Palantir: Stalling Commercial Growth Raises Doubts

Summary

• Palantir's government business continues to drive revenue, and while robust growth is likely to continue, it may be lumpy.
• Growth in the commercial segment has stalled in recent quarters, although this may just be due to market conditions. If Apollo finds adoption amongst developers, this could spur growth.
• Palantir may not be a pure software company, but this does not necessarily mean they are not building a defensible and profitable business.

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Palantir's (NYSE:PLTR) growth rate continues to decline rapidly, due mainly to weak growth in the commercial segment. The burden of operating expenses has also increased in recent quarters as Palantir continues to invest in product development and its salesforce. Investors appear to have lost faith in the company, which may be at least in part due to a recognition of the service heavy nature of their business. Developing and implementing customized solutions for customers may actually be a defendable business though, particularly within defense and intelligence.

While financial performance has been fairly weak, Palantir continue to progress their business. Gotham is being adopted by US and allied defense organizations and continues to be an area of strength, driven by geopolitical tensions. Palantir has officially received DoD IL-6 accreditation, further enabling their SaaS offering on secret networks. IL6 is reserved for the storage and processing of information classified up to the SECRET level.

Palantir’s new Fed start offering builds on Apollo to enable software companies to achieve FedRAMP authorization faster and at a lower cost. Whether this can be leveraged into a significant source of revenue remains to be seen, but it could have potential. Larger software companies are likely to pursue their own FedRAMP authorization, but for smaller companies chasing rapid growth this is likely to be an attractive option.

Palantir recently displayed their TITAN vehicle at the annual AUSA conference. Palantir was awarded a prime contract by the Army to build a prototype for the Tactical Intelligence Targeting Access Node. TITAN is a ground station focused on generating situational awareness based on data from a series of sensors. This is a 36 million USD contract for the competitive prototyping phase, which will span 14 months. To deliver the vehicle, Palantir partnered with organizations like Anduril Industries, L3Harris (LHX), Pacific Defense, Sierra Nevada Corporation, Strategic Technology Consulting, and World Wide Technology. I don't think this type of initiative is particularly important to Palantir's future, but it does highlight how different the company is to most software vendors.

Consulting or Software?

There continues to be debate about whether Palantir is really a software company or more of a consulting organization, although this debate misses the point somewhat. The distinction does not really matter, provided that Palantir is able to deliver profitable growth, and even if their business is services heavy, this may not be such a bad thing. Partnering with customers to implement customized solutions may increase costs and decrease scalability, but it also likely increases barriers to entry and reduces the likelihood of a customer churning.

A number of Palantir’s recently announced deals point toward the service intensive nature of the business:

• A 50 million USD, five-year expansion of its work with SOMPO Holdings. This expansion will enable the roll out of critical workflows and further development of SOMPO's data platform. Within SOMPO Japan, use of Foundry has been focused on improving profitability for the insurance business, and supporting disaster response. The disaster response work has streamlined labor-intensive workflows, like exchanging information with inspectors and processing claims.
• Collaborating with Cardinal Health (CAH) to design a solution that will give health systems and hospitals dynamic purchase decision insights. Palantir will bring together diagnosis and clinical data with real-time customer purchasing and consumption data to help inform purchasing decisions.
• The UK Ministry of Defence awarded Palantir a 75 million pound contract over three years. Palantir will support the MOD’s efforts to leverage data to deliver a military advantage and greater efficiency.
• Palantir and Crisis24 have entered a multi-million dollar strategic partnership to transform security and risk management with the power of AI.
• Palantir is collaborating with Lockheed Martin (LMT) to enhance software development and delivery for the Navy, using their Apollo software. The Navy requires these capabilities to update software at the edge rapidly and securely.

A lot of these projects lean more towards data science than AI or even machine learning. There also appears to be a customization component to many of these, with Palantir collaborating with customers in order to develop a specific solution.

SPACs Investments

Palantir invested over 400 million USD in 20 start-ups in 2021, with many of these deals also having the start-up enter a contract for services with Palantir of a similar size to the investment. Palantir typically invested 10-40 million USD in exchange for a multi-year contract with a similar value. This was widely criticized at the time, with many investors viewing it as an attempt to purchase growth. In Palantir’s defense, these investments may have been made to try and accelerate the adoption of their platform by smaller customers, who had the potential to grow into larger customers over time.

Most of these starts-ups have experienced significant share price declines, and some are now facing bankruptcy. Regardless of intent, the strategy clearly did not work and this may be dragging on the financial performance of Palantir’s commercial business.

Financial Analysis

The performance of Palantir's government and commercial businesses paint two very different pictures, although this is likely due mainly to macro conditions. The government business continues to grow steadily, possibly aided by rising geopolitical tensions. Growth in the commercial business has stalled in recent quarters, although the US business is performing fairly well, growing 53% YoY in the most recent quarter. The international commercial business was roughly flat YoY, due to both macro conditions and the strength of the USD.

Figure 1: Palantir Revenue by Customer Segment (source: Created by author using data from Palantir)

Palantir's customer count grew 66% YoY, although this growth is being driven by smaller organizations. The US commercial customer count increased 124% YoY, and was responsible for much of the total increase in customers.

Palantir closed 273 deals in the past quarter representing an increase of 63% YoY. 19 of those deals had a total contract value of at least 10 million USD, 32 were at least 5 million USD and 78 were at least 1 million USD. The majority of these deals are relatively small by Palantir's historical standards.

Palantir's net dollar retention continues to be fairly robust (119%) and trailing 12-month revenue from the top 20 customers continues to increase (15% YoY).

Figure 2: Palantir Customers (source: Created by author using data from Palantir)

Palantir's business has been scaling reasonably well, although progress towards profitability has stalled over the past 12 months. This appears to be largely the result of increased investments in sales and marketing along with R&D, while growth disappointed to the downside.

Palantir has a reasonably efficient go-to-market motion, which is likely a function of their focus on extremely large customers, but the burden of general and administrative expenses is unusually high. Why Palantir is spending 600 million USD a year on general and administrative expenses and what benefit this creates for the company is unclear.

Figure 3: Palantir Profit Margins (source: Created by author using data from Palantir)

Figure 4: Palantir Operating Expenses (source: Created by author using data from Palantir)

Palantir added 450 employees in the most recent quarter, including 141 new graduates. Job openings have fallen off significantly since then, suggesting a more modest increase in operating expenses going forward. Whether the rapid decline in job openings is also suggestive of weak demand is unclear though.

Figure 5: Palantir Job Openings (source: Revealera.com)

Valuation

Palantir appears priced in line with peers based on its current growth rate and gross profit margins. Based on a discounted cash flow analysis, I estimate that Palantir's stock is worth approximately 10 USD per share.

Share price performance over the next 12 months is likely to be determined by whether Palantir's growth continues to moderate and how much progress is made towards achieving operating profitability. Palantir has stated that they are willing to invest through a downturn, which may leave investors disappointed on the profitability front. Palantir's exposure to the government sector should help cushion any decline in growth.

Figure 6: Palantir Relative Valuation (source: Created by author using data from Seeking Alpha)

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.