Palantir Technologies (PLTR)

Note: click on images with graphs and figures to enlarge.­­

Introduction­

Palantir Technologies Inc. (PLTR) “builds and deploys software platforms for the intelligence community in the United States to assist in counterterrorism investigations and operations. It offers Palantir Gotham, a software platform for government operatives in the defense and intelligence sectors, which enables users to identify patterns hidden deep within datasets, ranging from signals intelligence sources to reports from confidential informants, as well as facilitates the handoff between analysts and operational users, helping operators plan and execute real-world responses to threats that have been identified within the platform. The company also provides Palantir Foundry, a platform that transforms the ways organizations operate by creating a central operating system for their data; and allows individual users to integrate and analyze the data they need in one place. Palantir Technologies Inc. was founded in 2003 and is headquartered in Denver, Colorado.”

Even though PLTR is effective at what they do, they do not run their business well. That is why I am closing my position in PLTR.

  • Unprofitable after being in business since 2003.

  • Significant Stock Based Compensation (SBC) rampant throughout the innerworkings of the business, which dilutes investors.

  • Client churn hidden from investors, showing a lack of core unit economics.

  • Great product + poorly ran business = poor investment.

  • Extreme valuations.

Why I Chose Palantir

I chose to research PLTR because I’ve never seen a business operate like this before. They are so secretive, and every single presentation from them feels like 100% propaganda. (Contrast this to any other public business where the presentations are approximately 20-80% propaganda). This secrecy stems from them making software for the defense industry, where giving away blueprints for how they work can jeopardize the safety of the United States, its assets, and its allies. Still, if I was to be an investor in Palantir, I had to know more. I can be in the dark somewhat, but I need to know what I’m getting into as an investor.

Sources

It’s important to note that I spoke with sources that have experience with Palantir both as employees and users in the Special Forces (SF) community. All sources wish to remain anonymous. I will, of course, grant these wishes out of respect for their safety, common decency, and as I hope to be trusted by future sources.

Some of the points in this writeup contain information from sources that I cannot verify, but I will point these out as we go along. The point here is not for me to tell you what to think, but to say “This is interesting. Check this out.” While information from sources isn’t as good as first-hand information, it is leaps and bounds better than relying solely on company filings and public reports. It’s also impossible for every investor to have first-hand deep information on a company. Keep this in mind.

All information in a due diligence writeup such as this one contains enormous amounts of secondhand information. Example: I completed this entire writeup in my office in a small town in Montana, surrounded by snow and ranch land. Therefore, the reliance on information becomes extremely necessary: I cannot internally audit the operations of PLTR, so I must rely on secondary information. On a scale of 1 to 10 (10 being a firsthand account), company filings are a 7, news is a 4, tweets are a 1, and sources are ~9. My sources have a rating of ~9.9 and have been heavily vetted. In short: My time in the Marines puts me in touch with sources that would not otherwise be available.

Why you should care about PLTR

  1. Palantir has a vision of being the main operating system for most of the US government and most large companies. With their aggressive growth this could very well become a reality, however it depends on many factors (which will be the main body of this report).

  2. PLTR has become a meme stock, closely followed by Cathie Woods and her Ark ETF. What this usually means is the story behind PLTR is grandiose. Let’s take a deeper look to see if that story warrants an investment or not.

  3. If you’re going to invest in PLTR then you should care, deeply, on whether it’s the highest quality investment or not. It does not matter whether you are a value investor, growth, or somewhere in between, if PLTR is not quality then the odds of any meaningful return are minimized.

Historical Performance

Price

Since its IPO, PLTR has had a similar path of other growth tech stocks in the broader market.

Compared to the SP500, PLTR has fared well with almost a 50% CAGR over 1.3 years since IPO, but the current trend does not look good. (Footnote: I am not one to time the market, or wrestle with Mr Market, but trends and history should not be ignored)

This price action shows hype on the IPO then a lackluster performance when reaching the market.

