Palantir: Demystifying this Black Box Company

Deep Dive into Palantir

Introduction

You might not be aware of this company, but there is a good chance that it is aware of you. Palantir is all around us, but does it make for a good investment? That is what this article will try and answer with a deep dive into the big-data management and analytics company, Palantir. The first section will try to expose what this secretive company does and why it has received so much attention. The author will then take the company through a customized scoring process to determine whether Palantir is an investable company.

Company Overview

Palantir's mission is to transform data into actionable insights. They emphasise that they do not intend to replace human intelligence but rather augment it. Palantir helps their customers by creating the ultimate user experience to work with data. To achieve this, they build vastly complex platforms, but these platforms act like a black box operating system and the user is not exposed to their complexity. Applications are then layered on top of this platform to create a fully interactive human-driven, AI-assisted analysis tool. Palantir's software lets technical and non-technical people use natural language to search petabytes of data and connect the dots with what seems like a revolutionary interface. Ultimately you get a product that is highly customised for the end-user, intuitive to use and delivers real-world results.  Furthermore, it empowers organisations to ask and answer the right questions. All of this might sound like the marketing pitch from every AI/Data Analytics SaaS (Software as a Service) company, but Palantir is not your typical company.

The first reason is the nature of their work which is viewed by many as controversial. Even the company's name has a mysterious aura around it, Palantir was adopted from the Lord of the Rings movie where a wizard uses his crystal ball Palantir to surveil and manipulate his enemies. Palantir has been described as one of the most secretive companies in Silicon Valley and after listening to an interview with CEO Alex Karp, it seems like Palantir does not want to be associated with Silicon Valley. 

The engineering elite of Silicon Valley may know more than most about building software, but they do not know more about how society should be organised or what justice requires. Our company was founded in Silicon Valley. But we seem to share fewer and fewer of the technology sectors values and commitments, Karp said. 

The second reason is their unique customer base, Palantir has large government contracts mostly in the defence industry. With the rise in privacy concerns in the last decade, it is understandable that a company with access to so much valuable data will face a lot of scrutiny.  Palantir is not a company that uses words like AI and machine learning as buzz words, they are at the forefront of these technologies, and this might rattle the more conservative among us.

Palantir's Products

For almost 20 years Palantir has provided the US and other intelligence agencies with their data analysis tools. They have played a significant role in counterterrorism and other military operations.

The company has transformed in recent years, they have massively expanded their operations to target a more diverse client base. They currently have three different product offerings.

Gotham is described by Palantir as the operating system for global decision making - this is quite a bold claim. If we investigate the impact this platform has had, we might come to accept this audacious statement. Samuel Reading, a former Marine said:

It's the combination of every analytical tool you could ever dream of. You will know every single bad guy in your area. 

Gotham is Palantir's oldest and most established platform, it was designed for the US military and CIA. It essentially takes any type and volume of data and transforms it into a single coherent data asset. Palantir explains as more data flows into the platform it is enriched and mapped into meaningfully defined objects -- people, places, things, and events -- and the relationships that connect them.

Foundry is described by Palantir as the operating system for the modern enterprise. Not as bold as their claim for Gotham but still quite disruptive. Foundry was Palantir's entry into the commercial market. Foundry solves one of the biggest issues with AI data analysis, it works on real-world problems and not only in a lab. Data is one of the most valuable assets for many organisations and Palantir helps their customers to rapidly unlock this value. One of the first users of Foundry is Airbus. Airbus is a familiar name they are one of the largest commercial aircraft manufacturers. Have you ever given any thought to the logistics of designing, manufacturing and maintaining an aircraft with over 500 million parts? Then you need to start taking into account the hundreds of teams working all over the world in different factories. This was an absolute nightmare until Airbus partnered with Palantir. Foundry enabled them to process an enormous amount of data and to give the relevant answers to any query from management or the technician on the floor. Palantir also recently partnered with Scuderia Ferrari to use their data analysis to make race-time decisions. Their website shows numerous case studies on the impact that their software has made.

