Palantir: New Market Environment, Old Problems

Intro & Thesis

So far I have published a total of 3 articles about Palantir (NYSE:PLTR) on Seeking Alpha - the last one is from early November. Since then, the stock has fallen an average of 51%, whilethe market has corrected only 4.71% (also an average):

It cannot be said that I predicted the fall of PLTR - rather, such a deep correction of the stock took place against the backdrop of the fall of the Nasdaq Composite, which is now 20% below its November highs.

In my opinion, however, the facts I pointed out in my articles were the reason PLTR fell so low - in particular, I wrote about the merciless dilution of shareholder value due to the SBC program continuation, the severe discrepancy between the company's revenues and expenses, and a grossly inflated valuation of PLTR as if the company would remain the only IT provider in the U.S. defense sector. Now that Palantir has lost half of its November capitalization, many investors may be wondering if they should buy the stock on the dip.

Looking at the new corporate data, I update my thesis: Palantir, in my opinion, still has the same problems as before, only now it is forced to operate in a tougher market environment where the same unprofitable businesses will likely continue to lose their inflated market value.

Why do I think so?

One of the main characteristics of today is the more difficult conditions for the availability of additional growth capital. IT startups that are unprofitable and not yet listed on the stock exchange are forced to raise new rounds of investment at a lower valuation just to stay afloat and keep working (such corporate moves are called "Down rounds").

It's the same with already listed companies that are not making a profit - if there's nothing to pay the bills with, they either have to take on debt or dilute the stake of existing shareholders or cut production in the long run.

Palantir has failed to become an operationally profitable company despite its impressive revenue and gross margin growth in recent quarters - in fact, in Q4 2021, the company accelerated the divergence between revenue and net income.

Bulls may object - the company continued to generate positive operating cash flow (CFO). And that's right - for the full year 2021, CFO amounted to $333.8 million, which looks quite impressive against the backdrop of a $296.6 million outflow in 2020.

But we need to understand why we are seeing such impressive growth in the CFO item - it's all the fault of stock-based compensation, which was $778.2 million in 2021. At some point PLTR's management has decided not to consider debt financing as a possible alternative to SBC, so it continues to increase the number of shares outstanding each quarter.

I have written about this before and I'll do it again now - PLTR is highly dependent on its employees because the company's business model was essentially born in the form of IT consulting. So the company will have to work hard to make them stay, given howfast the wages are rising in the tech sectordue to inflation.

The only way to get them to stay is to continue to give them stock options and dilute the future EPS. Thus, I believe the current EPS projections are a bit overstated, despite the revenue and contract growth prospects, and the downgrade trend that began in early 2022 will likely continue in the coming quarters, pushing the company's valuation even lower.

Giving more than 12 times projected sales for a company that continues to make losses while inflation in the U.S. is already above 8% is pointless, in my view. Valuation is always a fairly controversial topic, decided on an individual basis by answering the question, "Who is willing to pay how much?" However, one way to assess the fairness of valuation - in addition to DCF - is to perform a comparative analysis of the market multiples amid business growth ratios. I did a similar analysis in my last article on PLTR - at that time I concluded that this company's stockwas overvalued by 70.20%. Now that Palantir has grown operationally and the stock has fallen 51%, perhaps it is fairly valued compared to other peers?

Unfortunately for bulls, we can't say so:

Source: Author's calculations based on Seeking Alpha data

A few words about the calculation methodology. We know that the revenue structure of the company consists of "Government" (58.2%) and "Commercial" (41.8%) segments (weights are taken from the company's latest financial report). For each of these two groups, I identified what I believe are the most comparable companies and wrote down their price-to-sales ratios for the coming year, as well as their revenue growth figures for the most recent quarter (YoY). I then expressed the average/median market multiples in terms of the average/median growth rates and multiplied the results by the shares of the sales mix. The weighted average amounted to 7.96x, which is 34.31% less than Palantir's current P/S (FWD) of 12.11x.

From all of this, I conclude that the business model Palantir has chosen does not provide it with the flexibility to reposition itself in the current reality - as it is forced to fund itself through additional shareholder dilution, shares will come under severe pressure in the coming months.

However, my conclusion is not without its risks

I could be wrong, especially about the strong demand for the company's services. As I wrote in one of my last articles, U.S. defense companies may feel an influx of new investors shortly due to the war in Ukraine and generally against the backdrop of a tense geopolitical situation.

Against this backdrop, however, Palantir lags well behind the defense giants and the defense industry as a whole - the effect of overvaluation is likely stronger than the future growth prospects.

In my view, however, growth will be short-lived because too many problems have accumulated in the global economy. The markets will not forgive an overvaluation as severe as that of Palantir. So the only conclusion that remains is that the risk-reward ratio will not turn to the side of shareholders as quickly as many bulls expect it.

Source: seeking alpha