If we zoom in slightly, showing a buyer at the very peak of market hype, then we see a very different story:

Revenue and Net Income

A quick snapshot of historical revenue compared to net income:

Quarterly revenue increased from 161 to 392 million while net income hovers around -100 to -150 million.

The increase in spending (thus keeping net income in the negatives) relative to increase in revenue is a major red flag for me. While PLTR hammers the theme of “we are still growing”, let’s not forget that they had since 2003 to grow and become profitable.

If they are not profitable right now, when markets are this inflated, then when will they be profitable? I expect the theme of “next couple years” to recur for more than a couple years.

If PLTR is so effective and everybody wants it, why aren’t they profitable?

Let’s look at the top level of the company and slowly dive in to find out.

Top Level

“But what does Palantir do?”

Palantir takes data from many sources and puts them together in a meaningful way so that operators can make better-informed decisions. You might think “that’s it?” but it’s important to keep in mind that most complex businesses are easily explained from a top level:

·       Google is a search company.

·       Microsoft is a business tools company.

·       Apple engineers’ hardware and software.

These are correct, but barely scratch the surface of each company. To dive deeper we need a basic understanding of big data and its role in defense analytics. In short, defense analytics is the answer to big data.

The Beginning: The Nature of Big Data

We’ve all had to work with Microsoft Excel. It’s easy, fun (if you’re like me), and extremely useful. The thing is, the more columns and rows you have of data, the exponentially more difficult it gets to manipulate that data for meaningful purposes. Now imagine you have 30 worksheets that all have thousands of rows, columns, and relationships with each other. The more data we have, the harder it is to manage. Complexity increases exponentially the more data and data relationships we have. This makes things difficult in organizations, but now we have multiple organizations with multiple data sets that all need to communicate with each other in an efficient and meaningful way. Palantir helps organizations across governments and continents communicate seamlessly in real time.

Let’s look at a couple examples. The first is Formula 1 racing.

Each Formula 1 season is 20 races. There are 100 laps per race. The car has between 200 and 300 sensors in it (depending on circumstances). About 500 data points per second are recorded. This equates to roughly 1.5 trillion data points per season, per car. This number is only going up.

(Fun fact: during time trials the car gets stripped down to ~200 sensors and only 1.5 kilometers of wiring.)

While this captures the enormity of data within an organization, it is only a sliver of what Palantir does.

The next example is very interesting to me. The role of big data and how it translates to SF functions across the globe.

Before PLTR, military intelligence personnel gathered intel the old-fashioned way: talking to people and forming a crude network of localized information. A good example of this is a military unit on deployment to their respective Area of Operations (AO). Each unit sees only a sliver of the total picture. Sometimes this sliver limits what data the unit uses in its day-to-day operations: everything is localized.

With PLTR, more units get access to global defense data in a meaningful way. They can see relationships between different data and different data sets.

A good example of this is with a unit deploying to a region of cities where good guys and bad guys are not so easy to distinguish from one another. Before PLTR, units would have to get a rough understanding: “X tribe generally lives in this area, so there shouldn’t be too many issues there. Z tribe is active over in this other area, so be careful here.” Troops would have to work with local leaders to learn names, relationships, and problems of the locals, then start hand-writing information.

Contrast this with PLTR, where vast amounts of regional and global data is readily available, contributed to, and used in daily operations.

Now that we have a basic understanding of big data and its role in defense analytics, let’s look at the different segments of PLTR.

Palantir Segments

Gotham

PLTR’s flagship product is Gotham, a software platform designed for the defense industry all the way from the NSA here in the USA to Special Forces in FOBS of hostile countries.

In their own words:

“Palantir Gotham is a commercially-available, AI-ready operating system that improves and accelerates decisions for operators across roles and all domains.

For over a decade, Gotham has surfaced insights from complex data for global defense agencies, the intelligence community, disaster relief organizations, and beyond. Gotham joins and enriches massive volumes of near-real time data and presents them in a single view that enables users to make faster, more confident decisions, together.

Decision makers from headquarters to the forward deployed edge access the most recent understanding of the world and can act while accounting for global tradeoffs and dependencies.”