Apollo is described by Palantir as the operating system for continuous delivery and then they go on to state: 

Going where no SaaS has gone before. 

This description is the most cryptic of the three and it is also their newest product. Apollo is actually the backbone of both Gotham and Foundry. Gotham usually runs on-premise, firstly because when it was launched the cloud was still in its infancy and secondly it was used for mission-critical operations. Foundry was launched in 2016 as a cloud-native SaaS. Most customers prefer this option and even the government uses it since it has been given FedRAMP Moderate and DoD IL-5 clearance, the highest authorisation for any SaaS.

When Palantir realised that some of their clients need a platform that removes the operating environment constraint, they decided to build Apollo as a standalone product. Apollo leverages the power of the Cloud 2.0. A typical SaaS company runs in the public cloud on one cloud server. Apollo seamlessly integrates on any cloud, regardless of whether it is Azure, Google, AWS or even the CIAs cloud. It can run across clouds and creates a true multi-cloud SaaS. The platform can now be deployed on any device anywhere in the world. It has even been deployed in space and on a submarine. Palantir plans to release a new suite of products for the Apollo platform on the 27th of April.

Palantir's moat (8/10)

An economic moat is a term conceptualised by legendary investor Warren Buffet. It is most easily described as a distinct advantage that the company has over its rivals. This advantage can come in many forms, but it should be able to protect the company's market share, future growth and profit.

Network Effect

One important distinguishing fact for Palantir is that they do not have customers in the conventional sense of the word, they rather establish partnerships. We can see the effect of this in the net dollar retention rate of 131% which show the stickiness of Palantir's products. 

The agnostic nature of Palantir's software architecture creates a strong network effect within an organisation. It can be used across different divisions by both technical and non-technical staff. This leads to scalability within an organisation.

Switching Cost

Palantir's software is certainly not cheap, with the average customer revenue for 2021 being $6.5 million and their average for their top 20 customers was $43.6 million per customer. These are astronomically high figures.  Switching to another vendor after spending millions on installation and training costs seems highly unlikely. Companies become highly reliant on Palantir due to their softwares deep integration. Palantir essentially becomes the central nervous system of an organisation and those are extremely expensive to replace. Once you have migrated to Palantir's ecosystem, you are probably locked in for a long period.

Management (8/10)

Palantir was co-founded in 2003 by Alex Karp (current CEO), Pieter Thiel (Chairman of the Board of Directors) and Stephen Cohen (President and Secretary). It is great to see that this is still a founder-led company after almost two decades as it has been proven that founder-led companies generally outperform the market. They still own a significant portion of the company and the total insider ownership is 10.47%, which is a great show of confidence.

Alex Karp and Peter Thiel are both considered controversial figures. Thiel is a libertarian billionaire, and he has been described as one of Silicon Valleys most powerful. Alex Karp is the eccentric CEO who has a PhD in neoclassical social theory. Karp has received many death threats due to the nature of his work. Karp also keeps 20 pairs of identical pairs of swimming goggles in his desk drawer for some inexplicable reason. We still gave management an 8 out of 10. Pieter Thiel is one of the most successful people in Silicon Valley, he co-founded PayPal, was one of the first outside investors in Facebook, and provided early funding for LinkedIn, SpaceX and Airbnb. His backing of Trump in 2016 might not make him the most popular person, but his successful track record speaks for itself. Karp may not be your stereotypical software CEO, but we believe he has an incredible vision and we would like to remind the reader about the last eccentric CEO from Silicon Valley who created the greatest company in the world.  Hint: The company logo is a fruit.

Financials (5/10)

The financials are for the year ending 31 December 2021. The table regarding the financials is attached.

Conviction (8/10)

Palantir is a company that solves real problems, and their solutions are clearly some of the best in the world. Personally, it is important to me that the company provides real-world value. One of Palantir's first uses was protecting soldiers from improvised explosive devices (IEDs), it played a crucial role to locate Osama bin Laden, it partnered with the CDC to bolster the fight against Covid-19, especially with the distribution of the vaccine, the partnership with the World Food Program led to the delivery of more food faster than ever before and the list goes on. It is a challenge to find a company with a greater purpose than Palantir.  

