2024-01-18 06:30:07 ET
Summary
- Palantir demonstrated improved traction amongst commercial customers in the third quarter, particularly in the US.
- Palantir's revenue growth is likely to continue accelerating, but it may not be sufficient to justify the company's current valuation.
- Overvaluation may not matter as Palantir's stock is more likely to be driven by AI hype and sentiment than company fundamentals.
Palantir's ( PLTR ) stock price has been fairly range bound over the past 7 months, despite increased adoption of AIP and growing evidence of traction amongst commercial customers. This is not surprising though as Palantir's stock moved well ahead of the company's fundamentals. Based on recent deals and management commentary, I expect revenue growth to continue accelerating, although this may not be sufficient to justify Palantir's current valuation. Regardless, the stock is more likely to be driven by AI hype and sentiment towards growth stock than company fundamentals.
Consulting or Software
There continues to be debate about the service heavy nature of Palantir's business and whether it is truly a software company. This is probably more pertinent now than ever given hype around AI. I have previously discussed this, suggesting that it doesn't really matter if Palantir's software requires a large amount of labor to implement and manage. In many ways it could actually be an advantage, as switching costs are likely to be extremely high once an organization adopts Palantir's software.
I do believe that AI hype is misplaced though, and that referring to Palantir as an AI company doesn't really do it justice. Palantir doesn't appear to have any technology lead in AI and even if it did, AI may not provide a sustainable advantage. It does has an expanding portfolio of solutions though, across diverse areas like process mining, augmented reality and software delivery. Palantir is a data platform that provides customers with actionable insights. AI should increase the value of this platform, but I don't believe it fundamentally changes the business or its prospects.
Palantir Government Web Services
Palantir launched Palantir Government Web Services in September 2023 . GWS helps emerging companies operationalize their software and gain access to government customers, with FedStart and Apollo being Palantir's first two offerings. FedStart provides accreditation as a service, reducing the time and cost required to access IL-5 markets. Apollo is an autonomous software delivery platform that reduces the complexity of delivering modern software.
These products leverage Palantir's capabilities to introduce a new revenue stream, although I wouldn't expect GWS to be a meaningful revenue contributor in the near term.
AIP
AIP enables organizations to use LLMs in a secure manner so that they can extract value from data and orchestrate tools, actions and other AI models. There are a range of companies trying to offer customers similar functionality though, and there doesn't appear to be much differentiating competing solutions. Palantir appears to recognize this, stating that value is likely to accrue at the application and workflow layer, with vendors that can address skills shortages likely to do particularly well. It is Palantir's ability to embed AI into its data platform to provide insights and enhance productivity that is likely to create value rather than the AI itself.
Palantir is positioning its ontology as a source of competitive advantage, believing that it enables LLMs to deliver reliable answers. The extent to which this is true remains to be seen, but it would address one of the biggest current issues with LLMs.
AIP is already being used by nearly 300 organizations , which is close to two thirds of Palantir’s customer base, with user numbers almost tripling in the third quarter.
Palantir shifted its go-to-market focus to AIP boot camps in the third quarter, which is reducing the time required to get customers up and running. Palantir has stated that boot camps are improving unit economics, accelerating customer negotiations and driving contract expansions. The impact of this on Palantir's financials is unclear at the moment though. Palantir's US commercial customer count is certainly up sharply, which is driving a growth reacceleration. The company's dollar based net retention rate remains relatively low though.
Mixed Reality
Palantir recently expanded its offerings with a mixed reality service and Immersive Command and Control application built on the mixed reality platform. The mixed reality service leverages Unity's ( U ) 3D game engine, making it compatible with a broad range of devices. While this is likely to be a fairly niche solution, it could help to present data in a more intuitive manner for some use cases. The Immersive Command and Control application offers native integration with major army programs.
Industrial interest in Unity’s platform and digital twins was robust in 2022 but has taken a hit in 2023. Unity reported over 100% growth in digital twins in 2022, with management stating that demand was exceeding their ability to supply. Unity recently turned to partners to begin providing professional services to make its digital twin business more scalable, one of which was Booz Allen. This suggests that there is demand for real-time 3D experiences in government, defense and national security.
Financial Analysis
Palantir's revenue was up 17% YoY to 558 million USD in the third quarter. Excluding the impact of strategic commercial contracts, third quarter revenue increased 21% YoY. Third quarter commercial revenue grew 23% YoY, compared to 12% YoY government revenue growth.
Commercial growth was driven by US customers and in particular, new customers. The international commercial business continues to expand but conditions are challenging in continental Europe.
US government was an area of weakness in the third quarter, but Palantir expects growth to reaccelerate despite the uncertain near-term budgetary environment.
Fourth quarter revenue is expected to be 599-603 million USD , representing roughly 18% growth YoY.
While Palantir's revenue growth has only accelerated modestly so far, things look more positive from a deal perspective. TCV booked in the third quarter was 830 million USD, up 29% sequentially . Deal count for the US commercial business in the third quarter was up 140% YoY. Palantir has suggested that it is seeing an acceleration of larger deals and shorter times to conversion and expansion.
Palantir's customer count increased 34% YoY in Q3, with growth increasingly being driven by commercial customers.
Net dollar retention was only 107%, which Palantir attributed to weakness in its commercial business in continental Europe. Expansion within Palantir's largest customers continues to be robust though, with revenue ((TTM)) per customer from the company's top 20 customers increasing 13% YoY.
Palantir is now consistently profitable on a GAAP basis and generating solid free cash flows. Margins also continue to improve with scale in a predictable manner. While I believe Palantir will become highly profitable in time, the company's heavy use of SBC is a negative. This is likely to normalize over time and become less of an issue, but investors who are bullish on the stock need to keep in mind that a dramatic increase in share price would make SBC far more costly than the income statement shows.
While there are a number of indicators suggesting that Palantir's growth is accelerating, job opening data doesn't point towards a growth surge. The most generous interpretation of this is that bootcamps and AIP are making Palantir's business more scalable. A more cautious interpretation is that Palantir is still not confident in the sustainability of the recent uptick in growth. Palantir may also still be growing into its headcount from rapid hiring in 2021 and 2022.
Conclusion
Ignoring the AI hype, I think there are actually aspects of Palantir's business to like. The company should become highly profitable as it matures, and its products are likely to have extremely high switching costs. Palantir also has a track record of landing extremely large deals with governments and large organizations, which not every company can do. As a result, I believe the stock should perform reasonably well over the long run, even if the valuation is currently stretched.
For further details see:
Palantir: Commercial Traction Is Raising Expectations