Full Diligence Post on Palantir (PLTR) – Earnings Next Monday (2/16) & Lockup Expiration (2/19)

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by rareliquid

Hello! Wanted to share my thoughts on Palantir ahead of its earnings next TUESDAY (Edit: sorry I got the day wrong in the title but the date 2/16 is correct). Warning: long post ahead and TLDR at the bottom.

Palantir Business Overview

  • In one sentence, Palantir creates operating systems that integrates vast amounts of data from an organization’s various data silos and allows users to build applications that drive better decision making
  • If that’s confusing, no worries. The way I like to think of Palantir’s software is that if Batman purchased the software from a company today for his supercomputer which aggregates data from thousands of sources and allows him to make intelligent decisions, that software would be from Palantir
  • The company has three main software platforms: Gotham, Foundry, and Apollo
  • Gotham (government side)
    • Gotham is Palantir’s software offering primarily for defense and intelligence sectors, AKA governments
    • Gotham is an end-to-end operating system that collects data from hundreds to millions of different sources and combines them onto one platform so users can manage operations
    • Gotham is quickly becoming the de facto data solution across many US federal agencies and rumor has it that it was the software that helped track down Osama Bin Laden in 2011
  • Foundry (commercial side)
    • Next up is Foundry, a platform that is geared towards the 6,000 businesses around the world with over $500 million in revenue
    • Similar to Gotham, Foundry transforms the ways organizations operate by creating a central operating system for their data
    • For example, one of Palantir’s customers is Skywise, an aviation platform that has become the central operating system for the airline industry
  • Apollo (underlying infrastructure)
    • Apollo is the last piece of the Palantir puzzle, and you can think of it as the underlying infrastructure that Gotham and Foundry lie upon
    • Apollo is a relatively new platform that Palantir introduced in order to more efficiently update the software that runs Gotham and Foundry, increasing the number of upgrades Palantir can manage across installations from an average of 20,000 per week in Q2 2019 to more than 41,000 per week in Q2 2020
  • The company has estimated its total addressable market as $119 billion, of which $63 billion is for the government side while $56 billion is for commercial side

The Palantir Business Model

  • Known as Forward Deployed Engineers or FDEs, Palantir leverages their technical talent as support and sales as well and they are often sent to the front lines of the battlefield for Gotham or company for Foundry
    • I believe that this in particular is what helped Palantir create a competitive moat in the government sector
  • While the FDEs are a differentiator, Palantir has also started to build out a more traditional salesforce in order to better target customers and explain the company’s value proposition but this salesforce currently only accounts for 3% of the company’s total headcount
  • Using both FDEs and a traditional salesforce, Palantir’s business model employs a 3 step process: acquire, expand, and scale
  • Acquire
    • In the acquire step, Palantir provides a potential customer with a short-term pilot program at Palantir’s expense and therefore operate at a loss
  • Expand
    • In the expand phase, Palantir seeks to understand the customer’s key challenges and ensure that its software delivers results
  • Scale
    • The scale phase is where Palantir thrives. At this point, the customer is essentially using Palantir’s software for its operations and Palantir can also upsell to the customer by continually offering new services with minimal extra cost
  • To give you a sense of the numbers for each phase, In 2019, Palantir generated a total of $742.6 million in revenue, of which $0.6 million came from customers in the Acquire phase, $176.3 million from the Expand phase, and $565.7 million from the Scale phase

The Bull Case

  • Section 2377
    • In 2016, Palantir sued the US Army in what’s known as Decision 2377
    • To go into the history a little bit, in 1994, the Federal Streamlining Acquisition Act (FASA) was passed, which required that the federal government consider and acquire readily available, proven commercial services like Palantir’s rather than custom-developed solutions built by the government which has a reputation for spending inefficiently
    • This rule was largely ignored until Palantir sued and won in court, and this was extremely important because it allowed Palantir to compete and win deals across all federal agencies, which greatly helps the company realize its total addressable market. Since then, Palantir’s revenue from the US Army and US government has skyrocketed
  • Sticky, Best-in-Class Product
    • Simply put, there is nothing that offers what Palantir is offering. Its technology is way beyond most of its competitors in terms of offering a premium operating system
    • Palantir’s Gotham and Foundry often take more than a year to get fully up and running and the more it’s used, the more data in the system and the more time that has been spent by customers training employees on how to use the system
    • Palantir’s platforms becomes incredibly expensive to switch out of not just in terms of money but also time, with customers saying replacing the system could take anywhere from 6 to 18 months
    • To further prove this point, Palantir’s top 20 customers have been with the company for an average of 7 years and as of October 2020, 93% of revenue was generated by existing customers
    • In addition to this, in the latest quarterly earnings, Palantir was selected out of 999 bids by the US Army for a 2-year $91 million contract to build AI and machine learning capabilities
  • Positive Secular Trends and Growing, Achievable TAM
    • I think everyone at this point realizes that companies are going digital transformations and Palantir has spent $1.5 billion in the past 11 years creating innovative software that becomes increasingly powerful each day
    • The company is at the right place at the right time with a total addressable market expected to grow into the few hundreds of billions of dollars in the next 5 years
    • And with just about $1 billion dollars in revenue over the past 12 months, Palantir has less than 1% market share and has plenty of room for growth
    • But perhaps most importantly, Palantir is creating a much more efficient business model with an improving tech product that will help the company achieve its TAM
      • In the latest earnings call, management said that it plans to triple its salesforce headcount due to its recent success
      • And among other improvements, the Apollo platform has helped the company greatly reduce the costs and time required to get a customer up and running
    • Being able to better target customers and onboard them quickly while providing a best-in-class and sticky data platform points to a bright future for Palantir

