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In an increasingly digitalized era, many products and services have started to generate user data at an unprecedented rate. To date, humans have created an astounding 59 Zettabytes of data, which has been forecasted to almost triple in size to 175 Zettabytes by 2025.
It is now common knowledge that the ones with data superiority often command business advantages. To that end, many firms have spawned offering value-added services that facilitate decision making in lieu of all the data available. For example, an enterprise may make use of Enterprise Resource Planning systems like SAP (SAP) to manage inventory, Power BI from Microsoft (MSFT) to visualize data, and Customer Relationship Management software like Salesforce (CRM) to handle sales and marketing needs.
Yet, the more data increases in volume, the greater the gap between data and insight. Many actors from governments to high level institutions rely on such data to make crucial insights. But some have grown too big, and have become encumbered by growing datasets that take on different shapes and sizes. When organizations start dividing and specializing labor to different functions, we start to get scenarios where insight capabilities become obscured by the shape that the data takes.
Business analysts in an engineering company think in terms of runtime, operating efficiency, inventory management and market demand, but rows, columns, cells and charts do not make sense to on-the-ground technicians that think in concrete parts, tools, systems and circuitry. Fancy charts and visualization may also come into conflict with ledgers, accounts and balance sheets in the finance function.
Palantir (NYSE:PLTR ) is not the first to leverage on big data, but they offer a unique value proposition: to consolidate the growing disparity between data and interpreters of data through creating a central operating system for all data in a firm to exist on so as to facilitate insight. As a result, each user, no matter how small, has the same interpretation of business concepts not obfuscated by the scale, diversification and specialization adopted by the business. And it is this crucial value proposition that will drive them to greater heights in the future.
What makes PLTR a compelling buy is its excellent long term competitive positioning, which will be elaborated below:
At its core, PLTR offers a unifying software architecture - an operating system for data to exist. They market themselves as the “connective tissue between an organization’s data, its analytics capabilities and operational execution.” Like how blood vessels connect different organs, PLTR unifies different analytical and operational tools used by different stakeholders in an institution, so data exists in high-fidelity and in the same language.
Once firms rely on the use of such a data-integration software, they are very unlikely to revert back to tribal means of organizing data - meaning that they will immediately find it cumbersome to pass data from one department to another, for the lack of a unifying operating system. For instance, data scientists experimenting with Machine Learning models need to manually look through the raw dataset passed to them by another department, write scripts to manipulate this data and finally upload this data to their model. The added benefit of coherence and convenience here adds an element of status quo bias that favors the continuous and long-term usage of PLTR’s product.
(A diagram of Information Silos, where data is isolated and much effort is needed to transfer this data across departments. Source: Wikipedia)
The lack of fidelity and traceability of source data without PLTR’s software can also create a major challenge for some institutions. When data sources are disconnected and trusted to intermediaries to parse, there is a certain “black box” where nobody except for the person who did the intermediate analytical work knows how this data is derived. Most of the time, intermediaries pull data from a source, work through this data on a separate platform (like a personal Excel template, or Python Script), and then manually upload it for the next person to consider. But within this black box, nobody really knows for sure whether the calculations and formulas used are correct in the larger business sense or their interpretation only exists for their specific business function. Disconnected data on top of this opaque black box parsing also makes real-time updates and trusting insights difficult, which is why once firms and institutions understand the need for data integrity as not just an afterthought, they will be unlikely to revert back to old means of passing data around for insights.
The nature of PLTR’s software helps to build brand loyalty for their platform, which will translate to an increased bargaining power against consumers in the future, implying a greater ability to monetize from them in the future when contracts are renewed. We can roughly see a semblance of this happening in their financials – their average revenue per customer has increased significantly for the previous three quarters.
(Average Revenue Per Customer of PLTR for last 3 quarters. Source: PLTR 10-Qs)
(Common tools that contribute to the "data-silo" effect in organizations. PLTR Serves to integrate the data from all these sources to expedite decision-making. Source: Respective company marketing materials)
PLTR’s positioning as a data integration firm that builds operating systems is unique. But what makes its competitive position compelling is the barriers to entry that make it difficult to contest its field.
