Palantir Technologies Inc. (PLTR) Analysis – Monthly Patron Pick

Company Profile

If you browse any investing subreddits or we’re on the internet in 2020, PLTR probably came across your screen. 

What does the company do exactly?

Palantir Technologies Inc. builds and deploys software platforms for the intelligence community in the United States to assist in counterterrorism investigations and operations.

Palantir Gotham, a software platform for government operatives in the defense and intelligence sectors, which enables users to identify patterns hidden deep within datasets, ranging from signals intelligence sources to reports from confidential informants, as well as facilitates the handoff between analysts and operational users, helping operators plan and execute real-world responses to threats that have been identified within the platform. 

Translation: They are in on that sweet defense spending from the US government.

But investors are also excited about their commercial side of the business as well because that can be grown without the upside cap of the government only contracting out X amount of dollars.

It also offers Palantir Foundry, a platform that transforms the ways organizations operate by creating a central operating system for their data; and allows individual users to integrate and analyze the data they need in one place.

I’m starting to get horrible flashbacks to Alteryx (AYX) as I think about data analytics (another pick that had multiples based on high growth that ended up falling after multiple earnings where guidance disappointed). Nonetheless, data analytics is still exciting, it’s just hard for me to determine which of these companies truly has the best tech without using the software myself. 

It seems like while Alteryx pitched themselves as a way for anyone to become a data scientist within an organization with their tools, Palantir seems to focus more on pure engineering and computing capabilities across their offerings.

That’s a lot of different sectors that they cover!

I also found it interesting that the cofounder of the company is Peter Thiel (who seems to always be involved in solid companies or investments as he also cofounded PayPal and was an early investor in Facebook). The guy seems to have the golden touch!

Stock Profile

The stock was a direct listing at $10/share and for a few months didn’t really do much and trading down all the way to the $9 range. 

Then seemingly out of nowhere the stock decided to attach rocket boosters to itself as it exploded for the ending months of 2020 and peaking out in January of 2021 at around $45. Since then it has essentially trended down similar to a lot of hot growth stocks of 2020.

I remember the euphoria around this stock quite well as it was around thanksgiving of 2020 where it just kept going up each day without any news and people over at wallstreetbets we’re printing money with call options (it was like a money machine feedback loop). Of course if you started buying calls early this year it’s a different story and you have most likely lost everything.

I had actually nibbled on to some shares at around $27 in February ($165 worth 🙂), but looking back it was definitely a bit of fomo as I didn’t buy into a full position thinking there was still some premium built into the stock and I was treating it more of a speculative bet at the time. 

I went ahead and sold the position for a $4 loss as I wanted to lessen the amount of positions in the portfolio, but would revisit the name if the price was right.

I would put this stock in the category of large cap growth (because while it was trading like a small cap for a while, the company does trade at a $42 billion market cap already).

Macro Environment

So is this company an AI company? A data analytics company? A cybersecurity company? It’s honestly hard to pinpoint them to one specific thing, but the overarching connection between everything they offer is data analytics, so we can take a look at that as the basis for their macro total addressable market.

Looking at the global market size of data analytics alone, the addressable market is growing at a decent pace of around 25%.

I mean what’s kind of nice is we don’t even really need this information to see how their revenue growth could shape up as the company has already given long term revenue guidance of around 30% through end of 2024 which would put them around a FY revenue of around $4 billion.

Financials

The name of the game for this company is clearly growth. It’s throughout their investor relations Q3 earnings report. Just looks at some of the charts below.

They are growing their commercial side at 37% and government revenues at 34% (both impressive growth rates). 

When it comes to converting that revenue into profits, though the company is still generating a loss from an accounting standpoint. 

Now here is a red flag that I honestly didn’t notice with the company at the beginning of the year. Throughout the financials they focus on this adjusted number and the red flag is in this stock based compensation.

See how the shares outstanding went from 905,462,000 to 1,964,395,000 in a year. That means the shares had increased at a pace of 116% in a year. Of course this is could be a result of the direct listing and that % increase isn’t expected each year. Unfortunately, I can’t find anywhere saying at what pace this is expected to continue. Based on Q2 to Q3 the rate of growth was more around 3.6% which would be around 15% compounded annually (and Q1 to Q2 was around 4%).

That means that even if the company is growing, shareholders are indirectly being hurt by this dilution. But Palantir throughout the report talks about the adjusted numbers backing out the SBC as if it was a one off. 

You see that for Q3, the stock based compensation is around $184 million. If you strip that out then the company has operating margin of 30% and adjusted FCF margin of 30%. Which sounds great, but if they are constantly using SBC to entice employees to stay, then is it really a one off?

