Palantir owns game-changing technologies in big data analysis. Revenue growth is accelerating and profit margins are expanding. The company has the ability to increase revenue per user and to gain more customers as the technology improves over time.
Chances are that Palantir will significantly outperform Wall Street expectations in the long term. Palantir is uniquely risky, but the upside potential should more than compensate for such a risk in the years ahead.
Palantir (PLTR) is a fairly unique business, the company offers both exceptional upside potential and some very singular risks. When Palantir first started trading in the market, Wall Street’s perceptions were initially more focused on the risks and the uncertainties around the company’s business model. This was probably due to the political uncertainty before the elections. However, this perception is clearly changing now, and Wall Street seems to be starting to understand the massive upside potential that Palantir has to offer. The future path of the stock will probably be highly volatile, but Palantir is offering abundant room for long term growth.
A Unique Company
Palantir was founded by Peter Thiel, Stephen Cohen, and Alexander Karp in 2003. Karp is currently the company’s CEO, Stephen Cohen is the president and Peter Thiel is the chairman of the board. These are some very big personalities in the tech world, and these kinds of investors don’t put their money and their reputation behind a company with mediocre and easy to replicate technologies.
Palantir is a specialist in a highly sophisticated analysis of big data, it basically integrates data from different silos and it applies Artificial Intelligence to find the right answers to many important questions and also to understand which are the right questions that need to be asked in a specific context.
In its origins, Palantir was providing software for organisations such as the CIA, the FBI, and the NSA in areas such as counterterrorism and financial fraud. More recently, Palantir is expanding into the enterprise market across multiple industries and areas.
Palantir covers a wide variety of uses and applications. Its software was reportedly used to find Osama Bin Laden and to convict Bernie Maddoff. In the enterprise segment, it helps big financial institutions with fraud detection and portfolio risk management, it streamlines oil production and logistics, it analyses data for drug development, it can identify new sales opportunities with data analytics and it is even helping Ferrari to integrate and analyse performance data in order to make faster and more data-driven decisions in the racing segment.
Selling to the FBI and the CIA is not easy to do, and it obviously takes a lot of time and effort. Life is literally at stake when it comes to providing the right tools at the right time to military personnel in the desert, the middle of the jungle, or even in a submarine. Now that the company is expanding into commercial applications, having big contracts with the CIA and the armed forces is a strong selling point in terms of guaranteeing security and the overall ability to deliver.
Palantir has a unique trajectory as a business. Founded in 2003, the company spent several long years building the product, and then it started gaining traction in the government sector from a very small base. Ten years ago, the company was making only $37 million in revenue during 2010, and analysts are currently estimating 1.07 billion in annual revenue for 2020.
Importantly, revenue growth has been accelerating recently, as the company makes more revenue from existing customers and it also gains more customers in both the private and public sectors. Some of this acceleration is probably related to data analysis requirements during the pandemic, but the overall trajectory of growth will probably remain strong in the middle term, with or without the additional needs produced by COVID-19.
When analysing a company such as Palantir, it can be very difficult to assess the technology, its uniqueness, and its ability to generate value for customers. Fortunately for us, we don’t need to be world experts in Artificial Intelligence to make these kinds of assessments.
Governments and big corporations have access to enormous financial and intellectual resources to buy and build whatever they may need, and these huge organisations can differentiate an average product from a game-changing technology.
The fact that Palantir is consistently increasing revenue per customer over the years shows that the customers are clearly willing to invest in Palantir’s technologies, so the company is consistently adding value and finding new growth opportunities via product innovation.
Palantir has huge contracts of more than $5 million on average, and it also has a long sales cycle. This means that revenue growth will be lumpy, and both cash flows and earnings can be expected to fluctuate over time depending on the timing of the contracts and how the sales cycle evolves.
Nevertheless, the contribution margin is moving in the right direction, and the business model should be structurally very profitable, offering expanding profitability as the company gains sales volume over the years.
Management says that the biggest competition is the software developed in-house by its customers. This is a compelling position because most public agencies and companies are no experts in this area, and it can often be cheaper and much more effective to go with a specialist such as Palantir versus building in-house.
