Palantir: Profit Booking

Summary

Palantir has experienced significant growth, with a return of around 114% since the portfolio doubled down on the company, but the stock now trades around its fair value.
The AI hype, driven by companies like Nvidia, has lifted the market's valuations of AI stocks contributing to PLTR's outperformance.
Palantir has ambitious plans to release its AIP, emphasizing its potential in commercial and military applications.
The Fed's monetary policy, particularly regarding interest rates, could affect the value of the AI sector, making it vital for investors to monitor the following actions.

Artificial Intelligence. Concept

Investment Thesis

Since I doubled down on Palantir Technologies Inc. (NYSE:PLTR) in November for the personal and Yiazou model portfolios, PLTR has skyrocketed to new 52-week highs, returning around 114%. Following the AI hype, Nvidia has lifted the market, and despite Palantir being one of my top picks, I trimmed my position to book profits, leading to a hold rating for the foreseeable future.

Palantir, PLTR, Foundry platform, Gotham platform, Denver-based company, public offering, commercial clients, government clients, earnings report, stock performance, growth potential, sales multiple, hypergrowth investing, AIP, AI, AI Hype, Nvidia

Yiazou Model Portfolio (2nd June)

AI Frenzy & AIP

The Federal Reserve's monetary policy is one crucial issue that might impact how much the AI sector is worth. A change in Fed's policy, such as pausing rate hikes and then restarting them, could cause the AI bubble to pop. Similar events occurred during the dot-com era when the Fed resumed tightening policy in 1999, ultimately causing the dot-com bubble to implode. As a result, investors must pay attention to the Fed's actions and how they affect interest rates since they may have an impact on investor sentiment and valuations in the AI sector.

PLTR surged after the result release as the market welcomed the company's ambitious plan to announce the release of its Artificial Intelligence Platform (AIP). However, while Palantir's AI ambitions are clear, its path to achieving the outlined goals remains to be seen.

The company intends to roll out its AIP to select customers soon, emphasizing its potential in both commercial and military applications. Palantir, known for its expertise in handling sensitive data, aims to establish itself as a leader in AI tools that require human oversight. However, concerns remain regarding introducing such technology in military contexts and the potential arms race it may trigger. Nevertheless, as per the CEO, the development of superior AI capabilities can deter adversaries.

Al/ML Platforms Q3 2022 Report (Palantir's Business Update 23Q1)

Palantir released a video demo with the AIP offering; when a military observer in charge of the Eastern European theater noticed enemy forces gathering close to the border, he or she asked a ChatGPT-style digital assistant for assistance in deploying reconnaissance drones, coming up with tactical countermeasures for the perceived aggression, and even planning the communication jamming of the enemy. Finally, using AIP, the operator generated three potential courses of action to defend against the enemy's threat.

Palantir is also not trying to market a large language model (LLM) or AI tailored specifically for the military in this context; rather, it is offering to integrate current systems into a controlled environment. Instead, it incorporates software that supports a variety of open-source LLMs, including Dolly-v2-12b, GPT-NeoX-20B with tweaks, and FLAN-T5 XL, in addition to many bespoke plug-ins.

Palantir

Exploring New Products That Can Spur Growth

There are several new and developing products that will gradually contribute to Palantir's growth over time. While Palantir has reached a scale level, it is challenging to identify a particular technology that will significantly impact growth in the short term. Nevertheless, it is an intelligent move for Palantir to market Apollo as a separate platform.

Apollo is a platform for continuous delivery and product infrastructure that helps deploy and maintain Foundry and Gotham. Recently, the company launched Apollo as a standalone solution and expects it to generate billions of dollars in revenue. While Apollo is a crucial component of PLTR's value proposition, it is most notable for military applications, allowing deployment across submarines, satellites, and other areas. As a result, the potential market size for Apollo as a standalone product is still uncertain at this stage.

