2023-12-14 09:32:07 ET
Summary
- Palantir's AIP takes center stage as companies "scramble" to find AI-powered platforms.
- Nearly 300 organizations have already used AIP - that's an attach rate of about 90%.
- Management is seeing the acceleration of larger deals and shorter times to conversion.
- Palantir still trades at a premium - but that's the price you pay for quality.
- What better way to ride the AI wave than to bet on the best surfer in town?
Introduction
Palantir (PLTR) is building the foundational software of tomorrow that serves as the central operating system for enterprises. At its core, Palantir's flagship platforms - Gotham, Foundry, and Apollo - integrate and optimize data, decisions, and operations at scale.
A few months ago, Palantir launched its Artificial Intelligence Platform ((AIP)). In short, AIP connects large language models and other AI with clients' data and operations, ultimately driving AI-powered decision-making.
More notably, AIP has taken center stage as the new platform reaccelerated Palantir's overall business amidst an AI-hyped world.
As AI grows increasingly important, Palantir will be the main beneficiary of this megatrend as the company has built itself one of the most powerful software stacks in the business, adored by hundreds of the most important organizations in society.
While Palantir stock may look expensive, the company's differentiated AI offering, strong outlook, and improving financials set the stock well for a banner 2024.
Palantir Revenue Growth
In Q3, Revenue was $558M, up by 17% YoY, beating analyst estimates by $2M and management's guidance by $3M. As you can see, growth reaccelerated after a disappointing second quarter, which saw the business growing only 13%. Many investors were concerned with the slowdown but Palantir's exceptional performance in Q3 reignited hopes of the company returning to strong growth.
Excluding the negative impact from strategic commercial contracts - or Palantir's failed SPAC investments - Q3 Revenue would have grown 21% YoY.
Even more impressive, Revenue Per Employee almost doubled in four years, from $299K to $558K, demonstrating the success of its acquire-expand-scale strategy.
Breaking it down by segment, Government Revenue was the clear laggard, up just 12% YoY to $308M.
- US Government Revenue was $229M, up only 10% YoY. Despite the weak performance, management expects US Government Revenue to accelerate moving forward as there was a "pickup in activity at the end of the U.S. government fiscal year".
- International Government Revenue fared better, increasing 20% YoY to $78M.
On the other hand, the Commercial segment rebounded in Q3, growing 23% YoY to $251M. As you can see, growth accelerated by 1,300 basis points sequentially.
- US Commercial Revenue drove the majority of growth, which increased 33% YoY to $116M. Excluding strategic commercial contracts, it would have grown 52% YoY. This was primarily due to the recent launch of Palantir's latest offering, AIP. It's important to note that AIP was only launched in April this year, so the impact it already had in just a few months shows how good Palantir's AIP offering is - imagine how big it can get over the next few years...
- International Commercial Revenue was $135M, up by 16% YoY.
The most impressive thing coming out of Palantir's Q3 earnings report was its customer count, which grew 34% YoY to 453 Total Customers.
Its Commercial segment continued to see exceptional growth, which grew 45% YoY to 330 Commercial Customers, again, due to increased demand for AIP.
Management also mentioned that nearly 300 companies have used AIP. To put that into perspective, that is an attach rate of ~90%, which is incredible.
The potential market for AIP and the trajectory of possible AIP growth for our business is massive. We almost tripled the number of AIP users last quarter and nearly 300 distinct organizations have used AIP since our launch just five months ago.
(CRO Ryan Taylor - Palantir FY2023 Q3 Earnings Call )
As Palantir "acquires" more customers, robust Revenue growth should follow as customers "expand" and "scale" their use of Palantir's platforms.
That is what we're seeing, with Revenue Per Top 20 Customer growing 13% YoY to $54M per customer, another record high for the metric.
In my opinion, customer growth is the single most important metric to track as it is a leading indicator of future Revenue growth. And fortunately, Palantir continues to see strong customer adds, which is also a reflection of Palantir's superior offering.
I expect Palantir to continue to acquire more customers down the road, given the strong demand for AIP. In addition, Palantir's recognition as the #1 ranked vendor in AI, Data Science, and Machine Learning reinforces its competitive positioning in a highly competitive industry.
