working with the Chinese communist party is inconsistent with its culture and mission” and as a result the company has limited it’s TAM for ideological reasons. We are neither judging these beliefs nor saying operating in accordance with your own ideological beliefs is wrong, we admire those who stand by their ideas, even if it results in less optimal results: however, investors have to know there is this risk, and to accept that the company has defined long ago both its mission and target.
What matters the most for Palantir’s future is to sustain the growth expressed in its guidance, and the only way it has to make it is by expanding its total addressable market through innovation and new services. Palantir’s current offerings are Gotham, introduced in 2004, Foundry, introduced in 2016, and Apollo, introduced in 2018. It’s worth saying that anyone can start collecting and analyzing data, but realistically speaking the target customers for Palantir are large institutions, corporations and other complex organization rather than small businesses, since for the latter ones it wouldn’t be worth it in terms of costs and scalability.
At the moment, the gross average revenue per customer is roughly $6.5 million, and that already accounts for all the 237 customers they had at the end of 2021. The commercial segment, which has 147 customers, last year accounted for $645 million in revenue but considering that the platform targeting this segment, Foundry, was launched just in 2016, the revenue per customer should increase rapidly. In 2021, we saw a drop in average revenue per customer in the commercial segment, but that is mainly attributable to the large commercial customer acquisition.
However, it’s important to bear in mind that given the company’s business model, customer growth is more important than revenue growth, as Palantir benefits from the economy of scale and the incredible customer stickiness. If the company is able to achieve a good growth in its customer base during the next years, the target of 30% annual revenue growth may be well reached.
In conclusion, the company is incredibly innovative and might change the rules of data analysis as it grows bigger and become more powerful. Furthermore, the intelligence it provides might help shaping the industries and societies of tomorrow. However, considering the major risks and problems that the company is currently affected by, we don’t think it’s a great buying opportunity at these levels. We will surely update our valuation if conditions improve or new relevant information comes out.
Business
Palantir build software for the intelligence community in the United States to assist in counterterrorism investigations and operations. The company offers three distinct platforms: Palantir Gotham, also called “Gotham”; Palantir Foundry, also called “Foundry”; and Palantir Apollo, also called “Apollo”. These platforms provide the critical infrastructure needed to integrate Palantir’s customers’ data and operations, and run their software in virtually any environment.
Gotham enables users to identify patterns hidden deep within datasets, ranging from signals intelligence sources to reports from confidential informants. It also facilitates the hand-off between analysts and operational users, helping operators plan and exectute real-world responses to threats that have been identified within the platform. This platform is mainly used by government, although it is offered also to Palantir’s commercial customers, such as those in the financial services industry in connection with fraud investigations.
Foundry transforms the ways organizations operate by creating a central operating system for their data. Individual users can integrate and analyze the data they need in one place. The software presents incredible stickiness regarding its customers, mainly due to the speed with which users can eperiment and test new ideas. This platform is mainly used by commercial customers, even though there are several of the Palantir’s government customers that are using it.
Apollo was originally built to enable the continuous delivery of Palantir’s software wherever their customers are: in the cloud, on-premises, or even more rugged environments. In 2021 the company began offering this platform as a commercial solution to allow its customers to securely deploy their own software in virtually any environment.
Despite their differences, both Gotham and Foundry serve as central operating systems for Palantir’s customers and are both backed by Apollo, therefore making them deployable in every kind of environment. Gotham and Foundry can be either be used separately, or bundled together as a single ecosystem.
Competitors
Palantir is competing with the internal software development efforts of its own potential customers. Indeed, the company said that many organizations frequently attempt to create their own data platforms before turning to Palantir’s. In trying to build something on their own, they generally rely on a patchwork of custom solutions, outside consultants, IT services companies, packaged enterprise and open source software, and significant internal IT resources. Moreover, Palantir faces competition from large enterprise software companies, government contractors, and system integrators.
There are seven main competitive factors in the markets in which Palantir operates:
- Platform capabilities and product functionality;
- Data security and privacy;
- Ease and speed of adoption, use, and deployment;
- Product innovation;
- Pricing and cost structures;
- Customer experience, including support;
- Brand awareness and reputation.
While the company is in a great competitive position, based on these factors there are some competitors that have greater name recognition, longer operating histories and larger customer bases.
Our valuation
We evaluated the company using our discounted cash flow model. The model relies on the past 4 years worth of financial statements data in order to estimate the future growth of the company. Each company is valuated in a slightly different way, and in this specific case we estimated the future free cash flows for the next 20 years by estimating line by line each of the three main financial statements. Usually we take into consideration a lower amount of years, but given the high-growth characteristics of the company and the predictability of its revenues, we decided to model the company’s future with more precision.
We made some assumptions in order to valuate the company:
- The terminal growth rate is 3.00%;
- The total shares outstanding are 2,030.12 millions;
- The effective tax rate will be constant at 21.00%;
- The United States 10-year treasury bond yield will reach 2.50% by the end of 2022;
- The risk premium is 8.00%;
We used those assumptions to model the weighted average cost of capital, which resulted equal to 12.86%, and to estimate the future revenue growth and free cash flows. We estimated a fair value of $10.56, meaning that according to our valuation there is a possible downside in the stock price of 22.29%. Therefore, we give the company a “sell” rating. A lot of factors could influence the valuation, including but not limited to economic policies, markets development and real economic growth: therefore, we will update this valuation at the start of the next quarter.