Perhaps the most salient barrier to entry would be PLTR’s experience managing data from big-name defense organizations like the US Army, CIA and the FBI. The experience dealing with data-sensitive customers gives PLTR a credibility that cannot be easily overcome by new entrants that want to contest its domain, especially within the government vertical. With more public-sector contracts, including that with the Space Force not listed above, PLTR’s moat is only growing wider. In Q2 alone, PLTR signed 9 new contracts with US government organizations, including: The US Coast Guard; Securities and Exchange Commission; Internal Revenue Service; National Institutes of Health; US Immigration and Customs Enforcement and many more. Big names aside, the pace at which they have signed these contracts also subtly tells the larger story of their acceptance within the public sector, which is a feat that many companies can only dream of achieving.
More importantly, PLTR has also positioned itself uniquely as a patriotic ally of the United States, and they have stated very clearly in their S-1 Filing that they will not “enter into business or governments whose positions or actions [they] consider inconsistent with [their] mission to support Western Liberal Democracy and its strategic allies”. They have also stated that they do not work with the CCP or host their services in China. While this may seem as somewhat of a marketing ploy, announcing their alignments as early as their pre-IPO signals that they are committed to serving the public sector, which immediately opens up many opportunities:
There are also technical barriers to entry if firms want to build platforms similar to Gotham or Foundry. Because each firm has data shaped to its own operating characteristics, there is no one-size fits all solution for the organization of data. However, tools like Power BI or SAP forces the firm to conform to the software, which suit a cookie-cutter style mode of scaling, but become very ill-suited for customized data organizations. For these firms, it is not as simply building another feature on top of their fancy array of dashboards: it requires deep consultation with the firm to customize the operating system and become the unifying fabric for their data to exist on, which is a concept that runs contrary to the operations of software companies in general.
To add on to the difficulty creating a direct PLTR competitor, firms also need to find a way to develop software that is customizable to each firm, yet scalable enough to build a product to sell instead of a high-cost consultancy service.
We have established that technical barriers exist for third party software firms to build data integration platforms. However, the reverse argument is not true for PLTR: there may be high barriers to entry in creating a data operating system from the position of a software platform, but the barriers are lower for PLTR to expand and contest general software platforms. This is because it is easier to build a standalone generic analytics platform from the position of an operating system, than it is to build an entire customized operating system from the position of a generic analytics platform. The former involves increasing the genericity of platforms to suit the mass market, while the latter involves increasing the specificity of software to cater to each customer – an inherently high-cost endeavor.
We are already seeing this with their value-added machine learning, AI and visualization tools built on top of their core data ecosystem, where they can in some cases substitute for commonly-used analytics tools in enterprises today. More recently, PLTR has also launched an ERP suite that complements its other product features. Therefore, it is not too far-fetched a scenario for PLTR to also include their own add-on CRM software, or cloud servers for rental, as true substitutes to popular ones already on the market. This will probably be many years away as PLTR focuses on scaling their core product and charting a path to profitability, but the nature of PLTR’s product positioning opens up many potential avenues for growth in the future, especially in the commercial market.
We compete against our customers. We compete against our customers' desire to build their own bespoke solution.”
- Shyam Sankar, PLTR’s COO at the Q1 Earnings Conference
As rare as it sounds, PLTR is realistically competing against its own customers, even more so than other software firms in the market. More specifically, PLTR fights the threat of internal substitution, where firms develop their own in-house solutions to fight the problem of data integration. Whether this is a credible threat depends on the nature of the firm itself:
As machinery and humans become more interconnected and the scale of data increases, the problem of data integration is only going to get more significant. This makes PLTR’s products less substitutable in the long run, in turn leading to improved monetization capabilities when tied in with brand loyalty. Scaling data also suggests that there will only be greater demand for PLTR’s products, not less, which is why there is reason to believe that PLTR is going to be a beneficiary of the oncoming data explosion.
PLTR’s business model is initially lossmaking, with a reliance on expansion to achieve economies of scale and eventually make the whole endeavor profitable. In the initial phase of seeking new customers, PLTR incurs an initial sunk cost to build and develop software for each customer’s need. However, since the implementation of this product only occurs at a small scale, revenue collections are limited.
