Palantir Stock: Land And Expand Is Working (NYSE:PLTR)

Despite mounting challenges to the global economic outlook and a battered stock market, Palantir (NYSE:PLTR) has remained focused on refining and executing its long-term growth plans, supporting robust free cash flow generation and its long-term multi-year growth target of at least 30%. Specifically, the company has continued to stay diligently committed to its “acquire, expand, and scale” business model by strategizing different ways to capitalize on its core data operating system offerings designed specifically for government and commercial application.

Organizations across both the public and private sectors are becoming increasingly digital, generating vast troves of data that will need to be integrated, processed and analyzed to drive key decision-making processes. And this trend will continue to propel demand for Palantir’s data software solutions. Palantir has ramped up efforts in building towards a comprehensive portfolio of offerings in recent years, with an aim to complement its end users’ increasing focus on modernizing their respective technology stacks to stay operationally and economically competitive. For instance, Palantir has continued to modularize its existing offerings to make them more relevant to the different needs of corporations both large and small, while also teaming up with industry partners to build tailored Foundry-based data analytics and management solutions for use across different operating environments.

This has allowed Palantir to penetrate new segments and drive increased customer acquisition in recent periods, as evidenced by strong double-digit growth in its smaller commercial business. The approach has also helped it expand business relationships with existing customers across both the public and private sectors by enabling cross-sell opportunities, and further scale opportunities by driving stickiness of its linked software offerings.

With the Palantir stock currently trading at about 8x forward EV/sales (~9x forward price/sales), which is just on par with the broader SaaS peer group mean of 8.1x and a bargain that is not reflective of the company’s robust multi-year growth profile, we believe the current market climate has created an attractive entry opportunity. Considering Palantir’s continued push towards its longer-term growth initiatives, including the ongoing expansion into non-U.S. opportunities and build-out of a comprehensive offering portfolio to encourage greater mass market adoption and better capitalization of digitization opportunities in coming years, the stock remains a favorable long-term investment at current levels.

Step 1: “Acquire”

Palantir’s government segment performance has remained the key focus area for most investors in recent quarters, as evidenced by the stock’s 20% post-earnings landslide observed in May after reporting continued deceleration in its larger business arm. But outside of acquiring new government deals, Palantir has been compensating for its larger segment’s recent short-fall by stepping up on expanding its market share in the public sector – a rapidly expanding addressable market.

The combination of modularization of existing offerings, and creating new solutions by leveraging existing offerings through collaboration with industry leaders have collectively helped Palantir better penetrate new segments within the private sector and acquire a greater share of the commercial market in recent quarters. The company’s infamous efforts in supporting the development of innovative start-ups through initiatives like “Foundry for Builders” is also poised to encourage mass market adoption of its commercial offerings over the longer-term. The continued success of these collective efforts in helping Palantir acquire a bigger share of private sector digitization opportunities is further corroborated by six consecutive quarters of growth acceleration in the company’s commercial segment revenues as of March 31, 2022.

As mentioned in our previous coverage, Palantir has been leveraging its core Foundry operating system designed for the private sector in the development of new, industry-focused modularized solutions (e.g. Carbon Emissions Management and Anti-Money Laundry / Know Your Client solutions targeting the crypto sector) to better cater to end users’ needs. The strategy has also helped the company break the barrier of IT resistance to new software structures like Foundry, and improve acceptance of the cutting-edge data analytics and management solutions that Palantir has to offer.

Palantir has also sought collaborations with industry-leading partners across industrial machinery manufacturing, water infrastructure consulting, and more recently, commodity trading as part of its ongoing efforts in building targeted solutions off of its existing Foundry operating system. In addition to its ongoing partnership with Hyundai Heavy and Jacobs (J), which we had discussed in previous coverages on the stock, Palantir’s latest industry collaboration counts Trafigura, a leading physical commodity trading company.

Palantir and Trafigura will jointly develop a carbon emissions tracking platform based off of Foundry that is capable of “calculating, reporting, and collaboration across commodity supply chains”. While Palantir already offers a modularized Carbon Emissions Management tool directly through Foundry, the carbon emissions tracking platform co-developed with Trafigura will mark the “first time it goes to market with a partner” on related solutions. Specifically, the co-developed carbon tracking platform will target the added complexity of tracking indirect scope 3 emissions across the supply chains of “crude oil and refined products, and concentrates and refined metals”, and drive insights on the “lifecycle of emissions of the commodities”.

