What would be Palantir Opportunity ?

Palantir: Here's Your Opportunity

Sep. 22, 2021 7:15 AM ETPalantir Technologies Inc. (PLTR)33 Comments27 Likes

Summary

• Bears routinely argue that Palantir is in a bad shape because of its lofty stock compensation expenses, its bleak margin profile, and its revenue concentration risk.
• However, the company has been actively making progress on all three fronts.
• Investors can rest assured that the company is being steered in the right direction, towards long-term sustainable growth.

Michael Vi/iStock Editorial via Getty Images

Palantir (NYSE:PLTR) has been berated in investing forums ever since its direct listing last year. Investors are concerned that the company has a poor margin profile, that it’s exposed to revenue concentration risk, and that the company as a whole has elevated stock-based compensation expenses which eats into shareholder returns. In this article, I want to explain how the company has made substantial progress on these fronts lately and why investors shouldn’t lose sleep over these issues anymore. Let's take a closer look at it all.

Quality of Growth

Let’s start with concerns surrounding the stability of Palantir’s revenue. Many investors are under the impression that Palantir largely caters to various US government agencies and is exposed to the associated concentration risk. The line of thought here is that if Palantir botches up at one of these government agencies and/or if the US government blacklists Palantir, then the company’s revenue would immediately dry up. This might have been a legitimate concern till a few years ago but it isn’t a major concern in 2021 anymore.

Palantir doesn’t disclose its revenue from US government alone, however, from the Federal Procurement Database, we know that data analytics firm has catered to 28 US government agencies since 2008. This figure includes agencies that haven’t contracted Palantir in several years, as well as agencies that have had miniscule contract values. But even if we ignore this minor detail, readers should note that Palantir had 169 active customers in Q2 FY21 which is significantly more than the 28 US government agencies that it catered to in last 13 years. Also, Palantir’s customer count expanded by 35% year on year, in Q2, which highlights how well it has mitigated the concentration risk.

As a reminder, Palantir defines its active customers as organizations that it has transacted with, in the last twelve months. But having said that, the point I’m trying to make here is that Palantir has active business relationships with several other customers – commercial enterprises and foreign government agencies – that provide stability to its overall revenue.

I’d like to also point to readers that Palantir’s revenue from its commercial business grew at a rapid rate in Q2 FY21. If the company is able to maintain this commercial revenue growth momentum in the coming quarters as well, then:

• it’ll diversify Palantir’s revenue stream (and customer base) and further alleviate concerns relating to its concentration risk;
• Palantir’s shares might rally going forward. I say this because commercial businesses generally attract higher valuation multiples than government contractors, since the former offer more transparency to their shareholders.

(Source: BusinessQuant.com, company filings)

So, overall, investors need not be too concerned about Palantir being overexposed to the US government, and should rather be optimistic about its growth prospects, especially in its commercial business. As I’ve discussed in my prior articles, Palantir has undertaken several initiatives – like transitioning to subscription model, offering limited and free trials to major enterprises and expanding its sales team – which can really bolster the growth of its commercial business in the coming quarters.

Improving Margin Profile

The next qualm is that Palantir has a bleak margin profile. This is a serious issue and any investor would be understandably concerned if their company has to sacrifice its margins just to be competitive in its line of business. While that may have been the case with Palantir till a few years ago, it isn’t one anymore, as we head further into 2021.

Let’s take a look at the chart below to understand how Palantir has made progress on this front and how it’s positioned in its industry. The X-axis highlights the gross margins for Palantir and over a 100 of its listed peers in the software infrastructure industry. Notice how Palantir is positioned to the right – this implies that its gross margin is better than a vast majority of its peers. Now, let’s shift attention to the Y-axis, which indicates the year-on-year gross margin improvement in terms of basis points. Notice how Palantir is positioned higher than most of its peers, which implies that it’s pace of gross margin expansion is higher than most of its other listed peers.

(Source: BusinessQuant.com)

The point I’ve tried to make here is that Palantir’s gross margin is better than most of its peers. Also, its pace of gross margin expansion is higher than a broad swath of other software infrastructure stocks. This indicates that Palantir:

• is able to command a price premium for its platforms,
• doesn’t have to sacrifice its margins to win business from its customers,
• competes on features and functionality, rather than merely on price.

These points should dispel any margin-related concerns regarding Palantir and should actually reassure its investors about the company's competitiveness and how it's on the right path to sustainable long-term growth.

Stock Compensation

Lastly, readers regularly point out how Palantir is rewarding its key employees with lofty stock-based compensation. This, once again, is a serious issue. Palantir is still a loss-making company on a net basis, which means that these stock-compensation expenses delay its breakeven point and essentially come at the expense of its shareholders. However, the company is making progress on this front as well.

First of all, the chart below highlights that Palantir’s stock-based compensation expenses have significantly come down over the last three quarters. These expenses were almost three-times the company’s entire revenue back in its September quarter but they amounted to a relatively lower 62% in the company’s latest June quarter. So the situation isn’t as dire as it used to be.

Secondly, the company disclosed the following in its latest 10Q filing:

As of June 30, 2021, the unrecognized expense related to options outstanding was $1.0 billion, which is expected to be recognized over a weighted-average service period of 8.07 years…the total unrecognized stock-based compensation expense related to the RSUs outstanding was $815.0 million, which the Company expects to recognize over 3.20 years.

Now let’s do some rough math. The $1 billion figure broken spread over 8 years amounts to roughly $125 million in stock-compensation expenses every year. The $815 million figure spread across 3 years roughly amounts to $271 million in stock-compensation expenses every year. So, essentially, we’re looking at aggregate stock-based compensation expenses of approximately $396 million for the next three years, and the figure will drop to $125 million from its fourth year onwards. Bear in mind that these figures are much lower than Palantir’s trailing twelve-month stock compensation expenses of $1.5 billion, which means that things will only improve on this front, going forward.

Final Thoughts

It’s understandable why investors are concerned about Palantir’s stock compensation expenses, its margin profile and its revenue concentration risk. However, Palantir is rapidly making progress in all three areas and investors should now rest assured that the company is on the path to sustainable and long-term growth. So, once again, I reiterate my bullish stance on the company (as I’ve detailed here, here and here). Good Luck!