Where their business becomes profitable is in the scaling of services offered to the customer. Even as the use cases for the enterprise increases, granular configurations and separate applications can now be integrated on top of an already-built platform. Since PLTR can now charge more for full suite services while only marginally adding cost by integrating services on top of an already-built platform, customer accounts in this stage of expansion turn profitable. In future, PLTR is expected to enjoy further economies of scale as the increased efficiency in deploying added software platforms across operations mean lower costs of revenue.
As mentioned earlier, the nature of the platform essentially makes it difficult for consumers who have tried PLTR to revert back to archaic ways of managing data, which reduces the risk of consumers dumping the product after an initial trial period. This suggests a great likelihood of prolonged revenue streams after initial customer acquisitions. In the long run, revenue streams from scaled customer accounts will likely outweigh unprofitable accounts still in the initial stage of acquisition, and on balance lead to the profitability of the enterprise as a whole.
While the whole endeavor will likely take very long, PLTR is already seeing positive expansion into the profitable Scale stage of their business: total operational expense less share-based compensation expense has been generally decreasing as a percentage of revenue for the previous 9 quarters. 9 quarters may not seem like much in the larger picture of things, but it is comforting evidence of a believable path to profitability.
(Combined Operational Expense less Share-based Compensation for PLTR. Source: PLTR 10-Qs)
No investment thesis is complete without a valuation of a firm. As usual, I have opted for a three-stage unlevered DCF model with a 15+ year horizon to value the firm, apt for a newly IPO-ed growth company like PLTR. Below lists some of the key assumptions used to build the model.
Other assumptions used to build the model are listed below:
(Other DCF assumptions used to balance the model. Source: Author)
(Comparable firms to PLTR and their related valuation ratios. Source: Tikr.com)
Relative valuation was used primarily as a sanity check. Over here, PLTR’s lack of profitability means that only Sales ratios will be useful. The competitors that I have selected primarily represent the spectrum of characteristics that PLTR takes – it is in some cases a software firm with scalable software like Gotham and Foundry, but in other cases more like a consultancy firm with highly-curated products. I will take an educated guess and say that its margins will fall somewhere in between these firms, and so will its trading ratios.
(Football Field Valuation for PLTR. Source: Author)
Computed over 100,000 cases, DCF estimates at the 25th to 75th percentiles yield a range of $12.64 to $15.48. Taking the median estimate of $13.98 to be the price target, there is an implied downside of almost 36%. This should not be a surprise to many I assume, since it has been market sentiment for a long time that PLTR is in no way undervalued. But does this immediately warrant a sell?
Many bears like to point to the same idea over and over again – that PLTR’s lack of profitability and overheated valuation metrics (whether on a relative or fundamental basis) is a major red flag that warrants an immediate sale of the good. But valuation risk should be evaluated in conjunction with its qualitative prospects to paint the full picture, in addition to other risks that may be material in the short to long term. In this section, I would like to spend some time evaluating some of the material risk associated with an investment in PLTR.
I will concede that not much is actually known about the true nature of PLTR’s product, aside from a few videos, presentations and demo events serving as examples to put something concrete on what is essentially a black box.
Without much clarity as to how their business is operated, what the process of building each product is like, and how they intend to scale their operations further in the government and commercial sectors, there is great uncertainty in the valuation of the firm. This contrasts with most tech firms, where there is often a clear pipeline forward (new manufacturing plants, improved chip architecture, or software improvements). Having access to the product firsthand also allows for a more holistic evaluation of actual product moats, which is something that is less doable for PLTR because each product is secretive. Much of the analysis relies on marketing material, word of mouth, and a trust in the management of the company.
These may be cause for concern, but the next question is whether there is a need to have access to the technical details in order to make a judgement about its competitive position. From what we can establish using the limited information available, PLTR appears to have a defendable moat and sticky products – factors that are unlikely to change even with technical specifications.
Moreover, this black box argument can also be turned on its head: the lack of details about its operating behavior actually augments PLTR’s competitive advantage as it makes their system less exploitable.
There is a whole list of controversies with PLTR, but this is something to be expected because they work as a government contractor. In particular, many of these controversies stem from working under agencies that have questionable relations with human rights, discrimination or “big-brother”-type surveillance state concerns.
