After 20 years of Palantir Technologies Inc.’s (NYSE:PLTR) existence, the company has never made a profit. Surprisingly, PLTR announced its first profitable quarter in Q4, which marks a new era for the firm. However, following the spike in the stock price above $10/share, the rally was short-lived as many investors rushed to exit.
PLTR stock has returned nearly 18% since we opened our position in our model portfolio. The improving profitability and dilution outlook reaffirm the strong buy rating for the next 3-4 years, suggesting more upside potential for the stock. However, PLTR is not for everyone due to its high uncertainty, relevant risks, and stock volatility.
Important Distinction TAM Vs. SOM
As previously examined in the company’s S-1 filings, Palantir has a total addressable market (TAM) of $119 billion, but the firm did not update its TAM beyond that figure. According to Slintel, Palantir’s current low market penetration is around 1.78%, suggesting the company has considerably more room for growth.
According to a report from Precedence Research, the global market size for data analytics will continue to grow at an impressive CAGR of 30.41% from 2022-2030 and is expected to hit $346.33 billion in 2030. To that effect, the rapidly increasing demand for data analytics services and solutions worldwide will benefit Palantir’s financial performance over the long term by expanding its TAM.
Although there is some disagreement regarding Palantir’s TAM of $119 billion compared to its serviceable obtainable market (SOM), my best estimate for Palantir’s medium-term SOM ranges between $40-$50 billion, consisting of data visualization, predictive analytics, and fraud analytics. In other words, with $1.9 billion in revenue, Palantir has captured around 4% of the market share.
Revenue Components (Gov Vs. Com)
Palantir has expanded its business beyond government contracts to include more commercial clients. This diversification move maintained the company’s consistent strong revenue growth (24% YoY) for 2022 despite macroeconomic adversities, and it expects a continued revenue expansion in 2023. In addition, Palantir’s revenue continued to experience growth over the long term with the expansion of the primary market due to its enhanced engagement in commercial space. However, its limited focus on non-US markets restricts its ability to expand its customer base and revenue streams.
Specifically, the government segment (Gov) generated 56% of the $1.9 billion revenue in 2022; the rest came from the commercial segment (Com), and the majority of the customers, 61%, were in the US. Favorably, Palantir managed to grow its total customers, however, by 55%, reaching 367 customers by the end of 2022. As a result, the average revenue per customer (ARPC) dropped for a second consecutive year by 20%, down to $5.2 million per customer.
At first glance, the drop signals that customers do not spend more with the firm on average. However, the drop was due to the notable increase in the commercial segment in 2022 by 28%, reaching 260 Com customers. Specifically, new Com customers start with relatively low contracts of around $2-$3 million, which drags down the overall ARPC. Yet, Com’s growth slowed down from a 24% QoQ increase to 14%, but the overall trend is still favorable.
Palantir initially started out getting contracts from the US Department of Defense. Despite the slight YoY 1.8% decrease in the number of Gov customers in 2022, the segment’s ARPC remained the same throughout the year under the current challenging macro environment, proving the expanding ARPC and the Gov segment’s recession-proof nature.
In previous articles, I stressed the importance of the Com segment, which could be the long-term growth driver of Palantir. With 147 Com clients that generated $645 million in 2021, Palantir had a commercial ARPC of $4.39 million, whereas, in 2022, the ARPC dropped to $3.2 million with an $834 million revenue. The decrease was due to sizable customer acquisition with rapid YoY growth of 79% but with smaller contract sizes.
CEO Alex Karp noted that 53% of Palantir’s business deals are over $50 million. Favorably, the firm’s top 20 customers spent $49.4 million in 2022, reporting a 13.3% YoY increase, supported by the Gov segment. Despite the customer base’s resilient-proof attributes, having a large portion of revenues generated from a few large customers leads to less diversity and exposure to downside and volatility. Nevertheless, the increasing number of commercial customers partly mitigates this risk.
Palantir has identified 6000 businesses with yearly revenues of at least $500 million, indicating potential clients with an average contract value of $9.33 million. To that effect, Palantir has achieved a 4.3% customer penetration but has an ARPC potential of nearly 3x. Furthermore, based on Palantir’s “Trojan Horse” business model, many of these new Com customers will likely renew with a higher contract value in the foreseeable future, boosting ARPC levels.
The company’s reliance on long-term government contracts can be subject to political and budgetary changes, resulting in revenue fluctuations. The company has succeeded in the government and defense sectors but has significant potential to expand its commercial segment and maintain its growth. PLTR’s software license and maintenance fees are its primary revenue streams. These revenue streams have been consistent for years and have provided Palantir with a stable revenue base.