The Bear Case

  • Double-Edged Business Model
    • While Palantir’s differentiated services and business model is one of the company’s key strengths, there are also several downsides as well
    • First, due to the custom-built solutions Palantir offers, the company undergoes a costly and complicated minimum 6 month sales cycle that can often amount to nothing
    • Second, even if a customer jumps on board, contracts are cancelable with a typical notice of 3-6 months
    • Third, the deep history it has with customers results in a very top-heavy concentration
      • As of the third quarter of 2020, the top 20 customers represented 61% of the company’s revenue, which notably is down from 73% from the year prior
    • Lastly, the deal-by-deal nature of Palantir’s business model means that the sources of revenue are lumpy and hard to predict, which can be a cause of concern for investors
  • Biden Administration and Negative Headline Risk
    • First, Peter Thiel was an outspoken supporter of Trump, who increased defense spending 5% a year while Obama decreased spending 3% a year.
      • While I don’t think this will be a long-term issue, a Biden presidency does represent a potential decrease in defense budgets which could hinder Palantir’s growth with Gotham
      • However, it is important to note that management during its latest earnings call did address this issue, stating that it has worked with many administrations across the world and doesn’t foresee this to be a problem
    • Second, Palantir has been targeted by the media several times for giving the government too much power and the political and social environment in which the tide seems to be turning against tech could present Palantir with headaches in the future
      • This risk is also further exacerbated by the fact that Palantir is 49.9999% owned by its co-founders, who are outspoken and strongly opinionated. Clear corporate governance risk.
  • Tough Competition in Commercial Space
    • In my opinion the largest obstacle Palantir faces is its ability to execute in the commercial space
    • Palantir offers an expensive, premium, custom-built end-to-end solution for clients, which is great for the government but not exactly what most businesses are looking for
    • Instead, most large scale businesses have already invested heavily into their own systems and want to buy best-in-class piecemeal solutions from different tech companies
    • Several notable businesses left Palantir from 2019 to 2020, including JP Morgan, Coca Cola, and American Express, and this decreased the customer count from 133 to 125
    • However, one important thing to note is that in the latest earnings call, Palantir’s management openly addressed this issue and the company has already started to provide solutions that are modular, which means customers can take the individual solutions they want rather than adopting the entire Foundry system
      • This also allows the company to offer different price points which may allow Palantir to be more competitive in the market
      • Recent news of bringing on BP and IBM as clients could also be a sign that its Foundry business may be ready for mass adoption
  • Lock-up Expiration
    • Because this is a short-term risk, I’m adding this as a bonus bearish reason
    • Palantir went public through a direct listing on September 30, 2020, during which up to 20% of shares were available to trade
    • The remaining 80% is available to trade starting February 19th when the lockup expires and this could lead to a flooding of shares being sold and at the very least, volatility caused by the uncertainty

Financials and Valuation

  • Starting off with the income statement, the important things to note is that from 2018 to 2019, the company has grown revenue by about 25% while maintaining roughly the same amount in operating expenses, which speaks to the improved operational efficiency of the company
    • The company has guided to $1.07 billion for the full year of 2020, which represents a 44% year over year increase and for a company with 1 billion in revenue, increasing revenue growth is a great sign
    • Comparing Q3 2020 to Q3 2019, the company was able to increase average revenue per customer by 38% and grew commercial revenue by 35% and government revenue by 68%
    • With all this said, one piece of concern in Palantir’s income statement is its net losses. The company has not been able to turn a profit in its entire history, but it did report positive adjusted operating income in its latest quarter when adjusted for stock based compensation
  • Moving onto its latest cash flow statement, what you mainly need to know is that the company has recently had a huge stock based compensation expense this past year due to the direct listing, so if you were to add that back, the company is essentially near break-even
    • However, the company’s free cash flow (operating cash flow minus your capital expenditures) is negative, so the company still is clearly losing money although much less than even a year prior
  • Lastly, Palantir has a great balance sheet
    • With $1.8 billion in cash and only $200mm in debt, the company is in a great position to fuel its future growth
  • Regarding the company’s valuation, while the company is growing nicely at 44% from 2019-2020, and is expected to grow 31% from 2020-2021 based on street estimates, it currently trades around a 45x NTM sales multiple depending on the day, which makes it one of the most expensive companies on the market
    • The key question here is do you want to pay an extremely high premium for a company that does have a best-in-class software or wait for a better entry point?

What I’m Doing

  • Personally, I can’t justify Palantir’s valuation, which may sound a little old-school but I think there are better opportunities out there
  • However, in the long-run I am bullish on the company and would buy on any major dips in the 20s (and teens if it somehow falls down to that)
  • I’m also closely monitoring what happens after earnings (2/16) and next week the lock-up expires on 2/19 so it’ll be interesting to see what happens to the stock then

TLDR: Palantir has a best-in-class, sticky data platform that it offers to both the government side (where it’s pretty much a monopoly) and businesses (which is picking up steam with tweaks to the business model and a growing salesforce). Growing healthy top-line but unprofitable and trading at a higher valuation than almost all other software companies. I am holding off on buying for now but would welcome major dips as great buying opportunities.


Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.


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