Data software company Palantir (PLTR -0.23%) has made a name for itself, providing the U.S. government and big corporations with the tools to make data-based decisions. Palantir is finding creative ways to uncover new growth opportunities. Investors could benefit from understanding both Palantir's growth strategy and these two new ways that Palantir is applying it.
Palantir's acquire, expand, and scale strategy
Palantir services its customers with its two primary products, software platforms named Gotham -- used primarily to service government clients -- and Foundry -- primarily serving businesses. These platforms take an organization's data and translate it into a simple language to identify trends and make decisions.
This software gets very close to a customer's core operations, so doing business with Palantir requires large commitments of time and money. The company's average customer spends $8.1 million per year on Palantir contracts and carries an average contract length between three to four years.
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The sales process consists of three phases that Palantir calls acquire, expand, and scale.
Palantir will begin with its "acquire" phase, where it exposes the product to a customer to prove the technology's capabilities and to get them familiar with the product. Palantir will do this at little to no cost to the customer, incurring financial losses. In 2019, Palantir generated just $600,000 in revenue from customers in the "acquire" phase while yielding a contribution loss of $65.4 million.
The company then graduates these customers to the "expand" phase, where it learns more about a customer's particular operations and challenges to offer effective solutions using its products. This is a financial turning point for Palantir; revenue begins to come in, but it is still unprofitable. Customers in the "expand" phase generated $176.3 million, while the contribution margin on this business was -43%, in 2019.
Once Palantir has proven the technology and infiltrated a customer's inner workings, customers enter the "scale" phase. This is where customer spending continues to grow while Palantir is done investing in establishing itself, so the business begins to turn profitable. In 2019, customers in the "scale" phase generated $565.7 million in revenue at a 55% contribution margin.
Palantir's ability to infiltrate a customer and expand over time makes its products "sticky" because, by the time Palantir begins to expand, its products are now essential to the customer.
1. Guiding start-ups
Typical customers are large organizations, government bodies, and large corporations averaging $500 million in annual revenue. The company estimates that this puts its addressable commercial market at $56 billion across 6,000 global companies.
Palantir spends millions of dollars to lay the groundwork for its "acquire" and "expand" phases, so CEO Alex Karp and management have gotten creative to identify and penetrate customers earlier on in their lifecycle.
With the recent launch of "Palantir Foundry for Builders," Palantir is aiming for start-ups and smaller companies. Management hopes to develop earlier stage customer relationships so that its costs to acquire these customers are lower while sharing in the growth these smaller companies produce.
2. Going the SPAC route
SPACs (special purpose acquisition companies) and their target companies will allow prospective investors (usually funds, banks, and other investing groups) to preview a company's information before it's announced to the public and buy stock in what is called a Private Investment in Public Equity, or PIPE.
Palantir has participated in several SPAC PIPE rounds, including:
- Sarcos: robotics
- Roivant: pharmaceutical
- Celularity: cell-based biotechnology
- Babylon: telehealth
- WeJo: connected vehicle data
- Lilium: electric aerospace
Palantir's investments in these companies have ranged in size, often $20 million to $30 million each, and it targets businesses seeking to develop breakthroughs in their respective fields.
These investments become a relationship with a two-sided benefit for Palantir. The early investments give it exposure to the success of these companies through its acquired stock, which can increase in value over time. Palantir also has a direct path to work closely with these companies at an early stage, utilizing Foundry to help these businesses grow. Many of these companies generate little to no revenue yet, so this is a long-term play for Palantir.
Is Palantir a buy?
Palantir is spending a lot of money on these investments and bringing on customers in its "acquire" and "expand" phases, so it hasn't yet been profitable. However, as Palantir moves more customers into the "scale" phase, its financials have begun to improve. In Q1 2021, its adjusted free cash flow grew to $151 million from -$290 million in the prior year.
With free cash flow turning positive, Palantir is expected to turn its first profit in 2021, and it's guiding for at least 30% revenue growth over each of the next five years. Investors could see Palantir produce rapid earnings growth as revenue begins to outpace expenses by a wider margin.
The stock traded at a price-to-sales ratio (P/S) of nearly 50 times in early 2021, but the stock has pulled back to a P/S of 27 times. Investors will want to keep an eye on how these investments translate to long-term revenue growth for Palantir, which continues to be a high-risk, high-reward stock.