Palantir also generates revenue through professional services. The revenue stream has been growing in recent years as the company has expanded its customer base and worked to diversify its revenues. While professional services can be a high-margin revenue stream, there is the risk that they may not be as scalable as software licensing because they rely on the availability of highly skilled professionals. Finally, a smaller revenue segment is the platform hosting and support services, which is relatively new and represents a growing opportunity for Palantir as it expands.
Palantir maintains its growth in the government segment by developing and enhancing solutions tailored to meet the specific needs of government agencies, targeting new government agencies or departments, and developing relationships and partnerships to expand its reach and influence. For example, a £75 million Enterprise Agreement with the UK Ministry of Defense and an extended contract with the US Army Research Lab to deliver AI and ML capabilities provLasegment’s resiliency.
Last but not least, based on the company’s weighted average contract duration, the firm expects an additional 2.8-year contract duration. Specifically, as per note 15, Palantir’s weighted average useful life stood at 4.85 years, and this enhances the predictability element of Palantir’s revenue.
Karp noted on the latest earnings call:
We were profitable for the first time in our company’s history last quarter.
Mr. Market rushed to buy Palantir’s “Profitability” cover story. Palantir reported its first profitable quarter in its 20 years of existence with a $30.9 million positive net income. Some unusual items stand out after digging deeper into the net income breakdown. As per note 14 in the 10-K form, the firm operationally is not profitable yet. Specifically, Palantir has recorded a $44.3 million fair value gain due to the Palantir Japan “step acquisition”. Excluding this item, net income would still be at a loss, but the path to operational profitability has become more evident.
Stock-based compensation (SBC) used to be Palantir’s Achilles heel and a deal breaker for many investors. Last year, Karp explicitly stated that investors could expect normalization in the next 18 to 24 months, as it happened. One of my favorite metrics for Palantir is the SBC-to-Revenue ratio, which has dropped to 30% in 2022 and was the second consecutive annual drop. The decrease was attributable to the inverse movement of 24% YoY revenue growth and the 27% decline in the SBC to $565 million from $779 million in 2021.
Looking forward, to develop a reasonable expectation for SBC’s trend, the Restricted-Stock-Units (RSU) provides the unrecorded SBC element. Specifically, this is the sum of SBC from the current plans, which include Options subject to vesting conditions as the employees fulfill their duties throughout the vesting period.
As of the year-end of 2021, the company had 326.9 million options outstanding with 8.33 remaining contractual life. The options outstanding account for 15.8% of total shares outstanding, slightly better than 2021, at 17.4%. Assuming the options vest and convert evenly in the next eight years, it implies around 39 million shares of annual dilution or 1.8% of the 2022 year-end share count. However, this figure does not take into account new RSU grants.
In last year’s article, we explored why Palantir’s SBC has reached an inflection point. If this inverse relationship persists for another two to three years, Palantir will eventually reach GAAP profitability. Nevertheless, we investors are looking for companies that can add shareholder value; thus, focusing on the revenue growth rate compared to the dilution rate is the key.
Additionally, although Palantir increased its share count by a staggering 97% in 2021, there is light at the end of the tunnel. In 2022, the dilutive effect was minor, with only a slight increase in share count of 7%. On the contrary, the revenue growth rate was much faster, and this gap added value to the firm. In general, investors should closely track this metric as the wider this gap gets, the more shareholder value Palantir offers.
Strategic Partnerships & Collaborations
Palantir has differentiated from competitors and positioned itself for sustained growth in the government and defense sectors over the long term. Palantir is developing and tailoring its products and services in the commercial segment, creating specialized solutions for specific industries or customizing its existing solutions to fit unique needs. In addition, it targets new industries or geographies and develops marketing strategies, strategic partnerships, and collaborations to reach new customers.
For example, Palantir collaborates with WesTrac, a provider of heavy equipment and aftermarket services to Australia’s mining and construction sectors. The partnership will see Palantir’s Foundry platform deployed across WesTrac’s servicing and rebuilding operations centers in Perth. This partnership further expands Palantir’s presence in the Australian industrial sector, complementing its long-standing collaboration with Rio Tinto (RIO).
Palantir has proactively formed strategic partnerships and collaborations with various companies to expand its reach, diversify its operations, and accelerate growth. With its flagship product, Foundry, Palantir is well-positioned to leverage data to drive better decision-making across organizations, making it an attractive partner for companies in various sectors.