See if they paid their employees higher in salary and got rid of SBC, then that turns into a “real expense” and all of a sudden you can’t adjust it out of the negative earnings and it’s not as easy to brush off analysts who ask questions around profitability.

I get it, the SBC attracts talent and retains employees at a company that is fighting for talent. But in a way, this SBC is devaluing the value of the stock even if the company is growing and ends up successful. It just seems like a way for the company to shift value from the shareholders to employees and management (if the shareholder’s don’t get pissed off and put a stop to it). Then again, if they stopped SBC, do they lose their talent pool to other firms that offer better compensation packages? That may be part of the worry of management and why they will continue to dilute in hopes that their growth outpaces the negative effects of SBC.

Plus the company talks about the fact that it is generating free cash flow after stripping out the SBC, but the company already has a stockpile of cash. I would honestly rather have the company pay more in salary and have negative cashflows and concentrate on scaling to profitability (from an accounting standpoint).

Overall, the financials seem fine, but the company loves SBC.

Guidance

I got to give it to PLTR for providing expectations on growth till 2025. I don’t often see that from companies and would love to see that be common place.

Price Target/Valuation

The stock currently trades at a P/S ratio of around 28 which seems high, but then again the market has given a lot of these high growth stocks a higher multiple in 2020 and 2021.

Just look at some other companies expecting to grow 30%+ CAGR revenue over the next 5 years with similar gross margins.

My rule of thumb is usually to apply a 20-40% multiplier against this 5 year growth and compare that to the P/S ratio. With a 30% CAGR rate that would be a P/S ratio of 12 on the high end which is way different than what it is currently trading at. The stock also hasn’t been trading long enough publicly to know what a typical P/S ratio would be for the company.

If I look at Finbox which provides a benchmark of companies that have more data and have traded publicly for a longer period it gives a P/S ratio of more around 20.

This part is more subjective as some may argue that we are in a new paradigm where these growth companies trade at higher multiples, but I am more on the cautious side and if there is a multiples contraction then the company can outperform and you can end up losing as an investor. So I think the company should probably trade at a P/S closer to 20 to be on the safer side which would bring the price to $14.60 for fair value based on TTM of $1.43 billion.

Now if your thoughts are that the company can maintain this P/S ratio based on that it is lower than some similar peers with even higher multiples, then the stock could potentially grow at 30% per year if everything held constant. But we have to remember that as the company get’s bigger in 2024 their 5 year growth may not still be 30%+ of growth and therefore may not command a higher P/S multiple (just food for thought).

Risks & Ops

There is a couple risks for this company. Stock based compensation is one of the bigger ones.

So right now if we annualize the dilution of shares to end of 2024 by 15% each year it would be around 3.1 billion shares. If the stock was trading at a P/S ratio of 25 and had sales of $4 billion as projected then we are talking about a $100 billion valuation. But since there is an increase in shares that would put the price at $32.25. It ends up worse if the P/S ratio shrinks even more. That would be a 15% annualized return. Which to be fair is higher than the historical average, but you are taking on more risk with PLTR and it’s volatility. Let’s say they don’t dilute, then you are talking about $51 and a 34% annualized return (much better). See how big of an impact that can have!

That is the deceptive piece on share dilution. Of course this is speculation as I don’t know if they will keep up the SBC at the current pace.

The second would be concentration risk. They currently have a smaller amount of clients and also rely on the government for a majority of their revenue still. For whatever the reason may be, if they lose contracts on the larger side it can negatively impact the company.

For opportunities, I think the company has shown it’s ability to continue to innovate. With that innovative ability, the company can unlock revenue and growth in places I don’t have insight into until it is public knowledge. Innovation I think is a key component for finding special companies that can be potential long term big winners. They need this innovation and the ability to scale faster than what is already expected of them.

Conclusion

Although the company is in an exciting space and is shown that it is growing at crazy speeds. The fact that the multiples are already higher for this company show that some of the explosive growth is already factored in.

This means if they ever forecast any guidance that shows any sort of slow down it can cause the stock to get hit and even if they continue to forecast this solid growth it would cause the stock to automatically go higher because that is what is already expected. So in order to outperform the company has to overdeliver on their growth expectations.

The other big reason I don’t love the stock is because of this stock based compensation risk. Although the underlying company may grow and with that the market cap, if the shareholders are getting heavily diluted along the way, the stock could actually underperform with the company itself is achieving solid growth (the value going to employees and management instead of shareholders).

For those reasons I am out unless this comes down to multiples closer to 20 or the SBC decelerates to a more reasonable level or stops all together.