Palantir: Now Even More Overvalued

Summary

• I confirm my sell rating on PLTR and do not recommend buying the prolonged dip.
• Palantir's inability to generate "net" cash flow from operations (excluding SBC) could, in my view, result in the company's inability to fund working capital and CAPEX in the future.
• If the current trend continues, further dilution to shareholders will seem inevitable.
• The overvaluation seems even higher today than at the end of April 2022.

Michael Vi/iStock Editorial via Getty Images

Investment Thesis

I believe that the inability of Palantir (NYSE:PLTR) to generate "net" operating cash flow (excluding SBC) may result in the inability to fund working capital and CAPEX in the future. Also, an important factor is thevaluation of the company, which is still too high despite the massive sell-off since November 2021.

Why do I think so?

I'll start with a little digression to remind all new readers that I have been writing bearish articles about Palantir on Seeking Alpha since October 2021 - at a time when overvalued tech companies were still riding high and the market blindly believed in their invincibility. Following mundane business logic, however, I was a skeptic - at least about the reliability of Palantir's business model as well as its incredibly rich valuation. And I'm glad that time has judged in my favor:

Seeking Alpha, my profile, PLTR

In fact, the return on a potential short sale increased to the same amount after each article would average 52.15%, while a similar short sale on the market would only make a profit of 6.28%:

Source: Author's work based on Seeking Alpha data

Why do I say this? Not just to feed my ego (and that too), but to show that stocks react primarily not to the number of positive articles (published several times a week about Palantir on SA), but to the actual prospects of the company's business model and the general macroeconomic background.

We all know what's going on in the market right now - rampant inflation, a war in Eastern Europe, the risks of a humanitarian and food disaster, a repeat of the ARK ETF bubble deflation similar to the Nasdaq Composite Index deflation during the dotcom crisis, and much more. Despite the bear rally that began in late May, many investors are still afraid to buy technology stocks. In theory, now should be the perfect time to do the opposite! Possibly... but I do not think that applies to buying shares of Palantir.

First, I don't believe PLTR can get rid of the so-called "SBC-addiction". The CEO, Alex Karp, said on PLTR’s recent earnings call that only $9 million worth of new shares would be issued this year. Great, but as SA Contributor Growth at a Good Price rightly pointed out in his recent article, SBC is projected to be worth ~$850 million over the coming years. He then constructs a DCF model in which he predicts a positive free cash flow net of SBC. In my opinion, however, such calculations are quite risky, as they imply rapid growth of operating cash flow (without SBC) - which is not the case in practice.

Data byYCharts

Data byYCharts

Yes, SBC as a structural element of the cash flow statement is steadily declining - but operating cash flow is declining much faster. To understand why, we need to turn to the quarterly report itself:

Palantir's most recent 10-Q, author's notes

According to the rules of financial theory, Palantir's top management is mismanaging its working capital - the company is reducing sources of free cash (short-term liabilities up to 1 year) while postponing the receipt of cash until later (growth of receivables). Thus, the company's operating cycle is rapidly increasing, as is the turnover of working capital.

Data byYCharts

This trend, if it continues, will inevitably lead to the need for additional outside funding, either through debt issuance or equity dilution. As we know, Palantir has no debt, but it does have a practice of funding through dilution - it is very likely that this approach will continue in the face of rising interest rates, even when the expiration of today's options ends (on paper). A company that has been around for more than 20 years will have to show us the adjustment of EBITDA and net income with SBC for a long time to come.

Second, the company's current valuation should confound any prospective buyer, as Palantir still appears overvalued on key multiples despite a nearly 50% YTD decline in its share price.

Data byYCharts

Data byYCharts

Paying more than 9X revenue for a company whose revenue growth forecast (next year) has started to shrink?No thanks.

Data byYCharts

Incidentally, the same trend applies to the forwarding EBITDA and EPS figures:

Data byYCharts

In my opinion, the company's business model does not make it possible to build a full-fledged DCF valuation model - the variability and unpredictability of the predictive input data for the model are too high. So, without complicating the forecasting process, let us try to assume that PLTR should trade at 25-30 times earnings in 2023. Why are these inputs almost 2 times lower than today? Because there is such a thing as multiples contraction - as a company grows, its growth eventually slows down, and high market multipliers shrink. As we can see,the growth slowdown is set to start in 2023:

Seeking Alpha, PLTR, author's notes

The consensus EPS forecast for 2023 is 24 cents per share, according to the calculations of 11 analysts. If this consensus forecast proves correct, Palantir should be worth $6-$7.2 per share - the downside of about 21-34% to the current share price.

And finally, an update on my SOTP (Sum-Of-The-Parts) valuation model that I gave as an example last time. Its meaning lies in the breakdown of Palantir's business segments into "Government" and "Commercial", determining the optimal peers for each of these groups, and comparing their revenue growth rates and P/S multiples (FWD). The weighted average of the outputs is compared to the FWD price-to-sales multiple at which the company is trading today.

Source: Author's calculations based on Seeking Alpha data and PLTR's IR

This time, the calculations show that the "fair" P/S (FWD) multiple for PLTR is 5.4x given its actual sales growth rates in the last quarter. This is the 3rd time I have used this spreadsheet to calculate PLTR's SOTP valuation, and with the benefit of hindsight, we can see how the multiple contraction played out in practice:

Author's work

The implied ("fair") multiple for PLTR is now > 32% lower than at the end of April 2022, but at the same time, it implies a much higher undervaluation. This is explained by the fact that the companies from the analyzed sample lost more in terms of their P/S multiples (FWD), but at the same time showed better revenue growth momentum than PLTR. The stock remains more popular than other peers due to its popularity among Reddit users and risk-loving high-growth investors - in part due to the "mysteriousness" of its technological edge. In fact,industry insiders know that Palantir's technology is nothing special- it is merely a symbiosis of analytics platforms and IT consulting without much competitive advantage. Moreover, this symbiosis is extremely labor-intensive (simply because of the role of IT consulting), which significantly increases the risk of declining business margins - something this 20-year-old company is indeed demonstrating after its IPO.

Data byYCharts

Risks to my thesis & Bottom Line

Despite the many drawbacks highlighted in this article, I recognize that the company's refocus on commercial customers should support long-term revenue growth, which is exactly what Alex Karp promises his investors. Perhaps in the future, PLTR will be able to pull up the rest of its P&L thanks to higher revenues and finally get rid of the dilution - in which case the stock will begin to recover rapidly. However, I rate the likelihood of such an outcome as unlikely - the way executives manage working capital indirectly suggests that PLTR is trying to increase revenues at any cost (increase in receivables), putting its future profitability and business sustainability at risk.

Another risk is that if the Nasdaq Composite breaks out of the bear market zone soon, the upside could trigger a favorable rally for stocks like PLTR. However, the same is true in the reverse case - PLTR stock has significantly underperformed the broad market since the beginning of this year:

Data byYCharts

Regardless of how you feel about the market, I believe there are more promising, less expensive, and more reliable names in the stock market among technology names besides Palantir (I plan to tell you about one of these companies soon - stay tuned). I confirm my sell rating on PLTR and do not recommend buying the prolonged dip.

Source: Seeking Alpha

$Palantir Technologies Inc.(PLTR)$