Palantir Technologies: Understanding Its Immense Potential
- As the world becomes increasingly digital and connected, we generate increasingly more amounts of data.
- Palantir gives organizations the tools to integrate and analyze vast scopes of data.
- The company’s unique business makes it a potentially lucrative long-term opportunity for patient investors.
The world is rapidly changing. As connectivity increases, we produce exponentially larger amounts of data. We have begun to see both businesses and governments grapple for control of this data. Palantir Technologies (NYSE:PLTR) is a unique business that is able to give organizations the ability to integrate with, analyze, and learn from data in a way that hasn't yet been possible. Palantir's business is somewhat difficult to understand due to secrecy and complexity, but today we will unravel the company to identify the long term investment thesis that investors should be considering.
Palantir is a software development and services company. The company was founded in 2003 by a group of individuals including Peter Thiel, who was Facebook’s first outside investor. Palantir got off the ground by working with the US Intelligence Community as its first clients.
While Palantir remains heavily involved with work for the US government, Palantir has expanded its business to lesser levels of government including state, local, international governments, and the private sector. The company continues to rapidly grow, and currently does roughly $1 billion in annual revenues.
Data Is The "Oil" Of The 21st Century
Before I talk about what Palantir actually does, I want to lay some framework by talking about “big data” as a whole.
Advancements in society are often gradual, with the exception of the occasional catalyst that sparks a revolution. We saw this in the late 1850s when the discovery of crude oil set off a chain reaction of innovation that powered the development of the modern economy throughout the 1900s. Even in recent years, oil has remained a core resource for the global population. Wars have been fought over oil.
Starting in the 1940s, a similarly important discovery was made with the electronic computer. In 1990, the internet was developed which was the catalyst that launched the digital age.
source: Analyst POV
The explosion of connectivity over the past decade or so has rapidly expanded the depth and rate at which data is created. Once upon a time, data was physical. Files stored in cabinets; spreadsheets saved on hard drives. Then the iPhone was launched, right around the same time that social media started taking off and cloud services were becoming a thing. This trio of events kicked off the emergence of what we see today – individuals are constantly connected, and mobile.
Today, a smartphone is a basic tool in the developed societies around the world and we create a TON of data. Everything from texts, emails, social media posts, etc. is all data that comes in many form factors and is constantly expanding because it’s created over time. As time passes, we simply create more data points. This data grows exponentially.
source: IP Carrier
With the continued advancements of technology including artificial intelligence, governments and businesses alike are now seeking out how to use that data in a way that is beneficial.
When Palantir was founded in the early 2000s, I think the company was a bit “ahead of its time”. Perhaps that is why the concept was met with so much skepticism. The US government is one of the most advanced organizations in existence (well, at least the intelligence community), so it makes sense that Palantir found its footing with government agencies first. But now that the private sector has caught up, this idea of “big data” has become mainstream, and companies that work in that space are seeing more opportunities for applications.
I didn’t invent the comparison, but I agree with it: “data is the oil of the 21st century”. It’s not hard to see this happening around us. You have fewer missile attacks and bombings, and more cyber attacks between sparring countries. Social media companies are being increasingly scrutinized over the data they collect, and the countries that have access to that data (read up on the TikTok dilemma).
As an investor, there is opportunity for long-term growth in finding the right companies that sit on the front edge of innovation in the data space. Some of these areas may include artificial intelligence, edge computing, or data analytics. In the case of Palantir, I believe Palantir is a unique business in what it does. So, what does Palantir do?
Palantir provides the tools for human-driven analysis of vast amounts of real-world data. So, imagine all of the data an organization may create. Emails, video, images, spreadsheets, etc. All of these formats are diverse, fragmented, and constantly increasing in scale. What Palantir does, is essentially takes all of this data and formats it via its platforms into a single “language”. Then, that data is integrated and managed in a way that users can analyze it with the assistance of machine learning.
Imagine having every picture, social media post, text, and email you’ve ever sent taken and analyzed for patterns and tendencies. This data could probably reveal information about you that you never realized was possible to find out without you telling someone directly. All of this is based on the data that you create day in, and day out.
Having this type of vision and ability to manipulate data that way is incredibly powerful and explains a lot of how Palantir gained traction with the US government. It’s been rumored even that Palantir’s system played a critical role in locating the hideout of terrorist Osama Bin Laden.
Palantir has two primary platforms, Gotham and Foundry. Palantir’s Gotham platform primarily serves government applications. Approximately 56% of Palantir’s total revenues are driven by government customers.
