Artificial intelligence (AI) is undoubtedly one of the biggest trends in our generation, one that could rival (some argue even surpass) that of the internet.
The rise of AI would lift many companies to new heights while sending some to the brink of extinction. For instance, Nvidia, a leading supplier of graphics processing units (GPUs) for AI computation, saw its market capitalization briefly surpass Microsoft to become the most-valuable company in the world before retreating slightly to occupy the second place.
While Nvidia is an obvious candidate, investors looking to invest in the AI trend should not place all their eggs in one basket. Fortunately, the AI tailwind should benefit many other companies beyond Nvidia -- and one of them is Palantir (PLTR 0.36%).
Image source: Getty Images.
Palantir has a sticky business model
If one were asked to name a top tech company, Palantir would unlikely be a top choice -- and for good reason. It's not a consumer tech-facing company like Amazon or Alphabet, or a small and medium-sized business-facing software company like Shopify. Palantir's primary customers are big organizations, mainly governments and massive corporations.
Founded in 2003, Palantir initially focused on building software for the U.S. government in counterterrorism operations. Its early success led to further expansion of its products to other governments globally. The company entered the commercial market at a later stage, leveraging its expertise and experience gained from serving government clients.
Palantir's value proposition to customers (where the majority are still governments) is relatively straightforward (though by no means easy to deliver). It helps them gather vast volumes of data from everywhere (internal and external), analyze the data with its software platform, and make critical operational decisions. Palantir's software tools must be robust, scalable, and reliable since they help clients make crucial decisions -- some of which are matters of life and death.
Besides, Palantir must tailor its software to match the needs of its customers. For instance, a local government agency will have completely different requirements from the defense department. So, while Palantir can leverage its common software platform and experience, it must tailor solutions to help various customers tackle their respective operations.
Given these reasons, Palantir's products can be highly sticky among its customers. The enormous financial and human resources needed to implement this software -- such as installation, integration, and training -- create a huge switching cost for clients. So long as the software continues to work, it makes little sense to consider switching providers.
Also, Palantir usually enters into a long-term contract with clients, further improving its revenue stickiness. As of Dec. 31, 2023, existing contracts last 3.4 years, up from 2.8 years from the previous year. Moreover, existing customers usually spend more money with Palantir over time. For instance, the top-20 customers paid an average of $54.6 million in 2023, up 11% from $49.4 million a year earlier.
NASDAQ: PLTR
Key Data Points
AI is set to propel Palantir's business in 2024 and beyond
Palantir's early track record in helping the U.S. government is an excellent springboard for it to build a massive business around government agencies. While impressive, this segment will unlikely propel Palantir to the next level. Instead, the software company must grow its commercial segment.
To put it into perspective, 55% of Palantir's 2023 revenue came from the government segment, with the remaining 45% from the commercial sector (up from 44 % in 2020). Herein lies a challenge: Palantir's ability to quickly scale its commercial segment further.
Don't get me wrong. There's nothing wrong with having a significant and robust government business, especially since many of these relationships are incredibly sticky. However, Palantir's largest opportunities lie in the commercial segment.
And that's where AI will play a significant role in shaping Palantir's next growth phase. In particular, the increase in awareness of AI, especially with the proliferation of generative AI apps like ChatGPT since 2023, has given the market a taste of what AI can do to their work and personal lives. This awareness raises the urgency for companies to implement the latest AI tools to improve their operations or risk losing to their competitors.
Palantir has multiple ways to win. One is that it can leverage its existing client relationships to upsell its AI solutions. This approach will be the most straightforward since customers have invested heavily in using Palantir's platform, so they can quickly run new AI models by leveraging existing data infrastructure.
On top of that, Palantir can leverage the near-term market excitement to recruit new customers. To this end, Palantir leverages its AIP Bootcamps to allow potential clients to try its AI platform for free, giving them a real taste of how AI can improve their business operations. So, customers get to see precisely what they can get out of the software without paying anything in advance, which should improve conversion rates.
While still early, there are already tangible signs that AI could be transformative for Palantir. For instance, Palantir's U.S. commercial revenue surged 40% year over year in the first quarter of 2024, and closed U.S. commercial deals jumped 94% year over year. Comparatively, companywide revenue rose by just 21%. Better still, this trend could continue for many years.
What it means for investors
Investors constantly seek the next megatrend which could shape society and generate massive wealth over long periods.
That's how Amazon, a young upstart from nowhere in the 1990s, became one of the most-valuable companies on the planet by leveraging the internet tailwind. That same tailwind led to the rise of tech companies like Alphabet and Meta Platform.
Similarly, AI would undoubtedly create new tech giants. Investors should, therefore, keep a watchlist of potential winners. Palantir should be on that list.