Palantir has partnered with Lockheed Martin (LMT) to speed up the delivery of Aegis and future integrated combat system software through Palantir Apollo. The collaboration aims to improve the delivery of software that supports defense systems. Palantir’s Apollo platform will enhance the efficiency and accuracy of software delivery for Aegis and other integrated combat systems. This collaboration highlights Palantir’s ability to use data analysis and software expertise to support the defense industry.
Recent partnerships, such as those with WesTrac, Crisis24, and Tampa General Hospital, demonstrate Palantir’s ability to serve industries such as mining, security, healthcare, and construction. These partnerships will likely accelerate the adoption of Palantir’s products and services and enable the company to expand its market share.
Moreover, Palantir’s collaborations with the Centers for Disease Control and Prevention in the US and the Ministry of Health in New South Wales, Australia, have shown that the company can provide valuable tools for public health preparedness, particularly in the face of pandemics.
Overall, Palantir’s partnerships and collaborations have positioned the company to continue to grow and innovate, with the potential to enter new markets and drive its expansion in existing ones. As a result, it will lead to solid long-term growth in its financial performance and valuations.
How Geopolitical Tensions Affect Palantir
Geopolitical tensions directly affect the competitive landscape for Palantir. Rivals may emerge in response to geopolitical tensions, or existing competitors may become more aggressive, which could lead to increased competition and pricing pressure for Palantir. For example, Palantir works with government agencies, including intelligence and defense agencies. Therefore, any perception that Palantir’s software or services could be compromised by foreign entities could damage the company’s reputation and erode trust with its government clients.
The impact of geopolitical tensions on Palantir’s financial performance and market valuation depends on various factors, including the duration and intensity of the event or conflict. Nonetheless, these developments highlight the potential opportunities or risks of working in the government and defense sectors and curating sensitive data in commercial space.
For example, if the 2023 Chinese spy balloon incident results in increased scrutiny of government contractors, it could impact Palantir’s ability to secure and maintain these contracts. On the other hand, if the US government becomes more cautious about working with companies with foreign ties, it could open up opportunities for companies with a domestic focus, such as Palantir, to win government contracts.
Karp’s Philosophical Views Support The West
Palantir’s commercial segment has significant potential for growth, but geopolitical tensions may cause companies to be cautious about doing business with a company with government ties. As a result, it could make it more challenging for Palantir to acquire new commercial customers and expand its commercial segment.
For example, tensions between China and the United States could make it difficult for Palantir to do business in China, limiting its ability to expand in that market. However, Alex Karp, the CEO, has vehemently expressed his political and philosophical viewpoints of the world, strongly supporting the West, making it highly unlikely to conduct business with West opponents. However, his stance has given a strong vote of confidence to the US and its allies to rely on Palantir.
Palantir has contracts with various government agencies, including the US Department of Defense and the Central Intelligence Agency. Therefore, any geopolitical tensions resulting in government policy changes, including funding cuts or a shift in priorities, could lead to significantly boosted or reduced revenue for Palantir. For example, NATO has increased its military budget by 25% YoY to $2.1 billion, and with more countries joining NATO, i.e., Sweden and Finland, the need for data analytics will remain elevated in the coming years, supporting Palantir’s growth outlook.
Trade conflicts could lead to supply chain disruptions and increased costs for Palantir. For example, if the company sources components or software from Chinese suppliers, it may be subject to tariffs or other trade-related costs. On the other hand, the Russia-Ukraine war provides ground for Palantir to acquire new domestic customers, particularly in the defense sector. Still, it could make it more challenging for Palantir to expand globally, particularly in regions affected by the conflict.
Additional Risks To Consider
The revised growth guidance of 16% revenue growth is nearly half last year’s 30% annual growth. Favorably, the Gov segment has shown its resiliency and recession-proof nature throughout 2021, so we shouldn’t expect much volatility considering the geopolitical tensions that favor Palantir. On the other hand, even though the Com segment has meaningfully expanded and remains a growth catalyst for PLTR, the macro uncertainty might decelerate its growth in the short run.
Criticism for Palantir’s collaboration with government agencies, particularly in surveillance and immigration enforcement, poses a significant risk to the stock’s price growth. Any public disclosure that Palantir’s software has been used to violate privacy rights and target vulnerable populations, such as immigrants and refugees, can severely affect its stock price.
Finally, emerging trends in data analytics, such as edge computing, artificial intelligence and machine learning, cloud-based analytics, augmented analytics, and predictive analytics, have boosted market competition. As a result, it could pressure Palantir to lower prices and invest more aggressively in research and development.
Although Palantir has established itself as a significant player in the data analytics market, its business outlook is subject to several risks and uncertainties. Nevertheless, the improving profitability and dilution prospects will strongly support PLTR’s market valuation over the long term.