I highly recommend you check out this demonstration of Palantir’s Gotham Platform:
Also, I wanted to highlight another use case from Palantir that does a good job outlining the Gotham platform in action:
“In September 2018, Hurricane Florence devastated North and South Carolina in the United States. The storm was responsible for thousands of displacements, over a million power outages, and an estimated $17 billion in damage. To help victims remove felled trees from their properties, muck out flooded houses, and tarp damaged roofs, military veteran volunteer corps Team Rubicon deployed 1,000 volunteers—and Palantir Gotham.
Team Rubicon used Palantir Gotham’s Operations Module so the National Operations Center and Field Teams could collaborate on planning and executing six consecutive operations. They combined publicly available flood data with weather information and social vulnerability census data to find the communities in greatest need. In the field, Team Rubicon Incident Command and volunteers used data to manage operations: from triaging incoming help requests, to dispatching assessment and work teams, and producing sharable daily metrics and reports. With Palantir Gotham, Team Rubicon used data to marshal resources faster, to those most in need.”
Palantir’s other platform is Foundry. Foundry is typically used by private enterprises. Commercial customers make up the other 44% of Palantir’s total revenue. The Foundry platform seeks to accomplish the same goal for its users – integrating diverse data sets at massive scale to provide actionable insights.
Some interesting use cases for Palantir’s Foundry platform can be found here: Palantir Foundry Impact Studies
Lastly, Palantir lists Apollo as its third main business product. Apollo is a standalone, continuous delivery platform that manages and deploys Foundry and Gotham across multiple cloud structures. Collectively, these three platforms make up Palantir.
source: Palantir Technologies
Because of the nature of the business and who they work with, Palantir is an incredibly secretive organization that operates a complex business. However, I think these use cases and our discussion thus far paints a fairly complete picture of what Palantir is.
Sticky Business With Room To Grow
When it comes to Palantir’s business and its growth trajectory, there are a handful of characteristics about the business that I like a lot.
First, the business is incredibly “sticky”. In other words, once Palantir has its “claws” into a customer, it becomes increasingly difficult to switch. Palantir’s software can be described as what is often called being “mission critical”. It impacts the core function of the customer’s business operations. Once Palantir is integrated into how an organization operates, it would be severely disruptive to the customer’s organization to remove/replace Palantir’s software. The uniqueness of what Palantir does at scale only reinforces this.
Getting more specific, Palantir’s long-term relationship with various layers of government makes it difficult for existing and future competitors to displace Palantir. Long contract terms, relationships with deep ties, and deep-rooted implementation are tremendous hurdles for challengers. Why do you think the same small handful of companies have been supplying submarines, jets, and weapons systems to the military for decades? Think of Palantir as the software version of Lockheed Martin (LMT).
Palantir is a business to business (B2B) and business to government (B2G) company. Thus, its target markets are quite substantial. There are various layers of government including federal, state and local, as well as international governments for Palantir to penetrate over time. In the private sector, Palantir has a lot of room to expand as well. The company’s total customer count remains low at less than 200.
source: Palantir Technologies
To gain a sense of the room that Palantir has for expansion, let’s look at the private sector where Palantir does business with just a fraction of the world’s largest companies, including just:
- 8 of the Fortune 100
- 12 of the Global 100
- 24 of the Global 300
On the flip side, this means that Palantir is highly concentrated. Much of the company’s revenue comes from a small portion of important government contracts. Also, the company’s top 20 customers contribute more than 60% of total sales.
On one hand, this could be considered a risk for the company. The loss of a top 20 customer would make a noticeable dent in the company’s revenues. However, I see it as a sign that there is much room for growth. The company is in the early stages of assembling a sales team, hiring its first formal salesperson in 2019. I don’t see why investments into sales efforts wouldn’t bear fruit.
Palantir has multiple growth levers to pull with Gotham and Foundry. The business finished 2020 with 47% year over year revenue growth and is forecasting 30+% revenue growth for 2021. The company is targeting $4B in revenue in FY2025, 4X the revenue it did in 2020.
Palantir’s path to this growth will depend on a simultaneous expansion of its client base, while growing revenue per user. As of now, there are positive signs of this.