“Palantir has a long tradition of providing cutting-edge technology to the United States Armed Forces and its allies.

Palantir enables military forces to interact with data from all sensors and sources through a single point of access. With one coherent model, users can discover previously unseen links across their entire universe of data. With Palantir software, military forces can rapidly turn mountains of data into plans of action.”

Foundry

This is Palantir’s commercial-focused platform:

“Foundry was built and tested in crises when time matters most. It offers everything from data integration to applications that power decision-making, in hours.

Whether integrating data, building a digital twin or deploying an operational application, you can choose the specific Foundry modules that serve your needs.

For more than a decade we’ve embedded with our customers to build Foundry backwards, starting from the most critical operational decisions. We’ve encoded this tradecraft into our product.

Today, the world’s most important institutions use Foundry to build safer cars, secure global supply chains, accelerate cancer research, and more.”

$8.00
Every month
$80.00
Every year

The best investing community in the world.

Apollo

“Most SaaS companies only run in the public cloud. We’re not like most SaaS companies.

Our software must operate seamlessly across on-premise data centers, classified networks, embedded edge devices, and a constellation of hybrid clouds.

That’s where Apollo comes in.”

“Apollo provides a single control layer to coordinate the ongoing delivery of new features, security updates, and platform configurations, ensuring critical systems stay up-to-date and operational 24/7.

With sophisticated DevOps features like canary environment integration, blue/green deployments, and automated recovery strategies safeguarding stability, institutions can operate with increasing agility.”

“From autonomous management of edge devices to fleet-wide integration of AI models, Apollo’s auto-scaling, containerized infrastructure powers workflows beyond traditional SaaS architectures.”

“Apollo is cloud-agnostic, liberating organizations from vendor lock-in and providing unparalleled flexibility to meet changing needs and regulatory requirements.”

If you really want to nerd out on what Apollo does, then I recommend reading this blog post by Robert Fink, founding engineer of the Palantir Foundry data platform: A sky full of clouds. The complexities of running SaaS in… | by Robert Fink | Palantir Blog

Selected Financial Data

Here is some selected financial data to help you get an overview of the company from a financial perspective:

As of Dec 29, 2021:

Investment Thesis

There’s some major pros and cons to PLTR. Here’s the main things I’m looking at:

Close To the Action

The main thing I like about PLTR is their willingness to build from the front of the client organization. Contrast this with the tendency for enterprise software developers to rely on client managers and not end-users. The result across the industry is often a clunky tool that barely passes spec, or takes so long to be implemented that it’s outdated within a year or two.

PLTR goes to the very front of the lines, literally, to make sure that their software performs as needed.  Forward Operating Bases (FOBs) are the final stop between US forces and their enemies. Not quite a military base, many FOBs are barely more than sandbags, plywood, tents, and conex boxes. The purpose of a FOB is to operate closer to the enemy.

I’ve learned from sources that PLTR would deploy their engineers all the way to these FOBs to work directly with US Special Forces (SF) to ensure that their software operated smoothly.

From one of my sources: “I’m confident we helped directly saved tens of thousands of lives from terrorist threats.”

They then tell me an example of a commonly known international terrorist attack. “In the hours and days that followed, we stopped numerous incidents. Many unsuspecting people are alive today because of Palantir.”

This is my main driving positive thesis behind PLTR. They are extremely competent at their function in the defense industry and have been awarded numerous contracts with the US government. Palantir Technologies Wins United States Special Operations Contract Worth $111M (yahoo.com)  

And my favorite: Palantir goes from Pentagon outsider to Mattis’ inner circle – POLITICO I am a big fan of Mattis. He is widely read and one of the greatest leaders of this generation. If he liked PLTR during his time in office, then that says something special.

A Popular Leaky Bucket

Palantir is one of those companies that does amazing things and truly helps make the world a better place, but Alexander Karp and his executives are driving the company into the ground by 1) Stock Based Compensation (SBC) and 2) ignoring churn.

