Why Palantir Fell Back to Earth This Week

What happened

Shares of big data software company Palantir (PLTR 3.19%) fell hard this week, declining 12.7% on the week as of 2:46 p.m. EST Friday, according to data from S&P Global Market Intelligence.

Palantir fell back to earth following last week's 20%-plus gain, which was due to the company's better-than-expected fourth-quarter report and surprising generally accepted accounting principles (GAAP) profit.

Yet one Wall Street analyst poured significant cold water on last week's bullishness, with a somewhat dire warning over large contract expirations coming up in 2023.

So what

On Tuesday, William Blair analyst Louie DiPalma issued a warning on Palantir following the stock's previous rise over the prior week. Importantly, DiPalma noted that six large government contracts were up for renewal over the upcoming 15 months, including three of the company's four largest contracts.

That adds an element of risk to the company's prediction for GAAP profitability this year, as well as continued revenue growth. Of note, Palantir's revenue works a little bit differently from a typical software-as-a-service (SaaS) company. Palantir tends to embed itself deeply with a target company or government agency, then comes up with a company-specific solution and works out a long-term contract on an individual basis. So, its growth can be very uneven, both to the upside and the downside.

DiPalma specifically noted contracts with the U.S. Army, the U.S. Air Force's Black Heron/Kobayashi Maru program, and the U.S. Special Operations Command, with all three agencies looking to potentially develop their own open-source solutions.

When asked about the company's government contracts on last week's earnings call, Palantir CEO Alex Karp seemed confident:

[T]he CAGR on our U.S. government has historically been over 30%. And I think there's a debate among people who support us or don't support us whether that's going to be in the future, it will -- the future will represent the past. I would say, you know, every time you open the news, you see another thing that makes Palantir more valuable, whether it's wars in the East or balloons over our society. This is a world that is dangerous, that needs AI-driven and, in general, software-driven weaponry. And no other company in the world has been focused on this for the last 20 years, and we are.

While that confidence is nice, if Palantir does happen to lose a large contract with the government in the near term, it would be a serious blow to the company's near-term results and make this year's goal of GAAP profitability much harder to achieve. 

Now what

Palantir is a fascinating company as a key service provider in major global conflicts today and over the past 20 years. Moreover, last week showed some impressive traction with U.S. commercial customers.

Still, Palantir is not a cheap stock, currently trading around 9 times sales while growing its top-line just 18% last quarter. On the positive side, the company does have a significant $2.6 billion in cash on its balance sheet -- nearly 10% of its market cap. Moreover, the company was GAAP profitable last quarter (though its operating income was still slightly negative) as GAAP profits were helped by a one-off investment gain and high interest income.

Still, its valuation is high enough that if Palantir loses a big government contract, the stock would very likely take a step back even from current levels following this week's decline.

Ultimately, Palantir remains an interesting but risky stock, which really requires a belief in Alex Karp's bold vision and Palantir's differentiation versus competing open-source solutions.