Similar to Palantir’s recent plans to commercialize industry-specific solutions developed via its partnerships with Hyundai Heavy and Jacobs, the carbon emissions tracking platform co-developed with Trafigura is also intended for future deployment across end users in the energy and metal commodities supply chain. The development comes at an opportune time, as emissions standards and regulations over the private sector’s carbon footprint become increasingly stringent as a result of urgent global pledges toward carbon neutrality to get in front of climate change. The energy and metal commodities supply chains currently account for about half of emissions in the U.S. alone, with electricity production accounting for 25% and the industrial sector accounting for another 24%.

After unlocking opportunities pertaining to digitization needs within the industrial machinery and global water / wastewater treatment sectors through partnerships with Hyundai Heavy and Jacobs, Palantir’s latest team-up with Trafigura will allow the company to better penetrate digitization opportunities stemming from ongoing carbon reduction efforts in the energy and metal commodities sector, especially across Europe and the U.S. – Palantir’s core markets. To put into perspective, global carbon prices are currently estimated at $75 a ton in order to “reduce emissions enough to keep global warming below 2 degrees Celsius”, and the price is expected to keep rising over the longer-term to ensure global net-zero targets are met. With global greenhouse gas emissions across all sectors coming in at more than 36 billion tons in 2021, Palantir’s increasing efforts in the development of carbon tracking and management technology aimed at complementing stringent emissions reduction initiatives across its targeted markets will not only do the world a lot of good, but also drive significant monetization opportunities for the company over the longer-term.

Step 2: “Expand”

The “expansion” leg of Palantir’s business model has always been stronger across its government business, thanks to the robust foundation built through the company’s successful collaborations with the U.S. government – especially the Department of Defense – in its earlier days of inception, as well as the later introduction of the Gotham operating system specifically designed for public sector application. Despite increased concerns that Palantir’s new government deal flow is decreasing, its pipeline of expanded opportunities rewarded through existing partnerships remain strong, though the lumpiness of contract awards have also weighed on the government segment’s revenue performance in recent quarters.

Although investors remain convicted that the fading “COVID tailwinds” are to blame for a part of the deceleration in Palantir’s government segment, a deeper look would reveal that the pandemic-era opportunities had actually helped bolster adoption of the company’s tools in non-defense agencies. In the core U.S. market alone, non-defense government contracts represent more than half of total public sector awards received by Palantir to date. Continued penetration of non-defense government opportunities, which represents about 3% to 4% of annual GDP in the U.S. alone, through expansion of existing partnerships, paired with increased military expenditure in the near-term are expected to reinforce Palantir’s government segment growth. In addition to expanded partnerships across the public health sector as discussed in our previous coverage, Palantir has showed consistency in being awarded extensions on its multi-year military contracts, underscoring the effectiveness and increasing importance of the company’s contributions in modernizing the public sector’s technology stack. Its latest public deal extensions reported in the second quarter include:

• U.S. Space Systems Command: Palantir’s growing partnership with the U.S. SSC continues to underscore the effectiveness of its “expand” phase within the public sector. In early June, the U.S. Space Systems Command (“SSC”) Battle Management Command, Control, and Communications (“BMC3”) extended a 2021 contract with Palantir until March 2023. Palantir was initially awarded the contract, valued at $121.5 million, for the provision of its “Data-as-a-Service platform capabilities which allow mission areas within the Air Force, Space Force, and NORAD-NORTHCOM to integrate, clean, share, and leverage data to help make decisions on personnel management, strategic and operational planning, cross-space situational awareness, and collaboration across combatant commands”. The latest extension adds $54 million to the contract value, and requires Palantir’s provision of “capabilities for decision support tooling for echelon planning and continuity of leadership operations”. Palantir’s continued partnership with the U.S. SSC also extends beyond BMC3. In addition to the provision of data-as-a-service solutions to BMC3, Palantir also works with the U.S. SSC’s Cross-Mission Ground & Communications Enterprise (“ECX”) under a multi-year extension valued at $43 million that is also the result of a successful previous partnership. Palantir is currently contracted for the deployment of its software to integrate and process data from various sources, and facilitate “application delivery, in-depth analysis, and data-drive decision-making” across the ECX and its partners.
• U.S. Army Tactical Intelligence Targeting Access Node (“TITAN”) Program: Palantir and U.S. defense contractor Raytheon (RTX) were awarded a $36 million contract by the U.S. Army in late June to proceed towards the “competitive prototyping phase” for its “Tactical Intelligence Targeting Access Node” (“TITAN”) program over the next 14 months. The TITAN program currently under development will be an intelligence ground station that pulls data from space, aerial and terrestrial sensors to generate insight for front-line command and control decisions. The latest award was the result of a successful $17 million, 12-month “design phase” for the program conducted by both Palantir and Raytheon. The continued development of TITAN will leverage Palantir’s “Modular Open Systems Architecture” (“MOSA”), which “enables data and insights to be sent downstream to other subsystems with little to no integration work required”. With the TITAN program being the “first intelligence ground station enabled by AI/ML” capabilities, Palantir’s MOSA architecture will play a critical role in supporting seamless integration of data generated from the sensors to drive insights needed for “real-time decisions at transformative speeds”. MOSA will also enable seamless integration and management of “vendor capabilities, like SpaceX’s Starlink system or Forcepoint’s security offerings, to be quickly onboarded and offboarded as needed” without any impact or alterations to the rest of the program.