These two giant factors are sucking the momentum out of the company. “We have very low dilution when looking at a fully diluted share count. So far this year, our share – fully diluted share count has increased less than 0.2%. So really, really low. With respect to SBC, it will normalize over the next couple of years as we’re working through this outstanding overhang. And at the same time, when you couple that with the top line growth, we’re going to continue to make progress towards profitability.” CFO David Glazer, May 11, 2021.

After being in business since 2003 I am not holding my breath. PLTR has been in business for 19 years and has yet to be profitable. Amazing.

“If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And if expenses should not go into the calculation of earnings, where in the world should they go?” Warren Buffett.

Elementary Leadership

I place a heavy emphasis on leadership when looking at any business. Quality leadership is indistinguishable from a positive culture, Free Cash Flow, and a trend of improving business performance. Palantir does not check any of these boxes.

Churn and Burn

A company that displays the ability to retain 90% of its customers has an amazing market-product fit. PLTR has been in business since 2003 and has relatively few customers. This, of course, leads to a high concentration of revenue per customer, and can lead to more unnecessary risk.

Churn should be one of the main Key Performance Indicators of driving sales costs down, which drives Cost of Revenues down, which increases Net Income. It’s not rocket science but having extremely low churn solves a lot of problems. It says a lot about your product. Palantir says “we are a software company” but they do not focus on that product and its churn rate.

Why are people leaving Palantir? That’s the main burning question I want to know. After being in business since 2003, PLTR should have more customers.

The main point here is that churn should be a major KPI within PLTR.

One of my sources tell me that PLTR has a history of clients choosing not to re-up their contracts due to being sold on a vision that didn’t match reality. “Our clients expected a level of high touch engagement commensurate with the price point.”

Where do these clients go if they leave PLTR? “Often it is just system integrators – IBM, SAP, whoever – who are perfectly happy to bill by the hour instead of by license.”

Valuation

The main prerequisite I place on valuing anything is its return. A vehicles return is getting me from point A to point B (and/or making me look really cool).

An investments return is its free cash flow available to shareholders.

A lemonade stands return is its money left over after all mandatory expenses are paid.

Palantir does not produce a real return. Sure, the price is up since IPO, but that is based on a story. I am not in the business of investing in stories, but real business that produce real solutions, and real returns to investors.

Here is the PLTR cash flow per share:

We can argue that Palantir is still growing and investing in R&D, but this isn’t the case.

So, if you bought a share of PLTR at 15 dollars at the beginning of 2020, you’d lose 32 cents. Not exactly what you want. It should also be noted that Stock Based Compensation is injected into much of the cash flow formula.

(A common question is “then why is the price of the stock going up?” The answer: investors hope PLTR will make a profit in the future.)

A helpful hint: beware the 4 horsemen of investing! They are hope, greed, fear, and ignorance. These 4 things have robbed more from investors than any crook.

Today’s market is rife with hope, leading to sky-high valuations across the board, even with unprofitable companies like this one.

Company Overview

History

It’s not my intention to go over every detail of the history of Palantir, but it’s important to get the full picture of where they are today, and where they might go tomorrow.

How the CIA leveraged Silicon Valley for Special Forces and the US Government: Incentives Rule Everything

Never underestimate the incompetence of government. – James Cook

Enterprise software has a lot of moving parts. It’s a rare occasion where an organization gets to use enterprise software that works well, efficiently, and across many different user archetypes. When the US Government needs enterprise software, the path is daunting and often unfruitful, wasting years and billions of dollars of taxpayer’s money. The CIA saw this problem contrasted against the success and innovation coming out of Silicon Valley, so they launched In-Q-Tel: “The CIA and government agencies, once innovation leaders, recognized they were missing out on the cutting-edge, innovative, and impactful technologies coming out of Silicon Valley and beyond. Combining the security savvy of government with the can-do curiosity of Silicon Valley, In-Q-Tel is born.” Focused on investing in national security, In-Q-Tel (IQT) targets promising startups that it could implement in augmenting national security. “IQT’s new business effort is IQT Emerge focused on commercializing technology innovation from U.S. government-funded R&D initiatives to support the mission needs of the U.S. national security community.”