Profitability
Palantir produced record Gross Profit in Q3, which was $450M, up 22% YoY. This represents a Gross Margin of 81%, a 400 basis points improvement YoY, and a record high as well.
As you can see, Gross Margin has been improving over the last few quarters, demonstrating economies of scale within the business.
Q3 Operating Income was $40M, representing a 7% Operating Margin. This marks Palantir's third consecutive quarter of GAAP operating profitability. Of important note, Operating Margin expanded by 2,000 basis points YoY, showing strong operating leverage.
This trend should continue as both Palantir and its customers scale further.
Another reason why Operating Margin should improve moving forward is that Share-based Compensation continues to fall over time. As of Q3, SBC as a percentage of Revenue was 20%, down 900 basis points YoY and 100 basis points sequentially.
Yes, SBC is still high at 20%, which is why Shares Outstanding is up almost 4% YoY. However, dilution should be less of an issue with each passing quarter as the company continues to focus on growing profitability and moderating SBC expenses.
Palantir's bottom line is getting better as well, posting its fourth consecutive quarter of GAAP Net Income profitability. In Q3, GAAP Net Income was $72M, which is a 13% Net Margin.
As you can tell, each of Palantir's profitability lines is at record highs with no signs of breaking their trends.
Without a doubt, Palantir is at an inflection point. It is no longer regarded as a loss-making growth company - it is now a highly profitable growth company capable of delivering strong, durable earnings for years to come.
Health
Palantir has a pristine balance sheet with $3.3B of Cash and Short-term Investments and $0.2B of Total Debt (mostly in the form of Operating Lease Liabilities), which puts its Net Cash position at $3.1B.
As you can see, Palantir's Net Cash balance has been increasing over the last few quarters, which is great to see.
Q3 Free Cash Flow was $132M, which is a 24% FCF Margin. Not much to talk about here but Palantir has always displayed strong FCF generation. Moving forward, I wouldn't be surprised if Palantir sustains a long-term FCF Margin of more than 30%.
With such a healthy Net Cash and FCF profile, management announced a $1B buyback program in Q2.
In my previous article , I expressed my confusion with the buyback program given that it was announced after the stock had rallied more than 100%. I like buybacks, but only when the stock is attractively valued, not after it has doubled.
Fortunately as of Q3, Palantir has yet to repurchase shares. Given that the stock is up more than 150% year-to-date, I would prefer the company keep its cash for a rainy day or invest it for growth. Only when we see a selloff would I be content with the company buying back shares.
Outlook
Management expects Q4 Revenue of $601M at its midpoint guidance, which beat analyst estimates by $2M. This implies an 18% increase YoY, which reflects continued acceleration from Q3's growth of 17%.
Q4 Adjusted Operating Income is expected to be $186M at its midpoint, implying an Adjusted Operating Margin of about 31% based on a Revenue of $601M. This is a 200 basis point increase QoQ and a 900 basis point increase YoY. In other words, profitability is set to improve even more.
Management also raised their FY2023 Revenue guidance by $6M, to $2.218B, suggesting a 16% YoY growth.
In addition, management raised their FY2023 Adjusted Operating Income guidance by $33M, to $609M - when management raises its bottom line more than its top line, it's a clear indication of strong operating leverage.
I expect this improvement in profitability to continue in 2024, aided by a robust deal pipeline. In Q3, Palantir closed the most number of deals of at least $1M in a single quarter.
- 80 deals of at least $1M , across 30 industries
- 29 deals of at least $5M , across 16 industries
- 12 deals of at least $10M , across 11 industries
Interestingly, management added the number of industries they closed, highlighting Palantir's broad use case and ability to attract a diverse set of customers.
In addition, Total Contract Value is up 29% QoQ to $830M. Moreover, US Commercial deal count is up 2.4x YoY and US Commercial TCV is up 55% YoY to $252M.
The most exciting thing is that management is "seeing the acceleration of larger deals and shorter times to conversion and expansion", due to AIP's strong traction and Palantir's renewed go-to-market strategy (i.e. the AIP Bootcamps).
That is great news as future deals will likely be reflected in Palantir's income statement sooner rather than later.
