Palantir (PLTR), founded by Peter Thiel in 2003 and named after the all-seeing stones from J.R.R. Tolkien’s Lord of the Rings trilogy, is a data analytics firm most noted for a rumor that its platforms aided the U.S. Government in tracking down Osama Bin Laden back in 2011. The company recently filed for IPO along a swath of other hyped technology companies. Given that Palantir is one of the more unique technology companies that we’ve come across, we decided to take a dive into the company’s filings to learn more about the business and determine if it’s worth keeping an eye on once it debuts on the public markets.
We first heard of Palantir around 2014 when they were looking to raise private capital at a valuation in the area of $20 billion. Some are estimating the company’s current value to be around $40 billion even though the company has yet to generate $1 billion in annual sales. The company has traditionally focused on serving government agencies around the world, but is starting to focus more on growing the commercial side of its business. Ultimately, we see too many barriers to scaling its commercial business to recommend a buy unless the public market values the company at a much lower price than expected.
Palantir offers two primary software platforms:
Palantir Gotham: Panaltir’s first platform designed to serve government agencies, particularly the defense and intelligence sectors. Gotham allows users to identify patterns and unique insights from disparate datasets. The information that Gotham uncovers allows users to identify potential threats or problems and act accordingly. Gotham is now used across multiple government sectors outside of the intelligence community as well.
Palantir Foundry: Foundry is Palantir’s platform aimed at serving the commercial sector. It allows organizations to centralize, integrate, and analyze data. The platform is currently used across a broad spectrum of industries.
Palantir’s platforms serve as data analytics infrastructure that connect data sources to enterprise software and produce actionable insights specific to the client’s interests. Some criticize Palantir’s systems as being a sort of “black box,” and it’s hard to argue against that without being able to see its products in action.
Here is a case study that highlights a particular instance where Palantir was used to great effect in an investigation into the illicit ivory trade:
At a price tag that runs in the millions of dollars per contract (average revenue per customer was $5.6 million in 2019), the decision to work with Palantir is not an easy one to make, even for the largest, most sophisticated organizations. Palantir admits their addressable market on the commercial side is likely limited to companies with more than $500 million in revenue. Amidst a few other criteria, the company estimates their total addressable market [TAM] on the commercial side to be around $56 billion with around 6,000 companies worldwide serving as potential customers. Comparatively, they estimate the government sector TAM to be around $63 billion.
Palantir generally signs multi-year contracts with its customers, during which costs are generally front loaded as the company works to integrate its platforms into the client’s data infrastructure during the early portion of the contract term. Over the course of the engagement, clients tend to become more self-sufficient and Palantir’s obligations decrease, although the company can still provide ongoing maintenance services.
It may be more appropriate to think of Palantir as both a SaaS provider and an IT consultancy that runs the consulting portion of the business at a significant loss. As such, an existing client that has had all the integration and setup work completed is far more profitable than a new client that still requires the services of Palantir’s pricey engineers. Per the company’s S-1 filing mature client accounts, or accounts in the ‘Scale’ phase as defined by Palantir, generated revenues with a contribution margin of 89% in 2019 compared to clients in the ‘Acquire’ and ‘Expand’ phases that had massively negative contribution margins. Thus, churn and client retention becomes an important metric in helping determine the company’s long-term profitability. Unfortunately Palantir does not disclose any relevant metrics in this area, making it difficult to get a clearer picture of an already secretive company.
One encouraging sign is that new clients made up well over half of Palantir’s revenue in the first half of 2020. As these accounts become more mature over the next year or two, there is a relatively straightforward path to achieving the company’s break even goal with possible profitability soon thereafter.
Looking through the numbers disclosed in the S-1, Palantir earned approximately $743 million in revenue for 2019, a nearly 25% increase over the $595 million earned in 2018. More recently, the company earned $480 million in revenue in the six months ending June 30, 2020. This represents a 49% increase over the $322 million earned during the same period in 2019. The company posted losses of around $580 million each of the last two years, but they have stated that they expect to break even this year on approximately $1 billion total revenue. With growth accelerating year over year, it seems that the COVID crisis has not slowed Palantir’s growth plans.
Palantir is well capitalized with about $1.3 billion in net cash and doesn’t plan to raise any additional capital through the IPO process.
After spending much of its early years serving government agencies, Palantir is in the early stages of scaling its commercial business. The speculated valuation of $40 billion represents a 40x current year sales multiple, which is undoubtedly high, but not out of line with how the market is pricing other growing technology companies. The problem is that we do not necessarily believe that Palantir’s growth potential warrants such a premium valuation.
Customer concentration and susceptibility to changes in government spending: With 47% of revenue coming from government agencies, a new administration and changes to government spending could impact a significant portion of Palantir’s revenue sources. Palantir currently has only 125 customers total, so customer concentration is fairly high in general. The top 20 customers generated $495 million, or 67% of total revenues in 2019, while the top customer represented a hefty 12% of total revenue. Needless to say, any one contract cancellation, government or otherwise, could represent a significant hit to company revenues in the short-term. As the company matures and further develops and diversifies its commercial business, this should become less of a concern, but investors with shorter time horizons should take heed.
Share structure: Palantir’s capital structure contains three classes of stock. Class A and Class B common stock, with Class B shareholders entitled to 10 votes per share. The company has also expressed the intent to issue Class F shares with the intention of keeping control of the company in the hands of its founders. While such a scheme is not new to Silicon Valley, investors should be aware that voting control is essentially locked up among the company’s founders and any chances of a minority or activist investor being able to influence the company or its board will be quite slim.
Growth: As we see it, the biggest problem with Palantir is the somewhat ambiguous of value that its platforms bring to its clients, which will also limit its growth in the near future. We are not contesting whether current clients value Palantir, since the average customer has been with the company for 6 years and current customers have tended to extend and expand their contracts. However, selling a new multimillion dollar contract for a product whose value is uncertain until it is implemented can be a hard sell for even the richest of companies. In fact, many of Palantir’s customers come to the company only after trying and failing to build their own data analytics platforms. We think many executives making capital allocation decisions may decide that they can build a platform that satisfies their company’s needs for less than what it would cost to go with Palantir. Ultimately, these type of projects are not successful, but it may be difficult to overcome the “DIY mentality” until use of Palantir becomes more widely accepted throughout the commercial sector. Furthermore, a valuation of $40 billion would indicate that the company is well on its way to capturing a large portion of its estimated $119 billion TAM when in fact the company is just getting started. The fact that the company is now 17 years old and has not yet hit $1 billion in annual revenue should raise questions about the company’s ability to accelerate growth enough to justify a premium valuation.
Palantir is an interesting technology business without obvious direct competitors. Although the company has what appears to be a long growth runway, actual growth will likely continue to be hampered by high barriers to sales due to the expense of deploying and integrating one of Palantir’s platforms. The most successful platforms and SaaS companies are able to deliver value to clients that obviously exceeds the cost of said platform. Palantir’s value proposition is not immediately obvious given the nature of its multi-million dollar, multi-year contracts.
While the attractiveness of any investment in Palantir will depend on the price that the public markets ultimately assign to its shares, there is sizeable upside in the scaling of the company’s commercial business and the maturation of current customer accounts that eventually move beyond the labor-intensive and costly ‘Expand’ phase.
Palantir is likely a company that we will keep an eye on, but will ultimately need to see more widespread adoption on the commercial side, evidence of low, long-term customer churn, and an attractive public valuation behind a cash generative business before we recommend an investment for our clients and partners.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.