Palantir (NYSE:PLTR) went public in 2020 with the reputation of being a somewhat mysterious big data analysis software provider for government agencies and large corporations. As a result, Palantir's direct listing went somewhat under the radar, and investors were able to pick up shares in Palantir below private market prices. At BTM, we were able to capitalize on this opportunity back in October at around ~$9 per share. However, before we could bring this idea to the broader SA investor community, the stock attracted massive interest from institutional and retail traders, and Palantir shot up to ~$45, rendering it an unattractive investment. After a much-needed correction and stabilization, Palantir finally looks attractive again. Furthermore, Palantir's financial performance is tracking ahead of our forecasts, and so I will be formulating a new valuation on Palantir in this note.
Today, Palantir is well known to most investors due to an enormous wealth of research coverage on this firm. And so, I will not discuss the business in detail in this note. However, if you don't already know, Palantir is a fast-growing defense contractor that offers two software platforms: Gotham, defense and intelligence analysis software, and Foundry, a cloud-native SaaS central operating system for data. These platforms empower governmental agencies and corporations to solve problems (such as human trafficking, money laundering, etc.) by enabling better real-time decision-making through the help of AI/ML-powered big data analytics.
Most successful modern-day businesses share common traits such as visionary leadership, proprietary technology, powerful secular growth trends, large total addressable markets, solid investor backing, and robust financials. One such example is Tesla (TSLA), a revolutionary company that's leading the world's transformation to EVs (and alternative energy at large). Palantir is also a revolutionary company that is changing the world (in its own way). During my routine research work, I came across some uncanny similarities between Palantir and Tesla, which bolstered my conviction in Palantir. Before analyzing Palantir's numbers, I will share these similarities with you. At the end of this note, you will find my fair value estimate and expected returns for Palantir.
So, without further ado, let's begin.
I have recently realized that the bold claims floating around about Palantir being the next Tesla are not entirely unfounded. Now, Tesla and Palantir are completely different companies operating in entirely different industries, and I understand that comparing them with each other is like comparing Apples to Oranges. With that being said, the similarities that I am noticing in Palantir and Tesla are truly uncanny. The following list is not necessarily all-encompassing, and you may come across other similarities. Please feel free to share those in the comments section below.
Palantir and Tesla are leading the transformation of the world in their respective fields of big data analytics and electric vehicles (alternative energy). Both of these companies are creating a massive impact on society through their mission-focused business operations. Let's learn more about Palantir's work from its CEO - Alex Karp:
The total addressable markets for Palantir and Tesla are massive, and as of today, these companies seem to have monopolistic market share (Palantir in Government defense software and Tesla in EVs). As you may know, big data analytics and the adoption of EVs are as yet emerging secular growth trends. Therefore, it is natural for both Palantir and Tesla to have long growth runways. As per management guidance, Palantir expects to grow at CAGR rates of 30%+ for the next five years, while Tesla's CAGR growth rate is expected to hover around 50% for the next four years.
Even though Palantir and Tesla are growing rapidly, both of these companies continue to operate at near breakeven. Well, Tesla has been profitable for the last 5-6 quarters, but that profitability has come from the sale of energy credits (not from the core EV business). On the other hand, Palantir's numbers show that the company is highly unprofitable (negative operating margins); however, the losses are due to its massive stock-based compensation awards. Palantir's adj. free cash flow is turning positive, and GAAP numbers will eventually turn positive over the next few quarters. By operating at near breakeven today, Tesla and Palantir are delaying gratification (profits) to drive higher future growth by aggressively capturing market share.
These eccentric-looking gentlemen are geniuses who need no introduction. Palantir's Alex Karp and Tesla's Elon Musk have devoted decades of their lives towards building mission-focused companies that are revolutionizing the world, i.e., Palantir and Tesla, respectively.
In the technology space, the PayPal mafia (co-founders and executives of PayPal (PYPL) (before eBay buyout)) command a great reputation for building iconic companies. After PayPal, Elon Musk founded Tesla and SpaceX, Max Levchin founded Affirm (AFRM), Steve Chen, Jawed Karim, and Chad Hurley founded YouTube (GOOG), Reid Hoffman founded LinkedIn (MSFT), and the list goes on and on.