Nexus Peering, which enables secure data sharing between different types of networks, and MetaConstellation, a software for managing AI-based satellite meshes, are two new products not publicly discussed due to their confidential nature. However, they could contribute to the company's growth in the future.

Palantir is concentrating on expanding its commercial business by increasing its presence in new verticals by establishing industry-wide platforms that can be utilized by multiple operators, as seen with Skywise in the airline industry. Nevertheless, the software is deemed more unique and valuable to government entities, and this is where they anticipate the most growth, especially in the near term.

Last but not least, Palantir formed a partnership with Cloudflare, which aims to reduce the costs of using multiple cloud services for businesses. Foundry will be used to optimize cloud costs, while Apollo will help deliver software cost-effectively. Finally, Cloudflare's development platform will also be utilized to provide scalability.

Challenges & Potential In An Evolving Market

The main factor in Palantir's triumph in becoming GAAP Profitable operationally in Q1 was the reduced stock-based compensation (SBC) paired with sustained revenue growth. As a result, the SBC-to-Revenue ratio, one of my favorite Palantir indicators, fell to 30% in 2022 and to 25% in 23Q1, highlighting a YoY drop of 22%. Even though Palantir has become GAAP profitable, SBC still poses a financial risk to investors, which is heading in the right direction.

Palantir faces challenges due to customer concentration and a decline in remaining performance obligations (RPO), indicating limited revenue visibility as IT spending slows down. RPO refers to the value of the contracts or agreements a company has entered into with its customers but has not yet fulfilled. In simpler terms, RPO indicates the company's future revenue and helps investors understand the company's backlog of work and revenue visibility. Specifically, RPOs dropped by 20% YoY but only 3.8% QoQ, a sign of the government's limited pipeline visibility and lumpy nature.

Palantir's Business Update 23Q1

The net retention rate dropped in the first quarter, primarily driven by smaller revenue customers in the Commercial segment compared to the Government segment. Similarly, international sales growth has also slowed, leading to a reduction in the salesforce expansion while improving profitability. As a result, while the company sees potential in leveraging LLMs for its US Commercial segment, it is unlikely to drive immediate sales. It may serve as a medium- to long-term sales driver.

A positive point was the performance of the government segment, which showed 20% growth and operating leverage following expense cuts. Though the company reaffirmed full-year top-line expectations of about mid-teens growth, that could slow in 2Q, but pick up in 2H, reflecting uncertainty related to order closings. Next, Palantir's lack of a recurring cloud-based subscription model remains a drag on predictability in the business and limits visibility around management's expectations of an acceleration in its top-line growth for 2H.

Concentrating on government customers and a handful of commercial accounts creates more risk of a longer sales cycle than software peers. Given the company's longer-duration contracts for its Government business, growth in the US may outpace international in the near term. Nevertheless, amidst geopolitical uncertainty and recession fears, Palantir boosted its customer count to 280 for the government segment, a 7.7% QoQ increase, and to 111 for the commercial segment, a 3.7% increase.

Yiazou Capital Research

Growth Of International Business Remains Slow

Expanding its business internationally is crucial to the company's growth strategy, as it would increase revenue and diversify its customer base. However, international sales have consistently underperformed domestic sales in recent years. The company attributes this underperformance to macroeconomic conditions, a strong US dollar, and resistance to enterprise software systems that challenge established habits and modes of operation in some countries.

Given these factors, I expect Palantir's international business to continue underperforming in the short term, but recent growth in commercial customers outside the US could lead to reaccelerated international growth in the long term. However, to achieve this growth, PLTR may need to overcome resistance to new software systems in certain countries, particularly in continental Europe.

Palantir's Deepening Ties With Governments

Palantir's Gotham platform has gained strategic importance in the US Government due to its usage in various military and non-military applications such as pandemic response. Nonetheless, government contracts are usually unpredictable, adding volatility in results, but let's briefly revisit Palantir's major milestones, which highlight the growing relationship with the US Government.