Most of these concerns come in spite of PLTR’s insistence that they are neutral and they are only providing the tools enabling its customers to analyze its own data more effectively. Whether this puts them liable for the consequences of actions taken with the help of these tools is a whole other can of worms, but the fact remains that these concerns have surfaced because consumers do not know enough about what PLTR is. The nature of PLTR’s platform also prevents them from defending themselves to the fullest extent, as it would require them to divulge many confidential information about its inner workings.
Nonetheless, these events will unlikely affect its long-term potential. In spite of the controversial light the media paints them in, governments and organizations are likely to continue working with them because they see value in their product. To PLTR’s customers, whether their tools can be used to facilitate bad actors in other areas is not their concern, so long as it can help them perform their task better.
Some argue that one of PLTR’s major risks lie in its excessive stock-based compensation expense, and it is a threat both to its path to profitability as well as to investors that might have to face some kind of share dilution from the exercise of these stock options.
I believe that PLTR is doing it to attract the best talent as a newly IPO-ed company with significant interest in the stock, which is not a wrong way to approach things. The alternative is to simply pay the engineers using cash, but this presents an opportunity cost of investment in innovation, as well as marketing to fledge out their consumer base – something which is necessary for them to achieve profitability. For a firm like PLTR in its early innings, it is prudent to utilize this method of attracting talent. As it matures, this SBC is expected to normalize and fall in line with the average compensation guidelines for listed firms on the market, so it is not exactly a large cause for concern.
Of course, the sudden spike in SBC when it IPO-ed a few quarters ago is cause for suspicion. It could point towards the possibility of something more sinister, like the possibility of management taking a quick payday cheque and exiting, but I think it is very unlikely.
I think that at this point, many investors have already acknowledged the possibility of PLTR being overvalued. And as I have shown in the discussion on valuation, this is likely the case with its intrinsic value lying beneath the $20.00 mark. This implies the possibility of capital loss in the short term if it floats towards the $15 range.
While this is certainly not desirable, it is definitely not out of the range of expectations for this particular ticker to be overvalued to this extent. For one, it suffers the same fate as meme stocks of late, its price artificially carried by mobs on Reddit holding tenaciously to their shares of PLTR. In fact, the first time I came across r/wallstreetbets before the whole GameStop (GME) saga was when they were advocating for PLTR to go to the moon. This hype together with a lack of understanding of their rather opaque business model makes confirmation bias rampant, causing small pieces of news that would not have otherwise mattered to its intrinsic value to catalyze its price explosion. PLTR’s recent US Special Ops and Space Force contracts are likely just one of hundreds if not thousands of contracts to come in the coming decade, but the market is reacting to this as if all its unprofitability suddenly evaporated overnight. At the same time, political risks, news about its unprofitability, and a possibly suspect share-based compensation activity can cause large movements in the other direction.
The large disparity between price and value is certainly not everybody’s cup of tea. But in a sense, this disparity is where both bulls and bears get it right: a long thesis suits an investor with a higher-than-average risk appetite, while a short thesis appeals to an investor that wants to protect his capital. In the latter case, there will be a significant opportunity cost of investment in PLTR. If you were to be a student of strict value, then this also presents a large opportunity cost of hunting for bargains on the market, even with a higher risk appetite.
But from a long-term lens (10+ years), PLTR’s competitive position – a unique and sticky business, defendable moat, a path to profitability and macro tailwinds for a growth runway – appears poised to lead them to outperformance in the market. Sure, it may take almost a decade to achieve it, but it is rare to find such an opportunity in the market, even if it means paying a premium for it. As its business improves, its short-term valuation metrics will also improve, just that it may not be that visible now because of the great uncertainty in how operating metrics will fare in the future. This uncertainty is also the reason why different analysts can put such different price tags on the firm.
How do we consolidate the PLTR’s stellar future prospects with its overvalued short term price levels? If PLTR is already in your portfolio, there is no reason to sell if you can deal with its volatility. Any price changes downwards would present a great opportunity to dollar cost average, fitting for a long-term investment. If not, an addition of PLTR at these price levels is still acceptable, but only in prudent amounts to avoid a catastrophic loss of capital. Personally, PLTR only takes up less than 5% of total allocation in my portfolio. Overall, PLTR’s excellent qualitative factors make this a compelling buy, at the price of stomaching its tumultuous short-term prospects; buy only if you enjoy watching paint dry.
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Disclosure: I am/we are long PLTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.