On 5 April 2021, Palantir Technologies announced that it has been awarded a 5-year contract, valued up to $89.9 million by the United State National Nuclear Security Administration (NNSA). As part of this contract, Palantir will serve as a platform for NNSA to manage nuclear security by optimizing its human and financial allocation through the integration of data.
This news initially sent Palantir shares up 5% the following Monday but the gain was short-lived and faded nearer to closing. This is not the first time Palantir’s share price has moved so sharply. Since the company went public in Sept 2020 the stock has surged over 140%.
So, what is driving this movement in share price? Is it base on fundamentals or purely on emotion? To end it off, does Palantir still have room to grow?
What does Palantir do?
Palantir is an analytics and data-mining firm that works with its client to integrate their data and optimise their workflow through machine augmented data analysis.
The company was founded in 2003 and initially served the United States Government by building software used by the intelligence community during counterterrorism and military operations. Apart from the Army, the company has also worked with the US customs and border protection to track immigrants at the borders and also New Orleans Police to test its predictive policing technology.
Ever since its early days, Palantir has diversified its business and is now working with commercial clients too. Nonetheless, Palantir still relies heavily on the US government for revenue.
Alvin has shared more previously:
So how does Palantir software differentiate itself from other business intelligence solutions like the Structured Query Language (SQL) and Tableau?
Well, Palantir software solved a few problems which made its software much more user-friendly and powerful.
- Firstly, unlike other software which has a steeper learning curve, Palantir’s data analysis runs on natural language querying which allows ordinary people to use it easily. This open up the opportunity for more eyes on important data.
- Secondly, Palantir software allows its client to combine multiple unstructured sources for analysis. This allows its client to consolidate all its fragmented data in one place allowing easy access for analysis. (Unstructured data like surveillance data, audio, and videos remains as Palantir’s core competency today, however, the company does handle structured data which includes spreadsheets.
- Next, Palantir software is optimized for speed, as such its client saves lots of time and storage handling the same amount of data. Lastly, the software can work with incomplete data sets, to provide valuable insights. This is much different from traditional business intelligence software which requires complete data sets to work.
These solutions are built into Palantir’s two principal software, Palantir Gotham and Palantir Foundry. The former was built for the US government while the latter was built primarily for its commercial customers. While these softwares were built for different clients, both perform similar functions in that it allows its users to integrate and analyze the vast datasets in their system, so to obtain actionable insights found hidden deep within the dataset.
3 Reasons to buy Palantir
Acceleration in Revenue growth
Source: Finbox
Palantir revenue has been increasing over the years. In FY2020, its revenue grew 47%.
Let’s take a look at their Government and Commercial business.
Palantir’s government business revenue grew by 77%. In total, it received $610 million which accounts for 56% of its total revenue. On the other hand, its commercial business revenue grew by 107%, receiving a total of $482 million which accounts for the remaining of its revenue.
Palantir’s operating margins have also been improving which helps boost its earnings. In addition to that, since 2009, the average revenue per customer has been increasing at a compound annual growth rate (CAGR) of 30%. In FY2020 alone, the average revenue per customer grew by 40% from $5.6 million in 2019 to $7.9 million in 2020.
Looking forward, Palantir expects year-on-year revenue growth of 45% and an improvement of its adjusted operating margin from 17% to 23% in FY2021. With 21 deals signed in Q4 2020 in which 12 were worth $10 million or more, I believe this goal is attainable for Palantir.
Strong cash position
As we look at their cash flow statement, Palantir is still not a profitable company due to stock-based compensation given to its employee (more on that later).
As such for the past 3 years, net cash from operating activity is still negative, meaning that Palantir is still not generating cash from its core activity. However, Palantir has over $2 billion in cash and cash equivalents on its balance sheet, which allows them some leeway to burn cash as they scale their business moving forward.
Assuming the rate of cash burn remains constant at $300 million, Palantir’s current cash would be able to last them at least another 6 years, which I believe is enough time for Palantir to turn profitable.
Besides, with a current ratio of 3.74 and a low debt to equity ratio of 0.3, it is safe to say that Palantir has managed its debt well.
Huge addressable market
Palantir being an analytics platform has unlimited application for both the government and commercial sectors. In this information age where tons of data are generated, both governments and commercial entities would definitely want to take advantage of the data they have collected to reach their goals.
This is where Palantir comes in as an analytics platform to help its clients. Currently, Palantir’s total addressable market stands at $119 billion (further broken down into $63 billion in the government sector and $56 billion in the commercial sector), which is roughly 100x of its FY2020 revenue.
Moving forward, the company will have more opportunities to work with prospective clients as seen in FY2020, where Palantir has been on a contract signing spree. Here are some notable ones that have been signed:
- $10 million contracts with US Space Force to help track objects in space
- $91 million contracts with the US Army research lab to integrate data and train AI models.
- $31 million contracts with NHS England to order, allocate, track and deliver vaccines across the UK
- Expanded Project Vantage which is worth $114 million for the first year (Total price tag for this deal is $500 million*). This is a multi-year deal with the US Army to help install systems that facilitate data-driven decisions on the field.
- A multi-year contract with Rio Tinto and PG&E to improve its safety measures.
In the commercial sector, Palantir has announced a partnership with IBM that potentially opens up more opportunities for the company. This partnership will integrate Palantir’s Foundry software with IBM’s hybrid cloud data platform, simplifying the way businesses build and deploy AI-infused applications without much deep technical skills.