IQT was one of the first major investors in PLTR in 2003, but PLTR still had to literally fight to get into the hands of US soldiers.

Revenue, Profit, Margin Trends

Here are quarterly revenues going back to PLTR’s IPO:

I love seeing steady gains in quarterly revenue up front. Let’s look deeper.

Here is revenues compared with gross profit and % gross profit margins (quarterly):

These margins are great and improving. It’s important to note that gross profit here is Revenues minus the Cost of Goods Sold: “the total cost of manufacturing and delivering the product or service to consumers.” (This will be important later).

A note about the dip in gross margins on 9/30/21: this was due to cost with the IPO and not tied to ongoing business operations.

The Business Model

PLTR builds software for organizations and government entities, and then charges those organizations money to use the software. Software contracts usually last 2-3 years at which time the contract is up for renegotiation. “We build software platforms for large institutions whose work is essential to our way of life. Those institutions must be able to function in times of stability as well as crisis and uncertainty. To do so, they need software that works.”

The more I think about this the more I realize that the larger the institution, the more important it is to our everyday lives that those institutions do not have ‘down days’ where their infrastructure doesn’t work.

Contrast this with the growing trend of listing a standard feature as a premium benefit: “. . . they need software that works.” Doesn’t most software in public companies work?

Company Background

PLTR started in 2003 at the heigh of the Iraq war. “We were founded in 2003 and started building software for the intelligence community in the United States to assist in counterterrorism investigations and operations. We later began working with commercial enterprises.”

Critical Factors

US Government

The US Government needs the best software available to help protect its interests. This basically means that if the US government remains intact, then PLTR has a number of very big customers who have a history of spending whatever it takes to stay at the top.

However, pricing power mixed with a spending problem in the biggest clients does not equate to a healthy relationship.

The graph in the next

Competition

One of the biggest leaks, churn, is likely to kill PLTR before it gains real traction. PLTR will have a much higher chance of success if they can fix their churn problem. However, this is a product problem.

So, while PLTR is a meme stock, they are simply the most visible company in defense analytics. They have sharp competition that they must overcome.

The main way I see this is with France’s discontinued payments. See below:

France (blue) discontinued payment in 9/30/21.

France had a decreasing payment going towards PLTR for a few quarters. This further points towards churn and competition.

Competition and Industries

In-Q-Tel Startup Queue

Right now, PLTR is the most known in their industry of analytics however they are far from monopolistic. The following companies are a list, in chronological order, of investments from In-Q-Tel newest first. You’ll notice that PLTR is close to the bottom of the list. And it should also be pointed out that the CIA is at the helm of In-Q-Tel, so that backing here is far from focused on PLTR.

Total Addressable Market

Palantir rated its Total Addressable Market (TAM) at $120 billion. This is split up with the government sector of $63 billion and the commercial sector of $56 billion. However, “analysts predict this will rise to $230 billion by 2025.”

It’s worth noting here that every attempt to predict the growth of data and the internet has been incorrect. It is far more exponential than anyone imagined.

I’m not worried about TAM in the slightest, but I am concerned with how leadership is steering the business.

Management and Ownership

Alexander Karp, CEO and Director

PLTR management is an interesting beast. The CEO, Alexander Karp, is extremely intelligent with one caveat: if a CEO’s goal is to make a company profitable by solving problems, then he has failed. An impressive history, compelling product, and inspiring corporate narrative do no good if the company cannot turn a profit by solving problems and practicing corporate financial discipline (spend less than you make). This is oversimplified, and in-line with a value standpoint of a company that is not trying to be a value company. However, if I am to invest then I am looking at the business as if I’m going to own a piece of it for 5+ years.

Therefore, I look at how management takes care of its stakeholders on a value basis.