Palantir is the brainchild of the PayPal mafia's leader, i.e., PayPal's former CEO, Peter Thiel. As the story goes, after the 9/11 attacks, Peter co-founded Palantir as a "mission-focused company" that would apply software technology to curb terrorism while preserving civil liberties, which was somewhat similar to PayPal's fraud recognition systems. Today, Palantir works with many governmental agencies and commands a monopolistic market share in the software defense sector in the US. Alex has led Palantir as its CEO for 17 years, and Peter is the chairman of Palantir's board of directors. With such visionary and committed leadership at the helm, Palantir is well-positioned to become one of the most iconic businesses of this generation.
The success or failure of a company is somewhat connected to the incentives of the leadership team. However, the stock-based compensation [SBC] plans in place at Tesla and Palantir are truly astronomical. Tesla's Elon Musk has a base pay of $0; however, according to BusinessInsider, Tesla's ~101.2M share compensation package (as of May 2021) could be worth ~$70B, which is record-breaking compensation for any business executive ever.
Palantir's Alex Karp received a total compensation package of $1.1B in 2020, and almost all of it was SBC. Palantir's SBC awards are massive in size and highly dilutive in nature. Alex and other Palantir insiders have sold a small yet sizeable portion of their shares since its direct listing, which is fine because most of their wealth created over the last 17 years was tied up in a single company.
By paying top dollars, Palantir and Tesla are trying to align their leadership's interests with that of shareholders (investors). A company's valuation is directly related to business execution and performance, and so, incentivizing leadership and employees through SBC works in favor of shareholders in the long run. However, the potential dilution is a risk that investors (business owners) must accept to get extraordinary leaders to work for them.
In its latest quarterly presentation, Palantir's first slide mentioned individual shareholder count in the company. Now, you may be wondering why this data point is so important that it turned up on the first slide of a business update.
Source: Palantir Q1 2021 Results
Well, if you study Tesla or any other retail favorites (like Netflix (NFLX)) that have significantly outperformed the market in the past decade, you will likely find that these companies (and its leaders) were able to build an army of fanboys who would vehemently support these companies through thick and thin. And so, Palantir already having 1.5M individual shareholders is a big deal. Palantir is building a fanbase similar to Tesla, and that's bullish for its future.
Cathie Wood, of ARK Investment Management (ARK), is probably the most famous technology growth investor out there, and millions of investors tend to follow her holdings. Cathie's fame has come from her bold bull thesis on Tesla materializing over the past couple of years. However, she has picked several other technology companies that have delivered exponential growth. Therefore, I believe that Cathie going long on Palantir is a solid vote of confidence in future growth opportunities for the company.
Palantir is the 16th largest holding (worth $500M) in ARK's flagship ETF product - ARK Innovation ETF (ARKK).
In addition to Cathie Wood, Palantir has many other great institutional investors on its side (just like Tesla). Therefore, Palantir has solid backing from retail and institutional investors alike.
There are only a few truly revolutionary companies globally, so it is natural for their stocks to trade at lofty valuations. As you can see below, Palantir and Tesla command rich trading multiples. Even after a massive correction in 2021, Palantir is still trading at ~29x P/S.
Tesla's stock has performed admirably over the last 12-18 months; with the stock going up by more than ~700% from its February 2020 lows on the back of strong revenue growth and a big expansion in trading multiples (from P/S ratio of 2.5x in 2019 to ~20x in 2021). This stellar move has rendered Tesla overvalued, and we have discussed this idea multiple times. If you're interested in our research work on Tesla, you can access it here. With Tesla's growth and margin profile (gross margin of ~20%), a P/S multiple of 20x is not sustainable. Now, I am not bearish on Tesla, but the stock could continue to consolidate for the foreseeable future until the trading multiples normalize to sustainable levels (P/S of 5-10x).
Palantir's trading multiples have also gone up significantly since its direct listing last October; however, a P/S ratio of 29x is probably reasonable considering Palantir's growth and margin profile.
In my opinion, Tesla remains overvalued despite its rapid growth; however, in the case of Palantir, it's a different story. Palantir's stock has been equally volatile; however, the valuation is much more reasonable due to its robust margin profile (and, by extension, higher potential FCF margin). Let us now analyze Palantir's financials to formulate a fair value for the company.
