AYX - Palantir: Treading On Thin Ice
2023-09-01 09:41:43 ET
Summary
- Palantir Technologies Inc. stock is in a precarious position due to its high valuation on the back of generative AI hype.
- While demand for hardware has surged, the impact of AI on software is yet to really be felt. This may come in time, but investors risk being disappointed.
- Palantir's Artificial Intelligence Platform aims to capitalize on the potential of LLMs, but the company does not appear to be investing in anticipation of a growth surge.
While Palantir Technologies Inc. ( PLTR ) stock had a strong start to the year, the share price has been fairly stagnant in recent months. Palantir's valuation is far higher than warranted by the company's current performance due to an expectation that generative artificial intelligence, or AI, will cause growth to accelerate. This may be difficult to achieve in a soft demand environment, though, and with an unclear path to AIP adoption and monetization. Improving margins will help to support the stock somewhat, but Palantir's share price is likely to come under pressure if growth doesn't improve in coming quarters.
Market
Palantir has been a large beneficiary of the recent surge in interest in AI. While LLMs - large language models - have created a large amount of hype, the main impact of this so far has been on the demand for hardware. This will potentially result in software demand in time, although the lag could be considerable. Snowflake ( SNOW ) has suggested that it may be 2024 before the impact is really seen. There is a large amount of uncertainty, though, as end market demand and monetization potential are unclear. Palantir's stock price has already anticipated significant benefits accruing to the company, creating downside risk if the expected growth does not eventuate.
Figure 1: ChatGPT Search Interest and NVIDIA and Palantir Stock Price Growth (source: Created by author using data from Google Trends and Yahoo Finance)
Palantir believes that there is strong demand for AI , particularly in the U.S., across both LLMs and other models which can impact business outcomes. This is difficult to see in current data, though, as Palantir doesn't appear to be investing ahead of a growth surge and the company's customer acquisition hasn't accelerated.
Snowflake has suggested that the macro environment continues to be unsettled , although there has been an improvement in sentiment. Generative AI is at the forefront of Snowflake’s conversations with customers, but customers are realizing their AI strategy must be built on a solid data strategy. This could be interpreted as bullish for Palantir, particularly amongst customers that do not have the expertise to implement their own solutions.
Alteryx ( AYX ) believes that demand has been fairly consistent, with data analytics continuing to be a priority for CIOs. The macro environment has had an impact on the company though, with longer sales cycles and greater deal scrutiny. Management suggested on the second quarter earnings call that the macro environment was tougher than expected , with a significant change in customer buying behavior observed in the last two weeks of the quarter.
AIP
Palantir wants to be the most important software company in the world, and a big part of that is combining its existing capabilities with the potential of generative AI. Palantir's AIP aims to enable organizations to use LLMs in a secure manner, extracting value from data and orchestrating tools, actions and other AI models.
AIP offers customers a range of functionality:
- AIP Builder enables customers to build data pipelines using natural language
- AIP Logic enables customers to build LLM-backed functions and includes no-code functionality
- AIP Automate enables customers to create and monitor AI agents
- AIP Assist is a productivity tool that provides guidance to users of AIP, Gotham and Foundry.
Many software companies are rushing to embed LLMs in their products, though often with unclear value propositions. Palantir is potentially differentiated in this regard by its ontological approach, providing a semantic layer that could enable LLMs to deliver more reliable results. Palantir's background in defense and intelligence also means that Palantir brings significant capabilities in governance and control, which could help to alleviate customer security concerns when utilizing LLMs.
AIP was only released a few months ago, and hence it is probably too early to expect it to be impacting performance. It is reportedly opening expansion conversations with Palantir’s largest customers, though. AIP has over 5,000 monthly users, and the number of users has been growing 50% month-over-month. Early interest has reportedly exceeded that witnessed during the introduction of Palantir’s other products.
Financial Analysis
Revenue growth was only 13% YoY in the second quarter. Excluding the impact of revenue from strategic commercial contracts, revenue growth was 16% YoY. Revenue from strategic commercial contracts was 19 million USD in the second quarter, down over 40% sequentially. Third quarter revenue from this segment is only expected to be $14-16 million USD, and fourth quarter revenue is expected to be even lower.
Palantir expects third quarter revenue to be between $553 and $557 million USD, a 16% YoY growth rate at the midpoint. Full year revenue is expected to be greater than $2.212 billion USD, implying greater than 16% growth. While guidance is for a modest acceleration in growth, and there may be some conservatism in the guidance, it appears that growth is stabilizing in the mid-to-high teens rather than moving sharply higher.
Figure 2: Palantir Revenue Growth (source: Created by author using data from Palantir)
Palantir's customer base continues to be fairly concentrated, but the company is making progress expanding its customer base. Palantir's customer count increased 38% YoY to 421 customers. This is dragging the average revenue per customer lower, but in general, Palantir's customer base still skews towards extremely large customers.
Table 1: Deals Closed in Q2 2023 (source: Created by author using data from Palantir) Figure 3: Palantir Customers (source: Created by author using data from Palantir)
Commercial revenue grew 10% YoY in the second quarter, although performance was negatively impacted by a decline in revenue from strategic commercial contracts. Excluding the impact from strategic commercial contracts, commercial revenue grew 19% YoY. The U.S. has been an area of strength for the commercial business, with commercial revenue in the U.S. growing 37% YoY excluding the impact of strategic commercial contracts. The international commercial business was relatively soft, only growing 4% YoY. Palantir continues to invest in its international commercial business though, specifically highlighting the potential of Japan, Korea, Canada and the Middle East.
Government revenue grew 15% YoY in the second quarter, with international government customers driving growth. International government revenue increased 31% YoY. This strength was attributed to UK Government work.
Figure 4: Palantir Revenue by Customer Segment (source: Created by author using data from Palantir)
The most impressive part of Palantir's business in recent quarters has been the ability of the company to consistently improve its operating profit margins. While much of this is a natural outcome of growth moderating and Palantir's customer base maturing, the company has also made progress in controlling costs.
Figure 5: Palantir Profit Margins (source: Created by author using data from Palantir)
Palantir is focused on controlling general and administrative expenses, driving cloud efficiencies and managing headcount increases. There is likely still significantly more room to reduce the burden of general and administrative expenses, but further reductions in sales and marketing and R&D expenses may be difficult to come by. Particularly if Palantir begins to invest more aggressively to capitalize on the generative AI opportunity.
Figure 6: Palantir Operating Expenses (source: Created by author using data from Palantir)
Given Palantir's ambition to be the most important software company in the world, and the anticipated growth acceleration due to generative AI, it is somewhat surprising that Palantir is not increasing its headcount faster. Hiring data seems to point towards ongoing sluggish growth rather than Palantir approaching an inflection point.
Figure 7: Palantir Job Openings (source: Revealera.com)
Conclusion
Palantir is in something of an unusual position at the moment. The stock has risen significantly on the back of AI hype, despite Palantir's actual performance being fairly sluggish. Palantir is also talking about a desire to be the most important software company in the world and helping accelerate GDP growth. So far there has been nothing to support these enormous ambitions (increased expansion rates, increased customer count growth, etc.), and Palantir does not appear to be increasing investment in anticipation of a growth surge.
While there could just be a lag between developing solutions which leverage the capabilities of LLMs and moving these through the typical sales cycle, Palantir Technologies Inc. will need to begin demonstrating progress in the near future, or the stock price is likely to correct significantly.
Figure 8: Palantir Relative Valuation (source: Created by author using data from Seeking Alpha)
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Palantir: Treading On Thin Ice