“Mr. Karp is one of our co-founders and has served in various positions with us since co-founding Palantir, most recently as our Chief Executive Officer, and has served as a member of our Board of Directors since 2003. Mr. Karp holds a B.A. from Haverford College, a J.D. from Stanford University, and a Ph.D. from Goethe University in Frankfurt, Germany.”

Stephen Cohen, President, Secretary, and Director

“Mr. Cohen is one of our co-founders and has served in various positions with us since co-founding Palantir, most recently as our President and Secretary, and as a member of our Board of Directors since 2005. Mr. Cohen holds a B.S. in Computer Science from Stanford University.”

David Glazer, Chief Financial Officer and Treasurer

“Mr. Glazer has served in various positions with us since 2013, most recently as our Chief Financial Officer and Treasurer. Mr. Glazer holds a B.A. in History from Santa Clara University and a J.D. from Emory University School of Law.”

This is where things get interesting with the accounting of PLTR. Let’s look at the balance sheet and Stock Based Compensation.

Balance Sheet

Here are annual revenues next to unallocated stock-based compensation expense:

In 2020, PLTR brought in just over 1 billion in revenue. They issued 1.2 billion in stock-based compensation. That’s bad.

Here’s how much went to officers:

The CEO, Alexander Karp, brought in over 1 billion dollars in total compensation while his base salary was just over 1 million. This is also bad.

This is taking equity out of the pockets of investors, which turns PLTR’s values upside down. Here’s an example:

My favorite companies put leaders last, just below investors. Palantir is putting their leaders above the business itself, a sure sign of either short-term thinking or Alexander Karp is playing 3d chess and we should expect him to single-handedly fund the solution to climate change (or something equally preposterous).

Here’s the long-term business value chain, with the top priorities first:

1.       Customers

2.       Employees

3.       Vendors

4.       Investors

5.       Leaders

Good leaders put themselves last. Palantir fails to do this.

Short- and Long-Term Risks

Dilution

The biggest short-term risk that we can almost bet on is dilution. Investors will hold less of PLTR as management continues to issue themselves more shares.

Investment Risk

I’ve hammered a lot on the stock dilution with PLTR, but there’s still a lot of risks with Palantir. Here’s my top 5:

1.       They may not be able to sustain their revenue growth rate through customer acquisition.

2.       The sales cycle “involves considerable time and expense . . . often long and unpredictable.”

3.       Competition. There are many newer defense analytics companies out there trying to beat Palantir at their own game.

4.       Culture. I’ve learned from sources that the internal culture of Palantir is one of short-sightedness. I have no way to gauge this except on the word of sources, but from what I see with decisions on the rest of the business, I am inclined to believe them.

5.       They may fail to acquire government contracts due to external factors which cannot be foreseen.

Conclusion

Am I Investing in PLTR?

After researching PLTR for the past month I have decided to not invest my own money in the company at this combination of high valuation and lacking quality. It’s worth noting that I usually decide to pass on a business, compared to the talking heads of the finance world who throw out ‘buy’ recommendations for almost every stock. I do not. If most of my recommendations are “buys” then I am not doing my job of finding value.

Value cannot be found everywhere. It is always hidden.

Palantir makes it easy though, to see the trap. They make 1 dollar and spend 2. I don’t see them acting responsibly to their investors or customers anytime soon, so I’m out.

Closing Questions and Notes

1.       I want to know what Alexander Karp, who is not a foolish person, is thinking. Is it straight greed? Is there another motive for taking so much from the company? What am I missing?

2.       How often does the US Government switch software? How long before major buyers start building their own software from within?

3.       I originally bought Palantir because I learned a lot about their effectiveness in the SF community by talking to one of my sources. It sounded so good that I had to have it. I could not have been more wrong. It is still possible that they will become profitable and grow into an amazing company that I would be proud to own, but the chances are low, and that’s not today.

4.       Here is Revenue, Cost Of Goods Sold, and Operating Expenditures. I like to see Other Operating Expenditures stay below revenue, but that would make sense, and none of this makes sense.

5.       Here is weighted average basic shares outstanding and change year-over-year. What do you see? I see investors getting diluted, and remember where those shares are going.

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