Michael Vi
Palantir’s (NYSE:PLTR) decision to put off its multi-year 30% y/y growth target for 2022 was a huge distaste to investors during the last earnings season. And the bleak economic conditions ahead certainly do not bode well for what is left in the remainder for the year for the stock. The company reported revenues of $478 million and earnings of $0.01 per share, representing mixed results compared with consensus estimates of $474.96 million in sales (the company guided $475 million on the upper range) and $0.02 in earnings per share. The company also reaffirmed its previously slashed revenue guidance of $1.9 billion to $1.902 billion for full-year 2022, inclusive of a $6 billion projected FX headwind, underscoring that the forward outlook on sales will remain better-than-expected like in the third quarter. Meanwhile, full year adjusted income from operations has been guided upwards, with the new range being $384 million to $386 million (previous guide: $341 million to $343 million).
The mixed results continue to underscore the near-term uncertainties that CEO Alex Karp had warned of during the previous earnings call, as well as rapidly deteriorating macroeconomic conditions ahead that have caused budgets across both the private and public sectors to tighten. Related impacts have weighed on the performance of even the largest and most resilient tech firms, including Microsoft (MSFT), Amazon’s AWS (AMZN), and Google (GOOG/GOOGL), highlighting that none will be spared from the current macro environment.
While we remain confident that the near-term macro and operating challenges facing Palantir are temporary, and its longer-term growth and profitability trajectory remains intact and sustained by its critical role in supporting next-generation cloud-based data management, storage and analytic solutions, we believe a bottom PT of $5 is near. The company’s resilient fundamental performance in the third quarter and solid forward outlook are expected to be partially offset by continued monetary policy tightening and rising risks of recession over the next 12 months, which will likely weigh further on investors’ confidence in the stock and add pressure to the shares’ near-term performance. We believe more compelling entry opportunities lie ahead for better capitalization on Palantir’s longer-term upside potential head of secular digital transformation tailwinds.
Commercial Slowdown
As observed in cautious commentary expressed by peers like Salesforce (CRM), Microsoft, AWS and Google, the near-term IT spending environment for Palantir is becoming increasingly uncertain given weakening financial conditions ahead – even key digital transformation trends like the migration to cloud has experienced a slowdown as corporate budgets brace for the looming economic downturn. This is further corroborated by the continued deceleration observed in Palantir’s commercial segment. The revenue stream has gained prominence in recent quarters as a potential compensatory factor against rapidly decelerating government segment revenues after the pandemic-era boom waned. This makes the significant deceleration in U.S. commercial revenues (2Q: +120% y/y; 3Q: +53% y/y) during the third quarter a huge setback on investors’ confidence in the stock’s near-term outlook, especially as rising recession risks tame IT spending, creating a weak operating backdrop in the months ahead for Palantir.
Yet, we view the segment’s robust double-digit growth as a sign of resilience against looming macro weakness still. Although corporate budgets are being cut across the board, continued growth at Palantir’s commercial segment provides validation for its differentiated solutions offered. Specifically, we view the continued ramp-up in Palantir’s newly-adopted modularization go-to-market strategy for Foundry over the past year, which tailors the offering for specific commercial end-user needs, as a core growth driver by encouraging adoption. The strategy is also expected to drive improved scale over the longer term, especially when macro headwinds subside and IT budgets that were previously put on hold pre-emptively, return.
This is also consistent with Palantir’s continued expansion of its industry-specific Foundry-based solutions in recent quarters across industrials to healthcare, as well as its recent plans to commercialize its co-developed product with Hyundai Heavy within the foreseeable future:
In addition, CEO [Ki-sun] Chung and Chairman [Peter] Thiel agreed to finalize the JV establishment this year to introduce and supply a tailored big data platform service to public institutions and the private sector in Korea. HHI Group and Palantir plan to expand sales through the JV by providing a customer-tailored big data solution in Korea, where the world-class IT infrastructure is established.
HHI Group will provide know-how accumulated in its world’s no.1 shipbuilding business and various manufacturing businesses and establish a bridgehead in the Korean market and entry strategies. At the same time, Palantir will build up a big data platform for customers and take responsibility for software supply and operation.
Source: “HD Hyundai CEO Chung Ki-sun Discussed Business Expansion with Chairman Peter Thiel of Palantir Technologies“, Press Release
And despite looming macroeconomic uncertainties, Palantir has continued to press forward with its long-term business plan, expanding its foray into new commercial verticals that include vehicle fleet management, which exhibits characteristics of a high-growth sector ahead of global electrification efforts:
- Hertz: Palantir became the latest to join a handful of tech companies – including electric vehicle makers Tesla (TSLA) and Polestar (PSNY) – in assisting Hertz’s (HTZ) multi-year electrification efforts. Palantir will provide Hertz with fleet management solutions under the partnership via the Foundry operating system. Curated solutions will include the provision of real-time “vehicle availability insights using service orders, location, rental status and registration data”, aimed at helping Hertz better manage its fleet of 500,000+ rental vehicles available worldwide, and improve economics by “[reducing] the time from vehicle purchase to rent and out-of-service rates”. The partnership is expected to open more opportunities within the commercial fleet management sector for Palantir. Global demand for commercial vehicle fleet management software is expected to expand at a multi-year CAGR of more than 9% through the end of the decade, with key drivers being the accelerating transition from ICEs to electric vehicles, as well as other requirements for improving operating cost efficiencies within commercial fleet operators. Specifically, the U.S. and UK – two of Palantir’s core operating markets – currently command the largest share of the commercial fleet management software market and exhibit the fastest growth characteristics, underscoring the advantage of Palantir’s continued ramp-up of its modularization strategy for deploying Foundry.
