Palantir Must Continue to Perform to Justify Its Valuation

Data analytics specialist Palantir Technologies (PLTR 4.01%) has made a triumphant debut on public markets, with the stock up more than 100% since going public last fall. But the stock was up as much as 300% as recently as February.

On this clip from Motley Fool Live, recorded on May 13, Fool.com contributor Lou Whiteman talks with Industry Focus host Nick Sciple about the company's recent earnings report and how investors should think about this promising, but highly valued, government and commercial IT contractor.

Nick Sciple: On the topic of parsing through massive amounts of data and intergovernmental intrigue on the data front, let's talk about Palantir. Folks who know about Palantir's role for a long time working with U.S. intelligence agencies. They were behind catching Osama bin Laden a number of years ago. Now they are a public company and they just reported earnings. Lou, what do we know about the company today?

Lou Whiteman: This is only, I believe, their second earnings report as a public company. They went out late last year. The headline numbers were all pretty good. They matched estimates $0.04 per share of earnings. Revenue was a beat by about 3% percent. They guided higher, which you always want to see. They guided to, I think, $360 million of revenue in the second quarter, which is $15 or so million above the consensus. This is a company that is in growth mode, they see revenue growing at "at least" 30% a year through 2025. They're scoring wins. They do very, very complex stuff. Some of these government contractors just manage email systems. Palantir is in a different realm. They are data analytics, they're trying to bring this to the commercial side slowly and surely. But this is everything you'd want to see if you're a bull on this company because there's growth priced in here and they're delivering growth.

Sciple: We can talk about the amount of growth that's priced in. The stock so far this year, year to date about 50% off its highs. You look at the price-to-sales ratio got as high as the 40s. Now it's down about 20 times price to sales, still very much pricing in continued massive growth. Like you just mentioned, this continued revenue growth of 30%. What do you make of the evaluation in the context of the irons they have in the fire and the growth opportunities they see outside of their traditional government business?

Whiteman: Sure. If you want, I guess, the cracks on the story, I would say. For one, 30% annual growth by any standard is impressive. But it's worth noting in the last 12 months, they have grown at 47% year over year. That would be a slowing from where they are. This valuation, coming from the defense side, I can't put my head around it. Most of the comparables, and there is no real comparable here, but are trading at two times sales or less compared to 20 times sales. On the commercial side, Snowflake, people like that, you will see more on-par valuation. It may be fair to at least say Palantir with its commercial business deserves to be above, say, Booz Allen Hamilton. But lost in the story in a way or you can't be lost, this is still very much a government-dependent business. If you look at the quarter, the government side is larger and it is growing faster. Government is 60% of total revenue today. It grew by 76% year over year the government side. The commercial side is only growing at 19%. You are not going to transform yourself into a commercial-focused company if the smaller side is growing much smaller. I believe, and there's a history here, if they successfully grow out the commercial, they will be a rare company. Many have tried. Commercial is a different animal, it's a different customer. You've already seen them partnering with IBM and other big names like that to try to sell this on the commercial side. That's good that they're doing that because it will broaden their exposure. But at the same time that means you're giving IBM some of the margin and it sort of speaks to a weakness. You do not partner with these guys if you are really seeing the traction you hope for on your own. The other side of it, too, is this is high-end expensive stuff. This is stuff that a company uses when they need to. It's not necessarily we're going to take over all the IT budget. My fear here is that they need to grow into this valuation. I don't know if the market fully appreciates how difficult that is going to be or how much time is going to take, so it's an odd moment. This is a great company, it's a great product, but even believing in the growth story, it's hard for me to wrap my head around this valuation.

Sciple: Just looking at historical comps, quite heavily valued. Is there a way you can get there? There's this idea that over time the way we engage in, I don't know how you guys want to call it, warfare or just intergovernmental conflict, moving more and more toward the digital space. Palantir, you could say, top dog and first mover as far as the type of work they do there. If we zoom out 10 years, do we see the addressable market just being that much bigger because of the trends we see in this space? Is at the story you have to tell yourself as an investor?

Whiteman: You can. I think that's dangerous, because yes, Palantir can do things that nobody else can or that few can. But a couple of things on that, the government very much values redundancy. We've see this throughout that the government will intentionally overspend to just keep two vendors in a field. I don't think there's a world in which Palantir gets 100% of the dark money or put between spy agencies. That's just not going to happen. Also for the size of this and for the amount that government spends, this is a little over $1 billion company right now that's trying to get to $1.5 billion or so in the next five years. You're not going to see the Pentagon boosting this a to a $3 or $4 billion dollar company just on their spending alone. Again, with a market cap of $35 billion, there's expectations. The only way they're going to get there is on the commercial side. Again, they can. They have tools that I believe commercial customers will value. But will they pay up for it in the volumes that investors hope? That's a harder thing to imagine in a three- to five-year period. I'm not negative on the company, I've actually been watching very closely as the stock has come down. I don't know when I would get in, but I'm not opposed owning this company. But I am just very cautious about valuation here. Just knowing the industry, knowing the defense side of the industry and how hard it is to grow when that customer is your primary customer.

Sciple: Absolutely. Just summing things up at 20 times sales so very much a show-me story for Palantir and what we need them to show us is continued robust growth in the commercial business that it is able to justify that valuation or the valuation come down to price that's more reasonable to fit the expectations we can comfortably make.