Let's Wait A Little More Before Buying Palantir

Summary

• Palantir has immense opportunity as the world seeks to harness the power of the data.
• The company has great software that delivers a sticky product, high margin, and a near-ubiquitous application to its service.
• However, due to the absurd stock-based compensation and a high valuation, I believe it is better to wait a little more before buying Palantir.

Michael Vi/iStock Editorial via Getty Images

Introduction and Thesis

Our future is inevitably data. Since the age of the internet, digitalization in all aspects of our society has been ongoing creating massive amounts of data. In the future, the one that can harness this data will be miles ahead of their competitors, so the ability to process this massive data is expected to be extremely valuable.

Palantir (NYSE:PLTR) is a company building "software that empowers organizations to effectively integrate their data, decisions, and operations," or in other words, Plantar is the company that is at the forefront of harnessing the power of data to solve enterprise-level extremely complex problems. Thus, being a leader in this industry makes the company's fundamentals and vision extremely attractive; however, I believe it is better for investors to wait for the time being before investing in Palantir. The economic policies and the market sentiments are moving away from the expansionary policy potentially opening up the possibility for further consolidation in Palantir stocks. Further, the massive amounts of stock-based compensation (SBC) that the company is justifying are unfriendly to shareholders. I think it is better for either the company to reduce SBC or wait until the revenue growth makes SBC a smaller part of the overall revenue.

Fundamentals

Before talking about the absurd valuation and the SBC, I would like to point out the marvelous business that Palantir has briefly pointed out that the only problem that the company or the stock has is its SBC and valuation.

Palantir's business is beautiful; it can be applied to governments and commercial customers in any industry. The company has the National Institute of Health, Department of Veteran Affairs, Army, Air Force, and etc., as its government customers who utilize Palantir's software to tackle everything from defense and intelligence gathering to improving veteran patient cares. Further, Palantir's commercial software applications are as flexible as the government business. The company has numerous enterprises as its customers including L3Harris (LHX), Airbus (OTCPK:EADSF), Ferrari (RACE), Rio Tinto (RIO), and etc. improving everything from manufacturing to mining. This alone shows investors the power of harnessing the data and the opportunity Palantir has moving forward into the future.

As a result of such a promising and dynamic product, the company's operational growth and financial health have been firing on all cylinders. In 2021Q3, Palantir reported revenue of $392 million, which was 36% growth year-over-year while the customer count grew even faster at 46%. I believe customer growth promises future revenue growth because it takes months to years for revenue to meaningfully materialize, so the fact that the customer growth grew even faster than the revenue growth was significant. Further, adjusted free cash flow turned positive to $119 million compared to -$53 million 2020Q3. The adjusted operating margins continued to be at 30% while the adjusted gross margin was at an impressive 82%. The company, in simple words, is showing growth and improving operations.

Stock-Based Compensation

Despite the promising fundamental thesis and top-line growth that the company has been showing, I do not believe Palantir stock is a buy at the moment because of massive SBC. The company has been massively diluting its shareholder base through absurd SBC citing that they need to attract talent, which may be true to some extent. As the chart below shows, since the IPO on September 30th, 2020, the company's outstanding shares increased from about 900 million to 1.964 billion, which is over 100% dilution. When calculating the dilution from the start of 2021 at 1.8 billion shares, the company has diluted shareholders by 10% in 2021 alone. I think this is simply absurd and shows the unfriendly attitude of the management towards its shareholder.

Data by YCharts

[Chart created by author using YCharts from Seeking Alpha]

To better understand how serious the dilution or the SBC is, I created a chart below showing the stock-based compensation data throughout 2021. As you can see in the chart below, SBC consistently represented over 50% of the company's revenue. It is the biggest cost for the company, and it has been the reason why the company has been reporting a net loss.

2021 Q1~Q3 (In Millions)
	Q1	Q2	Q3
Revenue	$341	$376	$392
SBC	$194	$233	$185
Cost Incurred Because of SBC	$37	$30	$23
Total SBC Cost	$231	$263	$208
SBC/Revenue	67.74%	69.95%	53.06%

Click to enlarge

[Chart created by author using Source 1, Source 2, and Source 3]

SBC is a great way to reward employees and attract talent in the market. However, Palantir, in my opinion, has been degrading shareholder value due to excessive SBC. Thus, until either the SBC shows a decreasing trend or the SBC becomes irrelevantly small in comparison to the revenue, I believe investors should think twice before investing in Palantir.

Financials and Valuation

Unlike valuations, I believe the financial health of Palantir's balance sheet is great. The company currently has about $2.3 billion in cash with about $3.2 billion in total assets while the total liability stood at only $987 million putting total liability to asset ratio (L/A) at 43%. Further, because the company generated about $240 million during operation with negligible long-term debt, I believe the financial situation of Palantir is great.

