Palantir: There’s A Lot To Love Here (NYSE:PLTR)

Business Fundamentals

Palantir Technologies Inc. (NYSE:PLTR) is a big data software provider operating with a Software as a Service, or SaaS, business model. The main target markets for PLTR products (I will refer to them as platforms) are governments and large enterprises with complex operations. However, PLTR is also open to small and medium-sized businesses and startups. Their software scales with the organization – as the organization grows the software becomes more powerful.

Palantir Technologies recently integrated large language models, or LLMs, into a platform dubbed AIP, which makes the software more user-friendly and even more powerful. Palantir’s greatest strength is product-led acquisition. Their sales strategy is unique in that they do not have a large sales team generating and working leads, rather they have a few dedicated support agents for each deployment. Then, they let the software sell itself, either by deepening existing relationships or cross-selling to businesses that work with their customers. The prime example of this is Skywise, built initially for Airbus SE (OTCPK:EADSF) but which has expanded throughout the airline industry.

The platforms are delivered either through Palantir Cloud, which is hosted through various CSPs, or on-prem. Apollo allows for the integration of multiple clouds and heterogeneous infrastructures (cloud + on-prem + edge).

Let’s take a quick look at the platforms.

Gotham:

Gotham is used for big data analytics and end-user data exchange. The most common end users are governments and big financial institutions (fraud analytics). This can expand into insurance (claims fraud) and countless other industries.

Foundry:

Foundry creates a central operating system for data. Individual users can integrate and analyze the data they need in one place. From the 10-K:

The speed with which users can experiment and test new ideas is what makes the software stick… Data projects often fail because the steps and methods used to build data pipelines are difficult to understand and recreate. We built Foundry’s backend to solve the root of this problem. All of our commercial customers now use it, as do several of our government customers.”

Apollo:

Apollo is a cloud-agnostic, single-control layer that ensures the continuous operation of critical systems. Palantir describes its function as such: “Today, Apollo enables the rapid, secure delivery of our software and updates across our business.”

AIP – Artificial Intelligence Platform

This recently released product allows users to connect LLMs with their data and operations to facilitate decision-making. Customer onboarding includes an AIP Bootcamp, which allows for insanely fast time-to-market. Bootcamp teaches end-users how to effectively use AIP:

Skywise

This is an aviation platform that is the central operating system of the airline industry. Adoption has been swift. Since June 2017, Skywise has expanded from zero to more than one hundred airlines. Each one is now an existing or potential customer – this is a product-led acquisition and something that will be an industry-agnostic tailwind for PLTR growth in the coming years. When other airlines saw the benefits of PLTR software, they were swift to engage with the company. There were no outbound sales efforts needed because the platform sold itself.

This initially grew from a single customer relationship with Airbus.

Important Business Characteristics

Data as an Asset:

Data is the lifeblood of modern governments and commercial enterprises. Palantir supplies the oxygen and breathes life into data. It allows customers to synthesize massive datasets and conceptualize solutions to problems they may uncover. This is accelerated with AIP.

PLTR platforms are built end-user agnostic, meaning developers, data scientists, product owners, and executives alike can find value in PLTR platforms:

We build software that empowers organizations to effectively integrate their data, decisions, and operations at scale… Gotham and Foundry enable institutions to transform massive amounts of information into an integrated data asset that reflects their operations.

Their platforms are built to instantly bring value and interoperability.

Principled Business Operations:

PLTR states multiple times in their reports that they turn down business opportunities that they do not believe they can fulfill in an “ethically responsible way.” They don’t do business with customers or governments who do not meet their ethical standards. As an example, they have no operations in China and do not serve the Chinese Communist Party. With platforms that handle sensitive personal information, this principled approach will serve as an asset over time even if it limits short-term growth.

Barriers to entry:

Palantir Technologies Inc. actively seeks out difficult jobs. They believe that as complexity increases, so too does their right to win. They’ve obtained strict government clearances, manage complex data environments, offer cloud-agnostic integration, and don’t shy away from long sales cycles. These are major barriers to entry for competitors.

They put it this way: “Rather than reject projects with risky and resource-intensive installation requirements, we actively seek them out.”

Still, their fundamental competition is their own customers’ internal software development. AIP Bootcamp makes platform onboarding much easier and forcefully addresses this competitive risk.

Focused Management:

Their focus is clear and compelling:

“…our focus in the short term remains making our principal software platforms available to an increasingly broad swath of our potential market… We believe that every institution faces challenges that our platforms and products were designed to address.”

This is complemented well by their current R&D efforts, which are focused on deploying software, models, and other critical assets at the edge. This includes integrations with complex hardware, operations in disconnected environments, and more. Edge computing is a growing market, and PLTR is ripe to accumulate a large share here.

