My Quick and Dirty Take on Palantir
See disclosure details below.
“Heads I win; Tails, I don’t lose much!” — Mohnish Pabrai
I identify myself as a value investor. With the clarity of thought that writing brings, I’m writing to distil my investment view on Palantir Technologies(NYSE: PLTR), a $37 billion market cap technology services company based in Denver with no earnings and a 33.75 trailing twelve-month (ttm) price/sales (P/S) ratio. At face value, the last place a value investor will be looking for ideas would be in tech — high multiples, levered capital structures, and a plethora of rosy promises. But why am I paying particular interest in this secretive company that was once owned by the CIA and other US security establishments? Simply put, I view that Palantir trading below $20 dollars offers me a compelling risk/return profile where the expected return outweighs the downside risks.
“It is mine, I tell you. My own. My precious. Yes, my precious.” ― J.R.R. Tolkien, The Fellowship of the Ring
The name Palantir was based on the fictional artefact “Palantiri” from JR Tolkien's Lord of the Rings. Palantiri was an indestructible crystal ball used to see other parts of the fictional world. How prophetic.
Palantir Technologies gained mainstream notoriety with the role it played in locating Osama Bin Laden. Palantir is a software company that specializes in data analytics. Founded in 2004 by its current CEO Alex Karp and PayPal co-founder Peter Thiel, Palantir was envisaged to leverage the data-driven fraud detection capabilities in PayPal to solve problems arising from voluminous data siloed in various places. Palantir aggregates the data in whatever shape or form (structured and unstructured in industry parlance) and makes it available in a central location to enable faster access, visualization, and testing — all in a secure and configurable “need to know” environment.
Palantir has two main product offerings namely: Palantir’s Gotham — used by an alphabet of US government departments and agencies in a gamut of applications from helping locate roadside bombs in Afghanistan to planning and executing operations; and its private-sector twin, Palantir Foundry, which brings the same model to solve real-world business problems.
Palantir estimates that its total addressable market (TAM) for both government and commercial sectors to be $119 billion comprised of $56 billion in the commercial and $63 billion in the government segment. Since its inception, the company has been growing with a 63% CAGR with $1.09 billion in reported revenues ($610 million for government and $482 million for commercial) for FY 2021.
Is it sustainable? My short answer is yes — my view is that as more government agencies/departments sign up for Gotham, the platform becomes more valuable due to its embedded network effects (the ability to securely share information within the platform). For Palantir’s commercial offering Foundry, management is reporting a lot of headroom counting only a “handful of fortune 500 companies” as customers.
Given Palantir’s underlying fundamentals in government and commercial offerings, expecting a 30 per cent y/y revenue growth rate seems very conservative at all.
“Your margin is my opportunity” — Jeff Bezos
The company reports a loss despite its revenue growth numbers. A closer look at the company’s financial statements reveals that it’s actually cash-rich (close to $2 billion by the end of 2020) and has little or no debt. One of its significant expense items is Research and Development, a line item US accounting standards require to be expensed and consequently taken out of the company, no matter how promising the investment could be in generating future commercial prospects. In the fiscal year ending 2021, R&D accounted for almost 51 per cent of its revenues.
Palantir gets a lot of attention for its small customer base that consequently makes its business relatively more concentrated in a handful of customers relative to that of its peers. A big part of its current handicap is the size of its salesforce which remains a mere 3 per cent of its total personnel headcount, servicing 139 customers as of its last 10-K report. Consequently, I expect the company’s operating expenses (mostly its SG&A) to remain the main driver of its soft GAAP earnings.
Will the company be at risk of running out of liquidity to finance its growth prospects? My take is a flat out no. In 2020, the biggest driver of its operating expenses are costs associated with its stock-based compensation — a non-cash expense. During its 2021 Q1 earnings call, aside from reporting a $300 million increase in its cash ($2.3 billion as it stands after the 2021 Q1 earnings call), it also doubled its revolver credit facility to $400 million which still remains undrawn.
My Quick and Dirty Take
As of 12 May 2021, Palantir appears to be relatively expensive at 16.53x ttm P/S versus Tyler Technologies (NYSE:TYL) and Splunk (NYSE:SPLK). The space Palantir operates in appears to be underpenetrated as even its closest competitors don’t really offer the same product offering as it does. The whole software market trades at 6.94x ttm P/S with median revenue growth of 7–10 per cent. Palantir is growing its revenues at a rate of 30–40 per cent y/y therefore its P/S remains highly justified.
Let’s simulate this. On a two-year period, even if its P/S expands to 40 — more double what it is now, and assuming an anemic 10 per cent revenue growth holding all else (particularly margins) equal, Palantir’s current price is implying a 50 per cent upside at least. Hence, at below 20 dollars a share, I’m a buyer.
Disclosure: I am long PLTR and I wrote the article myself, and it expresses my own opinions. Data referenced are both from primary and secondary sources and without guarantee for its accuracy. I have no business relationship with any company mentioned in this article. The article should not be considered as investment advice. Please consult your financial adviser.