Government Lumpiness
Lumpiness in Palantir’s government segment revenue remains a key risk to the segment’s performance, especially with continued deceleration in the third quarter being a top concern on investors’ minds. As discussed in our previous coverage on the stock, the bulk of Palantir’s government contracts are long-term in nature, with no assigned revenue recognition timeline nor minimum guarantee value on some:
Although Palantir’s name has been a consistent showing across major government deal wins valued in the lofty range of hundreds of millions of dollars, the realization timeline on said contracts are often uncertain, with some even subjected to an “up to” clause with no minimum guarantee. Recall that GAAP-based accounting does not permit the recognition of revenue until the contracted services are rendered, and the prescribed transaction value has either been paid for or acknowledged by the receiving party as an obligation for services performed. In other words, a hypothetical two-year contract valued at “up to” $100 million awarded today may not even hit Palantir’s P&L until two years later; worse off, the “up to” might not even come with a minimum deal value guarantee, and end up being a nil-value contract upon expiry.
Source: “How We Arrived At A $5 Absolute Bottom For Palantir“
However, Palantir has time and again proven that the bulk of said revenue recognition risks is driven by timing, rather than contract termination. Specifically, the continued trend of government contract extensions/renewals continues to corroborate consistent demand and deal flow from government agencies across the U.S. and allied countries:
- FDA 21 FORWARD Initiative: The FDA has extended an existing working partnership with Palantir since 2020 for its 21 FORWARD initiative. Valued at $22 million, the partnership requires Palantir to see through the development, execution and deployment of a “central operating platform for monitoring food supply chain disruption and crisis response efforts”. Specifically, true to Palantir’s mission of overcoming inefficiencies in siloed data with its commercial-focused Foundry and government-focused Gotham operating systems, the company works together with the FDA under the 21 FORWARD initiative to consolidate multiple data sources from government agencies including the U.S. Department of Agriculture, as well as the Centres for Disease Control and Prevention, enabling a “modernized approach” in detecting and preventing risks to food safety and security.
- U.S. Army Materiel Command (“AMC”): The AMC has awarded Palantir a five-year contract valued at $85.1 million to deploy software aimed at supporting “logistics in contested environments, improve equipment reliability, and advance supply chain optimization”. The multi-year contract, though with a fixed contract value, again does not specify the annual contractual obligation, underscoring the lumpiness nature of Palantir’s government segment revenues.
- Department of Defense Impact Level 6 (“IL6”) Accreditation: Palantir was recently accredited IL6 clearance, joining Microsoft and AWS as the “only three companies with an IL6 Provisional Authorization from DISA [Defense Information Systems Agency] for their cloud offerings”. The accreditation adds to Palantir’s existing FedRAMP and IL5 accreditation, which gives the company additional national security clearance to provide cloud offerings for other classified public agencies across the U.S. federal government, including the Department of Defense and Intelligence Community. We view this as a positive development that not only validates Palantir’s technological competency against cloud-computing industry leaders Microsoft and AWS but also points to further penetration into new government verticals, underscoring sustained growth within the high deal value segment over the longer term.
However, despite Palantir’s continued demonstration of an effective “land and expand” strategy in capturing government deal share, uncertainties underlying the government segment’s revenue recognition do not contribute positively to the stock’s near-term prospects as investors divert focus from growth to profitability ahead of mounting macro concerns. Specifically, the lumpiness of government contract revenue recognition drags on the segment’s margin expansion trajectory (corroborated by 3Q margin contraction) and introduces significant uncertainty to Palantir’s consolidated profitability timeline, which management currently projects to happen by mid-decade. Although Palantir’s growing government deal backlog continues to expand (3Q: $1.3 billion inclusive of commercial contract value, representing sequential growth of 64%), which points to a sustained long-term growth trajectory for the segment with improved visibility, the choppy nature of related revenue recognition remains a near-term risk on the stock’s performance as it does not bode favourably with the loudening drumbeat “for companies to solve for profits” under the current market climate.
Meanwhile, Palantir’s progress in expanding its presence across non-U.S. allied countries and non-defense public agencies as planned earlier in the year remains a bright spot for its government segment. The company has leveraged its reputable success in supporting the NHS during the pandemic and showed consistent deal wins with the UK government this year. And Palantir’s upcoming addition of a second headquarter in the north of England is expected to bolster its presence and expansion efforts in the region, reinforcing its share of deals stemming from two of Britain’s largest public agencies – the NHS (2022/2023 budget $690 million) and UK Ministry of Defense (2022/2023 budget $50+ billion).
Final Thoughts
As Palantir continues to face both idiosyncratic (e.g., government revenue lumpiness; competition) and broad-based market risks (e.g., monetary policy tightening; recession risks), its shares are likely poised for further volatility ahead. And its latest fundamentals, which were mixed, have only done little to calm volatile sentiment, making our projected bottom PT of $5 a real possibility over the next 12 months. While we believe Palantir’s stronger-than-expected sales, inclusive of worsening FX headwinds, and upward-revised adjusted earnings guidance were positive notes coming out of a macro-impacted 3Q22 earnings season in recent weeks, the company’s inability to stem deceleration and sustain its 30% multi-year growth target and its continued GAAP-based losses remain unfavourable overhangs under the current macro climate where investors’ confidence is largely backed by profitable growth.
However, the company’s position as a critical next-generation data analytics software provider, and as one of few among its peer group with exclusive security clearance for providing cloud-computing service across the U.S. federal government underscores further market share gains ahead of longer-term digital transformation tailwinds. This reinforces the stock’s bullish narrative for sustained growth ahead, as well as rapid scale towards profitability (not just on a non-GAAP and cash basis), which are favourable to its longer-term valuation prospects. While we await further turmoil in the Palantir stock’s performance in the months ahead, the company continues to demonstrate the potential in becoming a long-term winner.
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