Among Palantir’s customer demographic, the company’s number of high dollar customers are growing the fastest. Over the most recent quarter, the company has signed 21 deals worth $5 million or more. As a result, average revenue per user has grown from $5.6 million in 2019, to $7.9 million in 2020.
source: Palantir Technologies
Perhaps the wildcard that Palantir has for driving growth over the long term, is innovation. We can see from the use cases how flexible the platform is. It can be applied to nearly any industry where data is collected and stored. As Palantir develops new technologies, these will enhance existing use cases, and as antiquated industries become more digital and modernized, it will grow the addressable market for Palantir.
One key observation I made for a business such as Palantir, is that the ride to growth over the long term will be bumpy at times. The company is projecting 30% (or more) growth in 2021 yet is projecting 4X it’s 2020 revenue in 5 years. Palantir’s growth will likely be lumpy and come in spurts as it signs new contracts over time. The company might have a soft quarter, and then land a massive deal that takes revenue up a notch.
This isn’t a consumer goods business where you can model a smooth long-term growth curve. This is important to keep in mind. The market is short-sighted, and we saw the stock get punished for its growth forecast for 2021. I push for everyone to think long-term, but I think that Palantir is truly a business that you only buy stock in if you intend to leave them alone and let them work over time.
Looking At Profitability
The largest knock I have seen on Palantir is the company’s lack of profitability. Despite being in business since the early 2000s, the company has never turned a profit. While every company needs to eventually turn a profit (and Palantir has gone a long time without doing so), I am not currently worried about this with Palantir.
Let’s look at this breakout of operating expenses as a percentage of total revenue over the trailing 24 months.
source: Palantir Technologies
The company’s gross profit margin is comfortably above 70%. As a software company, Palantir benefits from a non-capital-intensive business model. Software businesses are typically able to scale well, and profitability accelerates rapidly once “critical mass” is reached where revenue growth surpasses the growth of expenses.
We also need to keep in mind that in 2020 expenses were a bit inflated due to stock-based compensation related to the company’s direct stock listing. Moving forward, investors should look for a trend towards profitability as revenue growth continues. The company is likely to see an uptick in marketing expenses due to its early-stage sales efforts (just 3% of employee headcount is sales related to date), and R&D will remain a major expense because of the nature of the business model. Palantir is not only innovating, but work goes into customizing applications for clients with Gotham and Foundry.
We will want to see profitability over the long term obviously, but investors need to understand the big picture. Tesla was another company that went many years operating at a loss, and the stock flew once that threshold was reached. Tesla is a much more capital-intensive business, so I think Palantir will have a much easier time reaching profitability in the coming years.
Stock Has Fallen To An Attractive Valuation
It’s one thing to find a quality business, but sometimes the timeliness of when you acquire the stock can make a huge difference in your total returns. Put another way, valuation always matters (just less so for growth stocks over the long term).
We are fortunate to be looking at Palantir on the heels of a market-wide correction among growth stocks. Once trading at a high of $45 per share, Palantir has corrected more than 50% and is at levels similar to what was seen in the fall.
The current state of shares places Palantir at a $36 billion market cap. This results in an approximate forward 27X EV to sales multiple. This may seem expensive at face value, but a long-term perspective tells a different story IMO. If Palantir achieves its 2025 target of $4 billion in revenues, the current multiple will more than burn off over the coming years – even if there is some degree of multiple compression due to shifts in the market.
A 25X multiple on 2025 sales puts Palantir at a $100B market cap in four years, but I think that is likely on the conservative end. Big data is such a huge space and is still in the early innings of how data will be used by governments, businesses, and institutions in the years ahead. As a unique model in such an important space, Palantir’s long-term ceiling could be higher than most realize.
Risks To Be Aware Of
No investment is "risk-free" so it's important that we talk about some risks that investors must be mindful of. Palantir generates a significant amount of revenue from its top customers. While I detailed why I am not personally worried about customer concentration, it is a risk factor because a disruption to these business relationships would be catastrophic to Palantir's operating results.
Secondly, Palantir may need to continue ramping up spending on sales and marketing to drive growth in the private sector. Given that the company has been in business for a number of years, and has yet to reach profitability - investors need to be mindful of Palantir's spending. If cash burn accelerates for a prolonged period, it may be appropriate to reconsider the investment thesis.
Great growth investments can be found when an investor identifies a unique or disruptive business model that is operating in a large and growing space. The world’s shift to digital has exploded the amount of data that we generate. Data has become the critical resource of modern times where governments grapple for access and control of it, and businesses seek to learn from data and unlock new levels of insight and performance. Palantir’s ability to give both the tools and platform to accomplish this make Palantir a potentially wonderful long-term opportunity.
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