There are also signs of Palantir’s “expansion” phase gaining momentum across its commercial segment. For instance, Palantir has recently expanded its existing relationship with Stellantis (STLA), taking the deployment of Foundry beyond the automaker’s founding companies and to the global stage through an “enterprise-wide license across [Stellantis’] ecosystem and 14 automotive brands”. Stellantis will also “leverage Foundry to build a unified digital twin of its operations and accelerate company-wide synergies” under the newly expanded partnership, and rely on Foundry to improve operational efficiency under the automotive industry’s supply-driven performance today.

The expanded partnership with Stellantis marks a milestone for Palantir’s presence in the automotive industry. Specifically, the partnership validates and bolsters confidence in Palantir’s capabilities related to the facilitation of critical digitization needs within the automotive sector, spanning supply chain management to the development of next-generation technologies like electric powertrains, and autonomous and connected mobility. Palantir’s continued success with Stellantis is expected to pave way for an expanded presence of Foundry across the automotive sector, as it undergoes a once-in-a-generation transformation that will require the assistance of innovative data analytics and management software to generate critical insights needed for success.

Step 3: “Scale”

While Palantir is starting to see an increasing base of customers in the “scale” phase, we do not expect its growth rates to normalize anytime soon. This is because there are still significant opportunities for Palantir to “acquire” and “expand” over coming years as both the public and private sectors view the need to bolster and modernize their technology stacks as a survival requirement within the increasingly digital era.

Despite mounting economic uncertainties amid surging inflation, increasing interest rates, and rising recession risks, there have been little sign of reduced demand in cloud-based data analytics and management solutions like those offered by Palantir. More than half of the corporate scene have expressed that they would rather “tighten the belt” in other parts of the business than to miss out on digital transformation, which is considered a strategic investment in differentiating themselves from competitors, while also enabling cost efficiencies. Commercial customers are increasing demand for tools to make sense of their massive data troves. To date, only 4% of companies claim to have a “highly sophisticated approach to leveraging data”, leaving sizable growth opportunities for Palantir over coming years.

With a structural “scale” phase taking over the majority of its customer base likely still years away, we expect Palantir – which already benefits from free cash flow margins of more than 20% – to benefit from a sustained trajectory of margin expansion and accelerated profit growth over the longer-term. Paired with favorable industry trends, Palantir is uniquely positioned for a lasting multi-year growth trajectory in both its top- and bottom-line as all of “acquire, expand, and scale” ramps up simultaneously over coming years.

Final Thoughts

With “acquire” and “expand” still gaining momentum to drive overall market share gains for Palantir, and a moderating “scale” phase that is still taking the back seat, yet gradually happening behind the scenes at the same time, the company continues to track favorably and positively towards its multi-year growth target of more than 30%. Although mounting macro uncertainties continue to weigh on the stock market’s performance, Palantir’s cash flow positive business, positive long-term growth trajectory, and critical role in the provision of next-generation software builds a strong case that the company’s shares will re-emerge stronger once the market headwinds subside.

We are maintaining our near-term PT on the stock at $15, which would represent upside potential of close to 50% based on the last traded share price of $10.11 on July 20th. We believe the stock has yet to reflect Palantir’s sustainable long-term growth profile ahead, and the current market climate has created a favorable risk-reward payoff at current levels for long-term investors.