Summary
Palantir is striving to build a data platform that prioritizes ease of use and security, and aims to become the operating system for the modern enterprise.
The company seems well positioned to benefit from trends in software and AI.
Despite a 173% year to date rally Palantir remains at the lower end of their recent valuation range.
While significant risks remain, we like the overall risk/reward and believe the stock is at an attractive level for long-term investors.
Palantir Technologies headquarters campus exterior view in Silicon Valley. - Palo Alto, California, USA - 2019
Thesis
Palantir (NYSE:PLTR $Palantir Technologies Inc.(PLTR)$ ) is positioning themselves to capitalize on the future of software and AI. The company is laser focused on building solutions that provide value for their customers. Their hands-on approach I think is a differentiating factor that can hinder their growth over the short-term but has the potential to provide long-term benefits. The stickiness of their software means that the company may be able to consistently raise prices in the future, as long as the marginal value provided to the customer exceeds those price increases. Palantir wants to allow anyone within an organization to work with data and has the goal of creating the "operating system for the modern enterprise". We believe current prices represent a good buying opportunity for long-term investors.
The Future of Software and AI
Palantir is seeking to build the operating system for the modern enterprise. Many companies have a plethora of software tools. The more software tools that a company has, the more complexity is involved when integrating those tools together and allowing data to pass from one to the other. This is before considering security and data permission concerns, which further complicate the matter. Palantir is striving to build a data platform that allows users to easily work with data in ways that are beneficial to their organization and increase efficiency and improve business outcomes. Many of the solutions that Palantir provides have been purpose built with security top of mind due to their experience working with government agencies.
The future of software and AI is one that values ease of use and security. Palantir's goal is to allow anyone within an organization to work with data, not just data specialists. There seems to be far too many software vendors out in the market and too many software programs that can only be used by those with a background in data analytics. In our opinion, the software industry will become increasingly consolidated and focus on allowing anyone within an organization to create value. Palantir seeks to build the operating system for the modern enterprise. This involves providing many different software tools under one roof, creating an ecosystem purpose built to prioritize ease of use and security.
Palantir's solutions will generate an increasing amount of value over time as the company learns more and improves their offerings.
We would like to see the company modularize some of their software solutions and offer them on a traditional SaaS usage-based or freemium model. This would lower the barrier to entry for those who are interested in using the platform but don't want to sign a seven figure contract upfront. Once Palantir refines their sales and go to market strategy they can see the growth rates and scalability that is typical for a software company.
Building Solutions for the Customer
There is much debate about whether Palantir is a consultancy or not, but this misses the point a bit. What matters is providing value to customers and making money. Their model allows them to develop relationships with their customers and help them solve their problems in a hands-on manner. Palantir works directly with customers to implement their solutions and what they learn helps the company optimize for that specific collection of use cases. This makes it easier to implement the software and generate value for companies that are similar to the ones they have worked with in the past. This is what can end up making their software highly scalable and incrementally easier to implement.
Just because a software company uses a different approach to selling and improving their software doesn't make them a consultancy. The sector specific designation of their business is irrelevant when compared to factors such as scalability, growth, and profitability. In all of those areas Palantir has the potential to outperform investor expectations as they continue to refine the platform and improve their sales strategy.
Potential Price Increases
Having an incredibly sticky software solution means that prices can increase at a steady rate as long as the value generated remains solidly above the cost. Palantir is intending to build an incredibly sticky software stack that generates massive value over the long-term. Many investors have criticized their focus on larger customers, however this makes sense when considering that these larger customers are the ones where the greatest dollar value of improvements can be generated. A high dollar value of generated value can justify a high contract price. After initial implementation Palantir may have the ability to continue to raise prices as long as the software continues to provide incremental value over time. For example, if Palantir is able to generate an incremental $10 million in efficiencies each year, a company would probably be willing to pay $1 million more for the software. This is especially true for sticky solutions with high switching costs.
I believe Palantir provides highly differentiated software solutions that become deeply embedded within the enterprise, which will likely give them the ability to raise prices over the long-term. We expect the LTV of a Palantir customer to continually increase as the company learns how to best address specific use cases and the software improves with time and data.
Price Action
Palantir is up over 173% year to date. This raises concerns of the rally becoming overheated. Long-term investors in Palantir can decide for themselves whether or not to try and adjust their positions. In our opinion, for a company such as Palantir it seems a better idea to hold for the long-term rather than try to trade around short-term concerns of overvaluation.
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The stock is at its highest level in many months but remains well below their 2021 highs. Good news for bullish investors is that the company's fundamentals are much better than they were in the past. For example, in late 2020 when the stock was trading at around $25 revenue was nearly half of what it is today. A similar trend can be seen in operating cashflows, with the company going from negative operating cashflows of around -$300 million to positive operating cashflows of $375 million over the same timeframe.
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Valuation
Despite the 2023 run-up Palantir remains at the lower end of their recent valuation range. It can be difficult to use trailing or forward twelve month numbers to value companies that are early in their growth and optimization phase. The true valuation of Palantir I believe is more concerned with where 2030 numbers will be than 2024 numbers. We believe the company can achieve a CAGR of 20% until 2030, leading to revenues of around $7.1 billion. We also believe the company can achieve operating margins of 30%. Using these numbers our estimate for 2030 operating income is $2.1 billion. If we were to just go off of just these baseline assumptions and the current $39 billion market cap, the stock would appear to be modestly overvalued at these levels.
With this in mind, the company has a lot of potential to meaningfully outperform expectations due to the nature of their software and business. While it's difficult to quantify, this added optionality is enough to sway the calculus towards the bulls as even a small increase in CAGR outlook or margins can meaningfully boost the intrinsic value of the company. At some level an investment in Palantir is a bet on Alex Karp and management, and their ability to continue to build and sell software that is highly value generative.
In our opinion, the company will be able to grow into their valuation as long as they can refine their go to market strategy. We believe that there is the potential for Palantir to massively outperform expectations if they can achieve their goal of building the operating system for the modern enterprise and increase adoption by small and medium sized businesses.
We believe prices under $20 represent an attractive buying opportunity for long-term investors. We would change our view if the company showed signs of being unable to effectively compete regarding their underlying technology or sales strategy. We would look to lighten up around the $25 range given the current fundamentals, but if growth and profitability meaningfully accelerated we would adjust that upper bound accordingly.
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Risks
A key risk to the bull case for Palantir is the potential for them to fail to grow customer count over the long-term. The company may be unable to broadly commercialize their offering in a way that makes the platform scalable across business sizes. The platform may be unable to compete with other solutions. Palantir may never be able to meaningfully improve their go to market strategy. Palantir may fail to build a developer community around Foundry.
All of these risks may end up being material. We currently view the risk/reward as being favorable. We believe that the company provides a high value solution and that management has what it takes to improve their go to market strategy.
Key Takeaway
Palantir is positioning themselves to capitalize on the future of software and AI. If the company can refine their go to market strategy and continually improve their software they can disrupt the enterprise software landscape. We believe current prices present a reasonable entry point for long-term investors.
Source: seeking alpha
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