In 2018, the company won a legal battle against the US Army that requires the government to consider third-party software like Palantir before attempting to develop in-house solutions, as mandated by the Federal Acquisition Streamlining Act of 1994. This ruling has implications for all US government procurement. This court decision has paved the way for the company to become a significant partner for the US government, and I expect this relationship to continue driving growth as more government agencies become Palantir's customers.

As a result, Palantir aims to become the sixth prime contractor and the first prime software contractor for the US government. As stated by Forecast International, Northrop Grumman Corp was the sixth-largest contractor for the US federal government in 2021, with $12.6 billion, equivalent to 3.2% of the total spend.

Palantir

Palantir's unique value proposition sets it apart regarding government use cases. The company's ability to provide real-time operational insights to military commanders by aggregating sensitive data from various sources, including satellites and submarines, is unmatched.

While there are some positive aspects to Palantir's government business, it still needs to work on its dependence on large deals from a limited number of customers, leading to revenue volatility. So again, the growth of PLTR's government revenue has slowed down. As the initial demand for its products due to COVID has passed, and the company has grown to a larger scale, it is still being determined whether it can maintain a higher growth rate in the near future.

In 2021, several federal procurement contracts cited the COVID-19 response as a reason for purchasing Palantir's software. The contracts came from the Department of Health and Human Services, the military, and other branches of the government, which needed assistance in coordinating decisions and maintaining preparedness in response to the pandemic. In addition, the United Kingdom's National Health Service also used PLTR's Foundry to manage its COVID-19 vaccination program.

In 2022, global supply chain disruptions hampered commercial activity, making it challenging for many manufacturers to deliver in-demand products. Palantir's software can model a company's or an industry's supply chain, allowing organizations to simulate the impact of specific disruptions and build better resiliency into their models. During an earlier 3Q earnings call, PLTR's management revealed that they had initiated 25 supply chain projects year-to-date, including projects related to shipbuilding at Hyundai Heavy Industries and collaboration with the US Food and Drug Administration (FDA) to improve the food supply chain resiliency and prevent a recurrence of infant formula supply issues from the previous year.

More recently, Palantir expanded its partnership with Ukraine to support the country's reconstruction efforts. The collaboration began last year and involved providing software and incorporating AI technologies for battlefield decision-making. Palantir uses AI to analyze satellites and drone imagery, which informs its software platform for making military decisions. The company aims to assist Ukraine in determining the number of new schools needed and the number of children who require educational facilities. Palantir has asserted its commitment to working exclusively with the US and its allies, refusing to engage with China and Russia. The company is not charging Ukraine for its services.

Although Palantir's suite of intelligence gathering and decision-making capabilities has potential military applications in warfare like that in Ukraine and counter-terrorism operations, these specific applications are not publicly acknowledged. Overall, given the frequent occurrence of global crises, Palantir's software will continue to be in high demand by governments and commercial organizations seeking to respond to and build resiliency for future events.

Palantir Lands New Contract With U.S. Special Ops

Palantir just landed a deal with US Special Ops to provide USSOCOM with technological solutions that enable enterprise capabilities under this multi-year, $463 million deal. This includes software that can analyze petabytes of data to help people make wise decisions.

USSOCOM and other American warfighters benefit from Palantir's best-in-class software capabilities, and this contract win will assist in securing their sustained competitive advantage in the upcoming round of competition. In addition, Palantir assists USSOCOM in making decisions by helping it to analyze the petabytes of data coming from modern contexts.

This agreement is the consequence of the trust established over more than ten years of collaboration between our communities, and it reaffirms Palantir's commitment to consistently offer the most advanced software to US warfighters in need.

Takeaway

Palantir makes significant investments in AI, emphasizing providing the fundamental systems and software architecture to let businesses take advantage of the newest LLMs and machine learning innovations. However, while Palantir's outlook is bright, some challenges need to be addressed, and the current stock price, which trades around its fair value, offers a relatively small margin of safety.

$Palantir Technologies Inc.(PLTR)$

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