While starting off as a data analytics company that catered to the U.S. government, Palantir (PLTR -2.84%) has pivoted to provide its services to the civilian market. Some people fear the government has access to too much personal data, and Palantir processes a portion of the information -- making the stock controversial for some.
As Palantir shifts toward commercial customers, can it break free from its government-affiliated stigma?
Powering businesses to process data and give the best insights
Palantir has three main offerings: Foundry, Gotham, and Apollo. Foundry is a data management platform that allows businesses to interpret information feeds. Tools like artificial intelligence (AI) and machine learning improve processing and can identify supply chain bottlenecks -- something all businesses could use with today's issues. With Foundry, code writing isn't necessary to analyze the data, making implementation easier across all business types.
Gotham is often used by governments to process real-time information and then present critical data cleanly so those making decisions have the best chance of succeeding. Former U.S. Secretary of Defense James Mattis said Gotham "came up with ground breaking technologies that help us make better decisions in combat zones. You are giving us advantages right now that we need." Gotham can be used in military applications, but it also works with disaster response and law enforcement.
The Apollo software allows Foundry to run across multiple networks, whether on-premise data centers or cloud networks. Companies can also use multiple cloud providers, so Amazon or Microsoft cannot lock a company into unreasonable contracts. This gives Palantir an edge against typical software-as-a-service (SaaS) companies, as most require sticking with one provider, be it on-premise or cloud.
Strong growth, but with a caveat
Examining Palantir's earnings performance from quarter to quarter can be misleading. Palantir's contracts are often massive -- it closed 54 deals of at least $1 million and 18 worth $10 million or more during the third quarter alone -- and can lead to odd comparisons. Still, Palantir had a strong third quarter and did well in 2021.
Q3 revenue increased 36% to $392 million, driving its remaining deal value to $3.6 billion, a 50% increase since Q3 2020. Showcasing its expansion into civilian enterprises, its commercial customer count grew 135% in just nine months. While it is too soon to tell, Palantir's business model expansion appears to be working.
Palantir isn't profitable yet, mostly caused by its massive stock-based compensation bill. During Q3, it shelled out $184 million in stock to its employees while bringing in $392 million. This led to an abysmal net loss margin of 26%. Once this expense is pulled out -- investors should be careful doing this when stock-based compensation is this high -- the net margin is 21%. Because this expense isn't cash, Palantir is free-cash-flow positive and sports an impressive 30% margin.
Supercharging growth with stock compensation is a great strategy when capturing market share, as it allows management to hire talent by compensating them generously with stock -- a cheap currency that can be created by the company. However, businesses must balance this expense; shareholders won't tolerate this strategy forever because existing shares are diluted each time a new one is created.
Like many high-growth unprofitable tech stocks, Palantir has seen its valuation reduced over the last month.
Still, a 23 price-to-sales multiple is expensive to pay for a stock growing at 36%. Examining Palantir with a rule of 40 lens -- often used to judge if a company is growing quickly enough to warrant losing money -- is calculated by adding its revenue growth to a profit margin of some type and seeing if it is above 40%. With a 36% revenue growth and a negative 26% net margin, Palantir fails this test with a paltry 10% score.
The company is seizing an exciting new market segment in cryptocurrency exchanges. With Foundry, platforms can detect money laundering schemes and reduce fraud. While the crypto market opportunity is still young, it could have a significant use-case for many entities -- including the government.
One Palantir competitor is Alteryx (AYX -2.77%). Alteryx offers many data analytics tools, but its stock has been hammered over the last year because of its lackluster earnings due to its cloud migration. As Alteryx completes the cloud transition, the battle between the two could heat up. However, there is plenty of room for multiple winners in the data analytics space.
Palantir has momentum going for it in 2022. I expect it to continue growing its revenue and customers rapidly. Still, its stock-based compensation will prevent it from becoming profitable for years. Additionally, Palantir is often mentioned on Reddit boards and could cause large price movements, depending on what the community is attempting to do. However, I believe Palantir can still be a great long-term investment.
While I don't know how 2022 will treat Palantir, its long-term prospects are bright.