On the other hand, Palantir's valuation is slightly questionable. The company has a market capitalization of about $37 billion dollars today. The company has a high price to sales ratio of about 28 with an expected forward price to earnings ratio of about 120. It is true that the company's business is high margin and crucial, but considering the SBC and today's economic conditions, I believe this valuation may be too high. Unlike in most of 2020 and 2021, the Federal Reserve is ending the expansionary policy. Instead, they are expecting to finish tapering by March of 2022 and raise rates possible in March, which will effectively raise long-term treasury rates and decrease the investment in the stock market. Therefore, a higher valuation might have been justified in the previous 2 years, but going into 2022, I believe a higher valuation may result in either contraction or range-bound trading for the time being.

Summary

Palantir is a unique company and a perfect example of a great company but a bad stock. I truly believe in the power and the potential of Palantir's software. It can be applied in almost any industry from healthcare to defense to manufacturing. However, the company's excessive stock-based compensation and valuation hesitate me. The company has been justifying its high stock-based compensation without showing signs of stopping, and I believe this is just taking advantage of its shareholders by diluting their value. Therefore, I believe it is better to wait until stock-based compensation is either showing a decreasing trend or becoming a smaller portion of the revenue due to Palantir's continued growth.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[leveled.da]

Didn't this company buy up a bunch of gold bars?

[ipex]

@leveled.da
Yeah, they did buy up some boomie rocks.

[midas_someday]

Because PLTR has fallen so much, the company will have to issue more SBC to true up to the $ value that was promised to employees. So, if the company’s strategy is to make SBC a big component of total compensation, dilution will go up more after shares fall. Double whammy to investors — higher dilution and falling share price.

[ipex]

@midas_someday More like infinite whammy. Even if this company falls to zero, they would probably still think and attempt to issue more SBC into the negative would solve all of their problem, taking a page from JPow's infinite money printer glitch.

[ipex]

SBC is the very reason I've grown annoyed and DUMPED all of my shares. I pay attention to what they DO, not what they SAY. And from their micro-subtle behaviors they have displayed, they are really shareholder-unfriendly. They want us to have their backs, yet they don't have ours.

[Catskills1]

@Eric Lim Appreciate your article. It's a conundrum. Clearly an amazing product, with exaggerated SBC. Agree with your conclusion regarding SBC as a percentage of revenue, if falling it will help. Rising revenue and reduction in number of SBC shares would be additionally beneficial. The price falling shows that so far, PLTR cannot convince the market that a higher valuation is warranted with potentially rising interest rates. As investors, we have to decide whether we think PLTR will put the pieces together. If yes, buy now and average down if necessary. If now, stay away. Long PLTR, made money on some shares bought just after the IPO, am down 20%, adding shares on the way down.

[sierranvin]

It is self evident that the CEO Karp understands little or nothing about the stock market. As he massively dilutes the shares, the promised benefit to the employees whom we can only assume he might be retaining/recruiting with his stock giveaways is completely shrinking. As the stock sinks from dilution, there's no benefit for anyone, be it suffering shareholder or stock-compensated employee!

[mbacapitalist]

Good luck landing or retaining talent without the absurd SBC.

[DLudwig777]

@mbacapitalist somehow the other companies manage it…

[RickJensen]

@mbacapitalist
All of the SBC goes to karp and the C-suite.
Wake up.

[mbacapitalist]

@RickJensen judging by your statement I can tell you’ve never worked internally at a startup.

[BenBminnesota]

that is right on I had the phone in my hand on day one waited it went to 40 and now back to 18- would have been a quick trade did not need the tax bill- too bad could be a great stock but it is a great place to work-- cheers to them-- they Win we loose- you are right- been watching this company fo 10 plus years waiting for public offering and disappointed-- OH well. I also new about the iPhone before it broke but did not believe--

[ONE FOOT]

I believe, strictly based on imagination, that Palantir has an astounding strategy that I have never heard described, although perhaps others have done so. I think they are getting paid to solve their customer's problems and making a small profit, and thereby creating an eventually enormously profitable library of specific applications that will be generically applicable to hundreds of other businesses. After the library is complete enough, they will use AI to sync their library of solutions to any business that walks in the door to solve their logistical/structural/legacy-IT problem with very little customization expense.

I worked at a huge aerospace company and am familiar with the nightmare of myriad information and work management systems that are unable to work together. Every other company in IT land is just another blind man trying to make a profit on what they think the relevant part of the elephant is. Palantir is making a box big enough package any elephant. But maybe I am wrong.

[Tatech]

@ONE FOOT The beginning of "Deep Thought" (the answer is 42). It WOULD take a PLTR to pull it off, though (...specific applications that will be generically applicable...) if anywhere near possible/desirable/legal/etc.

[OURBILLS83]

don't forgent to mention a 'foundry for crypto'. PLTR'S TAM is getting bigger and bigger and contracts from private sector are growing.