In Q1 2021, Palantir's revenue growth accelerated to 49%, with revenues jumping from $229M to $341M. Of these, $208M came from Palantir's government business which grew at 76% y/y. The commercial segment grew at just 19%, but Palantir reported that commercial opportunities in the US and UK have increased by 2.5x since February 2021. Therefore, I believe we will see an acceleration in Palantir's commercial segment over the coming quarters.
Source: Palantir Q1 2021 Business Update
Palantir is growing rapidly, and its highly differentiated software platform offerings command ultra-high gross margins. In Q1 2021, Palantir reported an 800-basis point improvement in gross margins (75% to 83%). The contribution margins jumped even more spectacularly, bouncing up from 41% to 60%.
Source: Palantir Q1 2021 Business Update
Big improvement on the margin front combined with strong growth (248% y/y) in billings enabled Palantir to turn adjusted free cash flow positive (44% margin). For Q2, the company upgraded its adj. FCF guidance from breakeven to in excess of $150M. Therefore, it is fair to assume that Palantir is already a free cash flow generating business entity.
Source: Palantir Q1 2021 Business Update
Now, Palantir continues to remain unprofitable due to its massive stock-based compensation program. However, a tapering in SBC awards will happen over the coming years, and then Palantir will generate massive amounts of free cash flow. The growth story for Palantir is easy to grasp, with the trends in big data analytics still just evolving. Alex Karp, Palantir's CEO, has guided for ~30% growth for the next five years; however, he may be sandbagging numbers.
Source: Seeking Alpha
The above consensus analyst estimates suggest a cumulative aggregate growth rate of ~26.66%; however, I think Palantir can spring a surprise to the upside. I have based my valuations on the following assumptions:
2021E revenue [A]
Potential Free Cash Flow Margin [B]
Average diluted shares outstanding [C]
Free cash flow per share [ D = (A * B) / C ]
Free cash flow per share growth rate
Terminal growth rate
Years of elevated growth
Total years to stimulate
Discount Rate (Our "Next Best Alternative")
I use these assumptions as inputs for our proprietary valuation model, which entails the following steps:
In step 1, we use a traditional DCF model with free cash flow discounted by our (shareholders) cost of capital.
In step 2, the model accounts for the effects of the change in shares outstanding (buybacks/dilutions).
In step 3, we normalize valuation for future growth prospects at the end of the 10 years. Then, using today's share price and the projected share price at the end of 10 years, we arrive at a CAGR. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.
Here are the results for Palantir:
Source: L.A. Stevens Valuation Model
As you can see, Palantir is currently undervalued by ~20%. Thus, according to a DCF analysis, Palantir is a buy. However, it is prudent to analyze potential ROI before deploying one's capital.
To calculate the total expected return, we simply grow the above free cash flow per share at our conservative growth rate, then assign a conservative Price to FCF multiple, i.e., 35x, to it for year ten. This creates a conservative intrinsic value projection by which we determine when and where to deploy our capital.
Here are the results for the expected return:
Source: L.A. Stevens Valuation Model
Over the next decade, Palantir's stock price could grow from ~$23 to ~$120 at a CAGR of ~18%. Since the expected return for Palantir is greater than our investment hurdle rate of 15%, I rate it a buy.
Palantir is showing massive potential, and it compares well with iconic modern-day businesses. The company has a great long-term growth story with a big data analytics trend still just getting started. Also, Palantir is operating at near breakeven and would likely turn profitable next year (once SBC awards from going public phase-out). With multi-year profitable growth to follow and undervalued stock, Palantir is poised to outperform the market over the next decade. Hence, I rate Palantir a buy at $23.
Key Takeaway: I rate Palantir a buy at $23.
I would love to hear any of your questions, thoughts, or concerns related to Palantir or this note. So, please post them in the comments sections below.
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This article was written by
I am the Author and Chief Financial Engineer at "The Quantamental Investor". At TQI, our mission is to help retail investors build generational wealth in equity markets through the power of financial engineering. To do so, we share robust model portfolios that cater to investor needs across different stages of the investor lifecycle. All of our investment ideas are thoroughly vetted through TQI's Quantamental Analysis process, which uses a mix of fundamental, quantitative, and technical data analysis. If you're interested in learning more about our marketplace service, visit: The Quantamental Investor
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Disclosure: I/we have a beneficial long position in the shares of PLTR, GOOG, MSFT, AFRM, TSLA either through stock ownership, options, or other derivatives. 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.