* Majority of these contracts like Project Vantage are subject to termination by its clients. Besides, for contracts with the US government, they are subjected to annual review as they are prohibited from signing a contract more than 1 year in advance. As a result, there is no guarantee that the full deal value will be realized by Palantir.
5 Reasons to avoid Palantir
Palantir’s ethical controversy
Palantir has been in multiple controversial projects over the years. It had provided tools to the US Immigration and Customs Enforcement (ICE) to conduct deportation raids. And in another case, Palantir software was used by the Los Angeles Police Department to track individuals by identifying characteristics like race and gender. This has resulted in Amnesty International slamming the company right before Palantir’s DPO.
These controversial projects not only caused an uproar from outsiders, but employees of Palantir have also protested against Palantir’s actions. In the end, the contract with ICE was cancelled.
Going forward, I believe the type of clients Palantir associate itself with would be the company’s biggest obstacle. While such deals do bring in revenue for the company, if their clients are using these data unethically, it may limit Palantir’s ability to hire a limited pool of top talent who may disagree with the way Palantir work. This may then hamper the company’s future growth.
Not profitable yet
Palantir has yet to turn profitable since its founding in 2003. To add to the matter, its net loss has double within a year from FY2019 to FY2020.
Over the coming years, Palantir’s operating expenses are expected to increase as it continues to expand into new markets, invest in research and development, and so on.
These expenses are costly to Palantir because in order to attract new customers, Palantir tends to invest significant resources to allows its customer to trial the system at no or low cost. As such if these clients choose not to continue with Palantir, Palantir may incur huge costs.
While the growing net loss is a risk, I am not too concern as the majority of the loss came from stock-based compensation which amounted to $1.2 Billion in losses in FY2020. If we were to look at the non-GAAP operating income which discounts the $1.2 Billion stock-based compensation, Palantir had actually made a profit for FY2020.
Stock-based compensation is a way of paying employees with equity in the business. This is quite common in high-growth tech start-ups like Palantir where their employees’ salaries are low. By compensating its employees with company shares, it not only creates an incentive for the employees to stay with the company, it also aligns the interests of employees and shareholders.
Apart from that, Palantir could conserve cash as stock bonuses help subsidies a portion of the employee salary. (albeit the share dilution from the increasing shares outstanding would affect shareholders)
Given that Palantir had just DPO, it is normal for the company to incur such a high stock-based compensation in the first few years especially as its employee starts to cash out. However, as a company matures, this compensation ratio usually declines significantly as the company updates its policy.
Concentrate customer base
Another risk that Palantir has, is its customer concentration.
As of 31 Dec 2020, Palantir had just 139 customers and its top 20 customers already account for 61% of the company revenue. As such if any of these top 20 customers were to terminate their contract with Palantir, Palantir’s revenue could be adversely impacted.
In addition to this, Palantir is one of the few software companies with a high dependence on government contracts, which currently make up 56% of Palantir’s total revenue. While Palantir remains the go-to software company for the US government, providing Palantir with consistent contracts for the past years, there is a risk that the government could decide to stop working with Palantir.
There has been news that the US Army is attempting to develop in-house solutions rather than relying on 3rd party. While it is currently more cost-efficient to use Palantir’s software than to make it in-house, this illustrates the risk Palantir could face in the future if the government decides to move away from it.
Volatility in stock price
While most companies choose to go public with Initial Public Offering, where new shares are created, underwritten, and sold to the public, Palantir did a Direct listing where no new shares were created, and only existing shares are sold to the public.
While direct listing is much cheaper as no intermediaries are involved, it created certain risks for investors. Unlike IPO where the underwriter would go on ‘road shows’ to find interested institutional investors and determine the fair value price, DPO sells the shares directly to the public.
This led to a smaller percentage of shares held by institutions which typically act as defence against volatility in the share price.
If we take a look at Palantir’s major shareholders breakdown compared with Facebook’s, you’ll see a stark difference:
PALANTIR TECHNOLOGIES’s shareholders breakdown
FACEBOOK’s shareholders breakdown
As retail investors tend to be more emotional as compared to institution investors, it could be the reason why Palantir’s share price has been so volatile compared to other stocks like Facebook.
High valuation
Do note that there are no tech companies which are comparable to what Palantir offers to its client. However, some comparison with its peers in the field could give us insights on the valuation of Palantir.
When we compare Palantir with MongoDB (NASDAQ: MDB) and Datadog Inc (NASDAQ: DDOG), Palantir’s valuation seems reasonable with a Price to Sales ratio of 20.95 compare to MongoDB at 29.65 and DataDog Inc at 43.96. Even after accounting for the higher revenue growth DataDog as compared to Palantir, Palantir is still priced reasonably.
However, when analysing Palantir using discounted cash flow with a projected growth rate of around 35% year on year, Palantir is way overvalued with its fair value only at $11.62.
My thoughts
Palantir has a great outlook ahead with such a huge addressable market. For investors willing to ride out the volatility as the company continues to gain market share, Palantir could be a good long-term play.
However, for myself, given my limited capital, I would skip this for now as I feel there is too much uncertainty around this company. Instead, I would consider other stocks which would benefit from the information age. One company would be Amazon which offers AWS, a software as a service subscription for its client. In fact, Palantir themselves uses AWS to host its platform which includes its cloud-based services, Palantir Cloud.
For those that are still interested in Palantir, do check out Palantir’s latest Demo Event, ‘Double Click’ that happened on 14 April 2021. This is a series of software demo events in which the company showcases how its platforms are used across industries. It is pretty interesting especially when we can see how their customer makes use of their data. Do check it out especially if you are planning to open a position in Palantir or are already in.