Palantir is quite a unique business, both in terms of opportunities and risks. The company has a lot of customer concentration risk, with government contracts representing more than half of current revenue. Palantir has only 125 customers in total according to the S-1 SEC filing, which is a very high degree of concentration for such a large business.
If anything wrong happens and Palantir loses these customers, the stock price would probably suffer considerably. The management team is also politically vocal, which can be both an advantage or a disadvantage depending on how they play their cards in the political game of thrones.
As stated above, Palantir has long-term contracts of enormous value and the sales cycle tends to be much longer than in other cases. For this reason, I am expecting revenue and earnings to be much more volatile than in traditional software companies and this will probably generate some volatility in the stock price too.
The company’s involvement with the Immigration & Customs department has also been a matter of much criticism lately. This can not only hurt Palantir’s reputation, but it can also be a headwind in terms of attracting talent if potential employees are reluctant to join the company for political reasons.
Palantir also has a “variable ownership control” share structure, which basically means that the management team can issue new shares for themselves with superior voting rights, these are the F-shares.
This does not concern me in terms of economic dilution because the economic impact would not be too large, but it does guarantee that the management team will maintain full control of the company’s operations.
Given that Palantir operates in key areas related to national security and healthcare, among others, it is only understandable that management wants to remain in control of the company under all circumstances. Besides, the management team is exceptional in its abilities and track record, so this is hardly a problem in my perspective. But it is still a notable factor to consider when pondering an investment in Palantir.
Stock-based compensation has been astonishingly high in recent years. I am inclined to think that management wants the stock price to do well and they are going to keep this under control in the future, but there are no guarantees, and this could be a potential problem if the company does not moderate the share dilution via stock-based compensation.
Source: SEC filings
We can expect competition to increase in the years ahead as Artificial Intelligence technologies become more widely accessible. This is not much of a problem right now because Palantir has the first-mover advantage, the scale, and the technological strength to continue leading, but it is always relevant to watch the competitive landscape in such a dynamic industry.
Palantir is also far superior to the software that most customers can develop in-house, but we also have to consider that these customers may still choose to develop the software in house for reasons that go beyond economics and product quality. Not all decisions are always based on rationality and effectiveness, and many organisations could be reluctant to buy such a mission-critical software from Palantir.
The Investment Thesis
Palantir is a fairly special alternative in the market, the company is leveraging the power of data in order to deliver unique insights and solutions to both the government and the private sector, and this can create massive opportunities in the years ahead due to both the proliferation of data and the Artificial Intelligence boom.
Palantir works with the most demanding customers in the world and it is successful at expanding revenue with those customers; this speaks volumes about its ability to drive value and to provide the best solutions.
Revenue is growing rapidly and profitability is expanding. We still need to see to what degree the acceleration in revenue is sustainable or not, but there are enormous opportunities for growth in the long term. It is not difficult to imagine a scenario in which Palantir rewards investors with vigorous revenue growth and expanding margins over the long term.
Palantir stock was under significant selling pressure during October, which may be due to the uncertainty caused by the elections on a company with so much political risk. After the elections, the market started to realise that Palantir is here to stay. No matter who the President is, data analysis is just too important to be considered a partisan issue.
As a shareholder in Palantir, I am personally not concerned about the ethical considerations of how the software is being used. If you don’t agree with what the government is doing in a specific area, you have the right to speak your voice and to reflect your opinions in your vote. But you shouldn’t blame the software for that.
The software is just a tool, and it is being used by the Marine Corps, the National Center for Missing and Exploited Children, and the ICE. All the responsibility lies with the people and the organisations using the software, as opposed to the company that provides the tools.
In this area, it is worth noting that Palantir only does business with democratically-elect governments, and this excludes countries such as China and Iran. China is a huge potential client in Artificial Intelligence, so Palantir is leaving a lot of money on the table by avoiding doing business with the Chinese government.
Since the IPO, Palantir stock has skyrocketed by almost 300% and this leaves space for significant drop on any bad news.
Nazrul Hoque – 01 December 2020