[becomjapan]

This article seems very poorly researched.

PLTR were totally transparent about the SBC that would occur in 2021 - even from the time of their DPO and in the DPO documentation it was clearly communicated.

Now is 2022, not 2021.

Further details on SBC past and present can be found here; twitter.com/...

[BenBminnesota]

@becomjapan so what difference that makes

[DLudwig777]

@becomjapan let’s see the SBC in 2022 before jumping to conclusions. If im a PLTR employee I’d want a nice juicy bonus in 2022 just as in 2021…

That’s the thing with fat bonuses, hard to discontinue them without royally pissing off the team.

Management has the right to dilute another ca. 20bn shares so let’s judge them by their actions…

[ipex]

@DLudwig777
That’s the thing with fat bonuses, hard to discontinue them without royally pissing off the team.

Words of wisdom. Never instill an reward program if you can't maintain it. The pain of loss hurts more than the pain of no gain.

[Jpokergman]

When Palantir stops doing the money dance, I will buy more…….

[necto]

agree.

[William- Billy Hill]

Agree on ridiculous amount of SBC. Dilution has been absurd. No business could perform well enough to offset this. I was will consider when it hits single digits(which won't take long).

[RomeVVV]

Good article granted the SBC is a problem. Probably the major issue. If you want to obsess over that and ignore great growth, strong commercial customer growth, an excellent product that is in high demand then don’t buy the stock.
None of you are Nostradamus, so the bottom is unknown. Throwing out numbers helps nobody. Maybe the stock hits 8. Maybe you came up with that throwing darts.
Adding small amounts at 16-18 does not seem illogical. Adding larger amounts at lower prices makes sense. If you are in for the long term at a cost average of 17 versus 14, that is not huge. Of course, you would like to buy as low as possible. Problem is nobody knows what the low will be.

[Tatech]

@RomeVVV >>Maybe the stock hits 8.<<

In a world where one plus one equals two, that may be so (stock hits 8)...but in my world, where the Mayor of NY city wants to be paid in Bitcoin, Foundry for Crypto alone is worth $8.00.

[cgold22]

Palantir shows no sign of reducing their SBC program, diluting investor shares.
Soon it will attain 'Monopoly Money' status. I'm out.

[ccchk82]

@cgold22 Not exactly. If you paid attention to the SBC vs revenue chart in this article, you should have realized that the Q3/21 SBC went down 4.6% from Q1 and 20.6% from Q2! Of course we will have to wait for the Q4 ER to find out if a down trend in SBC is being established.

[Cautiously]

@cgold22 Actually, SBC (and related dilution) has peaked:

twitter.com/...

[cgold22]

@ccchk82 A trend downward of SBC is certainly desirable for all stockholders, I'll wait.

[RickJensen]

Wait about a year. Then it should be obvious.

[karondongotbanned]

fair value PLTR is around 8 dollars

[jara-mill]

@karondongotbanned - And why is it $8 fair value?

[RomeVVV]

@jaramill Nostradamus how did you come up with 8? Throwing darts?

[jara-mill]

@RomeVVV I think you meant to reply to @karondongotbanned instead of me. I too was asking them the same question as you.

[acpennington]

Bear thesis: Unprofitable company with huge multiples, tons of insider selling, and a share structure that gives insiders permanent voting majorities.

Bull thesis: Yeah, but palantir does stuff with data.

[micromaniac]

@acpennington not oversimplified at all

[RickJensen]

@acpennington
Sadly, you nailed it.

[jara-mill]

@RickJensen - For now, sadly...I must agree, but when blood in the streets, I'll take advantage of the garage sale.

[65959876876]

I wonder if PLTR will end up in a viscous cycle where a lower share price means that they need to print more shares to retain top talent, lowering the share price, meaning they need to print more shares?

[ankitp3490]

@Ian65959876876 Lower share price will hurt the management and everyone whose wealth s tied to PLTR stocks and options. When they realize SBC is the reason for the low valuation, they'll start tightening the SBC tap. So lower the stock value goes, the higher the chances this happens.

[ipex]

@Ian65959876876 Palantir is taking a poor play from JPow's printer.

[Doc 224899]

The elephant in the room that nobody is talking about is that there is no evidence of support in the chart between the IPO price and today's price, so that implies support at ~$10. That share price is absurd, but this is the sort of historical price data that corporate investors find it hard to ignore.

[DerrickXIII]

@Doc 224899 if it gets close to $10 I am selling my organs for more shares.

[becomjapan]

@Doc 224899 ...and the business as grown close to 50% since the listing too....

[ipex]

@DerrickXIII Then watch it goes to $5 when they increase their SBC even more. They could probably at least show some sign of caring about investors, instead of thinking they're so high and mighty that it's an honor to invest in them. No, they should bow to us, investors, not the other way around.