Culture:

Management promotes employees based on merit, not politics or years of experience. This will allow high-achievers to elevate to senior positions regardless of age, which will build a robust talent pipeline over time.

They also have a fanatical focus on privacy – they build Palantir software with the principle of “privacy by design.” Their internal goal is to eliminate the trade-off between privacy and utility in software platforms.

The Financials

Income Statement

Palantir is growing rapidly and managing this growth well. Their revenue profile favors the U.S. – 62% U.S. (18% YoY growth in U.S. rev), 11% UK, 27% rest of world, and governments – 56% government, 44% commercial.

YoY revenue growth in Q3 was ~$100m with only $300k COGS growth demonstrating strong operating leverage. No customer represented more than 10% of total revenue for Q3 and YTD and revenue growth is outpacing both COGS and OpEx growth. An important component of COGS is cloud hosting cost, which will increase over time and with increased usage. Despite this, revenue growth should continue to outpace COGS growth at least in the medium-term. The green highlights below show very positive trends. You’ll note there are no red highlights.

2023 also saw the long-awaited inflection in profitability. 2024 will likely see S&P 500 (SP500) eligibility, and with S&P inclusion, major institutional inflows.

Their margin profile is phenomenal and growing. Gross margin was 81% in Q3 (ex stock-based comp). TTM gross margin is ~80%. This suggests a strong competitive advantage. Meanwhile, contribution margin (defined as (revenue – COGS – sales & marketing)/revenue) is above 50% and growing. Growth here was aided by a meaningful decrease in OpEx from 2020 to 2023 TTM from $1.9b to $1.66b.

Net margin is low – around 7%. This is mostly because of very high SG&A expenses. It’s the cost of rapid growth and customer acquisition. S&M expense shrunk YoY in Q3 but grew YTD YoY. Meanwhile, G&A shrunk across both measures demonstrating respectable cost discipline.

Balance Sheet

Palantir Technologies made huge investments in marketable securities in 2023 – up from $350m to $2b YoY. This is mostly in U.S. treasuries which are held AFS so will benefit from rates dropping. In the meantime, it’ll provide strong interest income. They saw meaningful accounts receivable growth & accounts payable shrinkage. Two customers accounted for 44% of total accounts receivable, so there’s some credit/concentration risk in receivables. They also saw meaningful growth in customer deposits signaling that customers are willing to put money down for PLTR. This is a strategic asset even though it’s a reported liability.

They have a great current ratio and total liabilities are significantly less than total assets. Overall, they have a very sound balance sheet for a growth-stage software company.

Other Important Metrics:

They announced a share repurchase program of up to $1b of common A stock in August 2023 but made no repurchases in Q3. Average revenue from their top 20 customers grew 13% YoY, which is overall great relationship deepening.

As of December 31, 2022, the total remaining deal value of contracts, as defined below, was $3.7 billion, down 3% from December 31, 2021, when the total remaining deal value of such contracts was $3.8 billion. No metric was given in the recent 10-Q. The total remaining deal value represents the total value of contracts, including existing contractual obligations and unexercised contract options available to customers. It assumes that all contract options will be exercised and that no contracts will be terminated. It’s important to note most of Palantir’s contracts have termination provisions, so there’s no guarantee that options will be exercised or contracts won’t be terminated.

Regardless, this suggests predictable and strong future revenue growth from existing relationships (most contract lengths are 1-5 years and revenue is recognized ratably over the life of the contract). The strong backbook is complemented well by strong customer acquisition: total customers grew from 337 in 2022 to 453 as of Q3 2023.

While Seeking Alpha awards PLTR a dismal D- Valuation grade, there’s one quite bright spot: a very compelling PEG valuation.

Despite showing quite high P/E ratios, mostly because of exorbitantly high OpEx, when correcting for growth on a forward basis Palantir looks undervalued. I don’t believe backward-looking valuation metrics serve any purpose here: Palantir is growing rapidly and investors need to pay a premium for high growth. While the forward earnings multiples are still not compelling, the FWD PEG shines light on the opportunity presented here.

Paying this high a premium to earnings is a risky endeavor, but Palantir offers significant upside to investors who are willing to stomach drastic volatility.

Closing Thoughts

The most meaningful risk I found was equity dilution. Palantir Technologies Inc., like most high-growth software companies, relies heavily on stock-based compensation. They addressed this risk well with the recent share repurchase announcement.

With S&P inclusion becoming increasingly likely in 2024, we could also see major institutional inflows that will put a lot of upward pressure on the stock. The world is not becoming any less digitized, and Palantir leans into this digitization at scale well. They are in a prime position to benefit from global megatrends in digitization and business transformation.

I see a lot to love and very little to dislike in Palantir’s fundamentals.