In a rally punctuated by investors' excitement over the advent of truly useful artificial intelligence (AI) solutions, shares of Palantir Technologies (PLTR 1.38%) have nearly tripled so far in 2023.
When the company unveiled its new Artificial Intelligence Platform (AIP) product back in April, Palantir founder and CEO Alex Karp even mused that his "software and company were built for this moment." Wedbush analyst Dan Ives later called it the "Messi of AI" -- referring to soccer superstar Lionel Messi -- saying that Palantir "has built an AI fortress that is unmatched."
But not everyone seems to agree. On Monday, Palantir stock fell 9.2% after William Blair analyst Louie DiPalma reiterated his bearish view on the AI analytics software provider, citing a potential issue with a notable upcoming contract renewal.
This Army contract renewal could "ruffle some feathers"
I generally take Wall Street's upgrades and downgrades with a grain of salt. And note that as of Friday's close, Palantir had rallied nearly 29% since DiPalma initiated coverage on the stock with a sell rating exactly two months prior. At the time, he pointed to a combination of increasing competition, decelerating revenue growth, and Palantir's then sky-high valuation multiple of 103 times this year's expected free cash flow.
So why did DiPalma's refreshed bearish opinion this week raise the market's eyebrows? Because he cited potential issues with one of Palantir's largest impending contract renewals.
In a note to clients, DiPalma raised concerns over potential data ownership issues detailed in a U.S. Army presentation at an industry event last week. While a U.S. Army project manager didn't name Palantir specifically, DiPalma says the project manager described plans to revamp the Army Data Platform -- previously known as the Vantage dashboard -- alluding to conflicts surrounding data ownership with the current vendor that could "ruffle some feathers." Palantir is the sole commercial software provider for Vantage under a four-year contract that began in December 2019 and is set to end in the coming weeks.
"The tone of the comments and plan to 'maximize the use of open-source vendors' provide a strong indication that Palantir's renewal contract ... will be significantly less than the original $458 million," DiPalma added.
All told, DiPalma reiterated his view that Palantir's valuation multiple -- now having climbed to 125 times estimated 2023 free cash flow -- could compress to a mid-30s multiple that's more in line with other analytics software providers.
What's next for Palantir investors?
It remains to be seen whether DiPalma's speculation is on point. There's no disputing, after all, that Palantir commands a rich valuation multiple, and investors are understandably concerned that a contract currently generating nearly $115 million per year in revenue could soon be renewed at a significantly lower run rate.
But you could also make the case that Palantir has a reasonable chance of growing into that multiple, especially as operating leverage takes hold. The company just announced its fourth straight quarter of net income profitability according to generally accepted accounting principles (GAAP) earlier this month, making it eligible for S&P 500 inclusion.
Palantir is also seeing increased success diversifying away from government contracts, which comprised around 55% of its total revenue in the third quarter of 2023. Government revenue grew 12% year over year last quarter to $308 million, while commercial revenue grew 23% to $251 million. The latter included 33% growth in U.S. commercial revenue to $116 million.
"The reacceleration in the growth of our U.S. commercial business, the new and emerging center of our company, is aided by the growing demand that we are seeing for our new Artificial Intelligence Platform (AIP), which was released only months ago," Karp wrote in his latest letter to Palantir shareholders.
If Palantir continues to enjoy relative strength in the commercial sector, concerns over this single U.S. Army contract renewal might well prove to be overblown.