My conviction comes from a strong belief in management, a healthy business model, a large Total Addressable Market (TAM) and the fact that they are a best of breed company. Palantir builds true relationships with their clients which will be very difficult to replace. Big has been a hot topic recently and I expect this trend to continue for the next decade. Apollo, their newest product, has great potential and I believe it to be severely undervalued at the moment.

Upside Potential (9/10)

The recent sell-off, especially in the high growth sector, has put this disruptive company on sale. At the time of writing the company is worth $12.71 a share, with a Market Cap just below $26B. My 3-year share price target is $28, representing an upside of 127% and a Compound Annual Growth Rate (CAGR) of 30,4%. I prefer to give 3-year price targets, but I want the reader to understand that this is a stock for the investor with a long-term investment horizon and a healthy appetite for risk.

Risk (7/10)

Palantir unfortunately has quite a long list of risks:

Customer Concentration

For most investors, the most concerning risk will probably be Palantir's customer concentration. Many have questioned Palantir's reliance on a few large contracts and their dependence on the government. In 2021, 18% of its revenue was from the top 3 customers, this is down from 25% in 2020, but if one of these customers terminates their contracts, it will have a significant impact on their financials.  At least the trend is downward, the customer concentration is declining, and their list of commercial customers is growing.  Their total customer count grew by 71% to 237. We expect this trend to continue with the new adoption of Foundry and Apollo. Palantir has also drastically increased its sales team, which should help to reduce customer concentration. Unfortunately, this can also be seen as a risk since Palantir is still not profitable and they are spending enormous amounts on sales and marketing which results in a high CAC (Customer Acquisition Cost).

Dilution and Stock-based Compensation

Shares, shares and more shares. There are so many of them and the number of outstanding shares just keeps on growing. This causes dilution for shareholders which reduces their value. The other red flag regarding their financials is the stock-based compensation (SBC). Palantir rewards its employees and executives by offering them shares, this is called stock-based compensation.  It is not inherently a bad thing as it motivates everyone to prioritise the success of the company. When the value of the company increases so does their own value. The amount of stock-based compensation at Palantir is unfortunately again an astronomical figure and almost the sole reason why they are not profitable. SBC for 2021 was $778,2 million, this is 50% of their revenue.

Volatility

The company also became a meme stock in 2021, driving its share price to a ridiculous valuation of almost $40. This kind of hype can create tremendous volatility and is not something that a quality investor wants to be associated with. It fell almost 75% from its all-time high, coming down to a much more realistic valuation. 

Competition

The data analytics landscape is filled with competition, but I do believe that Palantir has created a deep and relatively wide moat to protect its position as a leader in this space.

Ethical Dilemma

There are also some political, ethical and moral issues that have created a war within Palantir. Again, this is due to the nature of their work and the customer base. One of Palantir's clients is Immigration and Customs Enforcement (ICE). Employees launched a petition against working with ICE and some employees even left.

Conclusion

There are only a few neutral reports on this company, especially regarding its stock, but most are either extremely bullish or extremely bearish. This is usually the case with these kinds of truly disruptive companies. Tesla is a good example of such a company with almost a cultish following or a severe hatred for the company. One conclusion we can draw from this is that Palantir falls in the category of high risk, high reward. I believe with today's lower share prices Palantir presents a good risk/reward opportunity for growth investors. Artificial intelligence and machine learning do not appeal to everyone but if you are interested, I highly recommend visiting their impressive website. Palantir truly excites me and it was a rewarding experience to do a deep dive into this company.

The current macro environment certainly does not look good for growth stocks, with the end of quantitative easing, increasing interest rates and a 40-year record high inflation. Don't forget the geopolitical uncertainty with the war in Ukraine. I guess each investor must ask the questions: How much of this has been priced in? What will the economy look like in 5 years? I will give you the answer: Nobody knows. What I do know is that I will never short true innovation.

Disclosure

Palantir is currently a 10.4% position in my US high growth stock portfolio. This article is not financial advice and is based on the opinion of the author.