Palantir FY2023 Q3 Investor Presentation
Not only that but the AI market is expected to explode in the next few years, from $96B in 2021 to $1.8T by 2030. With Palantir's best-in-class software, the company is well-positioned to capture a good chunk of this massive emerging market in my view.
Given Palantir's return to strong growth, improved profitability, robust deal pipeline, effective new marketing strategy, and the ever-growing AI market, it looks like Palantir is set for a banner year in 2024.
PLTR Stock Valuation
Palantir is not exactly the cheapest stock out there. As a matter of fact, it's quite expensive, especially after its 180% rally this year.
As such, it won't be surprising to see the stock pull back slightly or trade sideways for a while, before ascending further.
After all, the stock trades at a Forward EV to Revenue multiple and Forward PE Ratio of 13x and 61x, respectively. While multiples have fallen from their peaks, Palantir is still not cheap by any means.
Perhaps, that's the premium you pay for a company with deep moats and improving fundamentals, buoyed by strong secular trends.
I've updated my DCF model as well. Here are my key assumptions for my base case.
For Revenue growth, I follow analyst estimates for the first three years. For the remaining years, I assume growth will eventually moderate to 18% and then 15%. By 2032, I expect Revenue to expand to $9.6B.
Palantir should continue to gain operating leverage over the next decade, ultimately reaching a FCF Margin of 35%. For reference, Microsoft ( MSFT ) has a FCF Margin of 36%. Given that Palantir is a pure software business, I think my FCF Margin assumption for Palantir is quite conservative.
Based on a discount rate of 10% and a perpetual growth rate of 3%, I arrive at a fair value estimate of $15.20 for Palantir stock which is roughly a 15% downside from the current price of $17.87.
Here's a summary of my DCF model with bear and bull cases.
Bear | Base | Bull | |
FY2032 Revenue | $8.8B | $9.6B | $10.9B |
FY2032 FCF Margin | 31% | 35% | 38% |
Perpetual Growth Rate | 2% | 3% | 4% |
Discount Rate | 10% | 10% | 10% |
Fair Value | $11.79 | $15.20 | $19.81 |
Yes, by looking at the results of my DCF model, Palantir looks overvalued.
That's why I trimmed my position a few months ago.
At the same time, I also acknowledged that there might be further upside given the shift in sentiment and the strong momentum of the business. What's more, Palantir could be added to the S&P 500 anytime now, which could be a major catalyst for the stock.
That's why I continue to hold a modest position in Palantir stock.
In other news, insider selling continues to be a major bear argument against Palantir. In the last three months, some notable sellers include:
- Co-founder Peter Thiel sold $48M
- Co-founder Stephen Cohen sold $13M
- CFO David Glazer sold $4M
On the bright side, institutional ownership is at a record high as 'smart money' piles into the AI revolution - and what better way to ride the AI wave than to bet on the best surfer in town: Palantir.
Risks
Dilution
It's hard to ignore the fact that Palantir's SBC remains high at 20%, which inevitably leads to shareholder dilution. If high SBC expenses persist, the upside potential for Palantir stock might be limited.
Growth Slowdown
The million-dollar question is: can Palantir sustain high double-digit growth - perhaps in the high teens to 20s - and justify its premium valuation?
If Palantir misses expectations or if growth slows down substantially, Palantir investors could be in for a rude awakening.
Thesis
Q3 was a mic-drop quarter for Palantir with a triple beat on analyst estimates. In addition, management left some positive remarks on the outlook of the business, particularly with the overwhelming demand for AIP.
As CEO Alex Karp mentioned in his letter to shareholders , companies are "scrambling" left and right in search of a platform that could leverage the power of AI - enter Palantir's AIP.
The newly launched platform should drive strong customer growth - both new and existing - and that should translate to rapid Revenue growth for years to come.
What's more, Palantir still has a long growth runway ahead as AI is still in its early innings.
Complementing its growth ambitions, Palantir's profitability continues to improve, eliminating its status as a loss-making growth company - for good.
While Palantir stock is already up substantially in 2023, there are reasons to believe that there's more upside for the stock, including:
- growth reaccelerating
- margins improving
- robust deal pipeline
- refined go-to-market strategy
- S&P 500 inclusion
That said, it seems like Palantir is primed for a banner year in 2024.
For further details see:
Palantir: Primed For A Banner 2024