Scott Olson
Article Thesis
Palantir Technologies Inc. (NYSE:PLTR) reported its fourth-quarter earnings results and easily beat estimates. This has made Palantir’s shares rise sharply, as analysts and investors had expected a weaker operational performance. The addition of new commercial customers and Palantir’s exposure to the ongoing war in Ukraine could allow the company to grow its business meaningfully going forward, while Palantir’s valuation isn’t overly high on a price-to-sales basis.
What Happened?
Palantir Technologies reported its fourth-quarter earnings results on Monday afternoon. These are the headline numbers from the report:
Seeking Alpha
The company beat estimates on both lines, which naturally is great. While one can argue that the earnings beat is not very important, as Palantir is barely profitable (on a non-GAAP basis) anyway, the revenue beat was great to see — after all, higher-than-expected sales prove that the market had overestimated the decline in Palantir’s business growth rate. While a 21% revenue increase was not as large as what Palantir has delivered in most of the quarters in the past, it is still very meaningful.
And when we consider that other tech companies are reporting flat or even declining revenues, including heavyweights such as Apple (AAPL) and Microsoft (MSFT), then an 18% revenue increase seems quite appealing on a relative basis. As a result of the better-than-expected operational performance, Palantir Technologies saw its share price jump up by 19% in after-hours trading at the time of writing. Since shares are volatile, that could easily change, however.
The Good And Bad
The headline numbers looked quite good, at least relative to what investors and Wall Street analysts had expected. But when we delve into the numbers, there were some negatives as well.
Palantir continued to add commercial customers at a rapid pace. The customer count rose 55% year-over-year, and continued to rise on a sequential basis, as well as PLTR’s customer count rose 9% from the previous quarter, which pencils out to an annualized growth rate of more than 40% [1.09^4]. It thus looks like Palantir’s offerings remain highly relevant for businesses and corporations around the world, as they otherwise wouldn’t flock to Palantir. The fact that new customers are added at a rapid pace despite the ongoing economic slowdown when many companies are looking to preserve cash, is positive, I believe. This suggests that a deal with PLTR makes economic sense and is not just a prestige project — otherwise, PLTR would have a harder time adding new customers at a time when many tech companies are reducing their headcount due to a weak business environment.
The fact that Palantir’s commercial revenue rose by just 11% despite a 55% customer count increase is somewhat perplexing at first sight. There are several factors at play here. First, a strengthening U.S. dollar hurts Palantir’s non-U.S. revenue performance once those revenues are denominated in U.S. Dollars. The same impact was seen in the results of many other tech companies, where underlying business growth was considerably stronger than the reported revenue growth rate. Second, when Palantir adds a new customer, the deal value oftentimes is rather small at first, as PLTR and the customer have to establish a business connection at first. When that goes well, additional orders can be placed and additional deals can be crafted, which allows Palantir to ideally grow its revenue per customer over time. When many new customers are added, with below-average deal values at first, then it is not surprising to see that PLTR’s revenue did not grow as much as its customer count. Last but not least, Palantir is not able to recognize all of the revenue it generates from a contract when the contract is signed. Instead, revenues will be recognized over time, thus adding a new customer does not boost revenues massively immediately, but it will still be highly beneficial for Palantir and its shareholders over time.
On the government side of Palantir’s operations, the performance was healthy as well. Palantir grew its government revenue by 23%, with most of that growth stemming from increased revenues from the U.S. government (around 40% of PLTR’s overall revenue). Ongoing growth in government revenues is positive, especially since currency rate headwinds are not an issue for the U.S. government business. The war in Ukraine plays a role for government revenues, as Palantir Technologies is a technology provider that helps the Ukraine Armed Forces in a range of tasks, including targeting, according to Palantir’s CEO. With that war continuing and seemingly becoming more active again, Palantir will likely receive additional attention from governments around the world — as they see the potential for Palantir’s technology in a real setting, additional governments might be inclined to craft deals with Palantir to get access to the same technology.
When it comes to Palantir’s profitability, there’s some good and bad news. Palantir has, somewhat surprisingly, managed to become profitable on a GAAP basis, although only marginally. On a GAAP basis, Palantir earned $0.01 per share, or $31 million on a company-wide basis — this was PLTR’s first GAAP profitable quarter ever. Some bears have argued that all of Palantir’s business growth was meaningless as the company would never become profitable, but this isn’t true. Instead, Palantir has made major progress in improving its profitability over time.
While Palantir’s revenue rose by 18% year-over-year, its operating expenses rose by just 4% over the same time frame, from $404 million to $422 million. This is great, as it means that Palantir’s revenue growth is highly accretive. When a company grows its revenue quicker than its operating expenses, that’s called operating leverage. Operating leverage allows companies to grow their profits faster than their revenue, all else equal. Some bears have argued that Palantir would never benefit meaningfully from operating leverage, due to presumed high operating expense growth per each additional contract and customer. But we see that this is not true — PLTR grew its customer count by more than 50% and its revenue by close to 20%, and yet, operating expenses were up only marginally. In fact, operating expenses were down year-over-year when we account for inflation, which was north of 4% over the last year.
As a result, Palantir’s margins have improved dramatically over the last year. While the company generated a $156 million loss in the previous year’s quarter, PLTR swung to a profit in the fourth quarter of 2022. Palantir’s GAAP operating margin improved by 1,000 base points over the last year. If the company keeps that margin growth in place, it will become quite profitable in the not-too-distant future.
For some bears, share-based compensation (“SBC”) has been a major concern. And Palantir did indeed issue a large number of shares to employees and management in the past. But the SBC spending has slowed down drastically in the more recent past. During the fourth quarter, Palantir’s share count averaged 2.09 million, up 4% from 2.01 million one year earlier. That still makes for some dilution, but it’s far from drastic relative to the revenue and profit growth rate. If the pace of dilution remains at this level, SBC shouldn’t be a major concern going forward.
Palantir’s guidance for the current year came in below expectations, which is negative, of course. The company has guided for revenues of $2.18 billion to $2.23 billion, or slightly more than $2.2 billion at the midpoint of the guidance range. Palantir has generated revenues of $1.91 billion in 2022, which implies that PLTR will grow its sales by 15% this year. That’s less than Palantir’s revenue growth rate in 2022 and less than what analysts had predicted. It should be noted, however, that Palantir might outperform its guidance, as management has sometimes given overly-conservative guidance in the past. Even if Palantir were to hit the 15% revenue growth guidance, that would still be a much higher growth rate compared to what many other tech companies will be delivering this year.
Final Thoughts
Palantir Technologies Inc.’s Q4 results looked very solid. The improving profitability and strong commercial customer count growth are great, I believe. The hefty after-hours price jump suggests that many investors were very negative going into this report, and a better-than-expected performance has resulted in significant rally potential.
Based on the current after-hours price of $9.20, Palantir is valued at $19 billion, which is equal to a little less than 9x forward revenue. That’s not a low valuation, but might be justified if Palantir continues to grow its business at an attractive pace for years while also benefitting from further margin expansion. When we account for Palantir’s net cash position of $2.6 billion, the sales multiple declines to around 7.5 — between that of Apple (6x) and that of Microsoft (9x).
I liked Palantir better at $7 than at $9 and higher, but especially if the broad market sentiment remains healthy, Palantir could climb further going forward. Meta Platforms (META) and Tesla (TSLA) have proven that stocks that have fallen a lot can rise rapidly once sentiment improves — and Palantir Technologies Inc.’s improving profitability could be a sentiment-improving factor for sure.
