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Hey everyone! Hope you are having a great weekend!
I did a pitch about Palantir this week during Commonstock's Market Game and wanted to share my pitch(briefly) and elaborate on my thesis on Palantir to provide a different perspective. I was planning for this to be paywalled but opted to keep it open for everyone's benefit.
Let's dive into it!
Palantir is a widely misunderstood business due to three reasons:
- They build software platforms that can be hard to understand if you don't work with technology in general
- People fail to disregard the widespread misinformation about them and move past it to look at their actual business
- They are visionary and creative, so they end up building futuristic software that can be incredibly hard to grasp as most people are concerned with the present or the past(If you fail to move beyond financial statements and fail to appreciate quality, you are here)
Let's look at Palantir's Innovation & Technology
Palantir is a platform(or operating system) builder at heart and they have built 3 platforms that have made them successful and will make them successful over the next decade.
- Gotham, Palantir’s first platform, was built for government operatives in the defense and intelligence sectors.
- The platform enables users to identify patterns hidden deep within datasets, ranging from signals, and intelligence sources to reports from confidential informants.
- Defense agencies in the United States then began using Gotham to investigate potential threats and to help protect soldiers from improvised explosive devices.
- Today, the platform is widely used by government agencies in the United States and its allies.
To learn more about Gotham I recommend you to check out the following videos created by Palantir(I want to keep this post brief)
- Foundry is the result of years of investing in the development of a platform that makes the task of integrating new datasets routine so that users can focus on taking action on the information.
- All of Palantir’s commercial customers now use it, and several government customers.
- Foundry transforms the ways organizations operate by creating a central operating system for their data.
- Individual users can integrate and analyze the data they need in one place. The speed with which users can experiment and test new ideas is what makes the software sticky.
To learn more about Foundry I recommend you to check out the following videos created by Palantir(I want to keep this post brief)
Apollo is the platform that enables autonomous deployment of software across any environment, think of it as Palantir’s secret sauce(think AWS and Amazon) that powers Gotham and Foundry.
To learn more about Appollo I recommend you to check out the following videos created by Palantir(I want to keep this post brief)
Another one - https://www.youtube.com/watch?v=3kSGlg8d5mI
Let's look at the success Palantir's Platforms have enjoyed till now
From the above image, we can see that Gotham which powers Palantir's Government business has had a 30% CAGR from 2013-2021. This is a lumpy business due to the nature of Government contracts and will stay lumpy possibly forever(unless there is a change in the way Governments invest). I expect this to pick up steam again in Q2 and Q3 of 2022. Also if you look at their unit economics for this revenue stream, they have tripled the revenue they generate per customer within a span of 3 years(that's hypergrowth - 40%+ CAGR).
Now, from the above numbers, we can see that in the most recent Q1 quarter there are in hypergrowth mode for their overall commercial revenue stream and this is just the beginning, they have started to press the gas pedal on their US commercial revenues and we will see a lot of ex-US commercial growth after some time(Usually Europe and other regions are a priority for expansion after significant US expansion).
Now, if you want to see the effects of Palantir pressing the gas pedal on their US commercial revenues, the above image should break a tear in your eyes. Look at that, they are exceeding 100%+ growth and I think this should continue for a while(They are still in the early stages of building their salesforce and GTM and they have just 103 US commercial customers). Over time I think US commercial revenues will contribute more than 50% of their total revenues and possibly exceed that threshold.
Let's look at the Market opportunity for Palantir's Platforms
The market opportunity for Palantir with Gotham and Foundry was $100B+ at DPO(yes, not an IPO, love this), and with the addition of Apollo, you can possibly add at least $5-10B(conservative) on top of it. Gotham, their flagship product is a monopoly with no viable cost-effective alternatives out there. Foundry and Apollo are new and I expect them to capture a 10% market share of their TAM over the next 7-10 years. That tells us they can achieve $10B of revenues over the long term. Also, uniquely, Palantir has issued long-term guidance of 30% growth till 2025 and $4B of revenue by 2025. I think this is conservative and they should exceed this.
So what is Palantir doing after they build a platform? They keep building on top of it and keep adding incremental value for their customers and importantly their actual users like analysts and software developers. From the above image, you can see their progress on their platform innovation.
Let's look at Palantir's Mission, Team & Culture
Palantir's founding team is legendary. Peter Thiel is one of the greatest investors and VCs of our time. Alex Karp is also known to be an incredibly successful investor. They appreciate the power of incredible talent in solving challenging problems with a mission and vision giving the employees a sense of purpose. This culture will help them power through difficult times. They realize the power of creating cutting-edge software that is futuristic that not only solves customers' current problems but also future problems is a creative endeavor. This is why they don't have traditional career paths at Palantir and have developed a differentiated culture that supports employees' strengths, skills, and interests for the long term. Also, while hiring, Palantir is very selective and is looking for individuals who are creative, entrepreneurial, have strong personalities, and deeply care about their work.
Both Peter Thiel and Alex Karp are philosophers and masters of understanding technology and applying it to solve problems. In a sense, they are harnessing the power of Art and Science to develop an unfair advantage in the creative endeavor of building software platforms.
Let's look at Palantir's Durability which is necessary for a long-term investment
Palantir is the most durable software business I have seen in recent times. Their strategy of vertically integrating all the numerous enterprise software tools & infrastructure for Data Analytics and Software Development & Delivery is truly differentiated. We can all see the enormously fragmented enterprise software landscape and cutting through all the noise and having a single vertically integrated platform to solve Data Analytics and Software Development & Delivery leads me to believe that their timing with respect to the DPO and current 2020's decade is perfect. Also, I love the fact that they did a DPO and didn't sell out to wall street. Amazingly, they have also figured out that they need to open up their platform for use by their customers and also modularized their software for specific verticals and industries is an indication that they have built a business for decades to come.
Palantir benefits from economies of scale as more customers adopt their platform due to the marginal cost of software development, maintenance, and innovation. Their heavy investment in the initial development of these platforms is already paying off, as we see that Gotham is a fully scaled software business and generating a lot of cash to fund further innovation. Their Foundry and Apollo platforms have already achieved escape velocity and are in a hypergrowth mode to capture market share(They are currently only limited by their Salesforce and GTM motion).
And of course, like every other enterprise software business, Palantir benefits from switching costs over the long term. But, in the case of Palantir, the intensity of switching costs is higher and can be seen through extremely long customer lifetimes(6+ years for US Gov and 4+ years for commercial) and high retention.
As Palantir is used to solve more and more use cases inside a company across different organizations and becomes the single source of truth for all things data and software, Palantir benefits with network effects inside a customer. They also benefit from network effects across industries with their vertical-specific offerings.
Let's look at Palantir's Secrets
The biggest secret that we should focus on is that Palantir is in the business of building vertically integrated platforms that are solving extremely challenging problems for both the physical and digital world. They are not in the business of just building products and keep upselling more products through acquisitions/consolidation. They are highly differentiated and unique in this aspect in the world of enterprise software.
Usually, when most software businesses create something new, they fail to capture a lot of value and leave the market open for others to encroach and exploit. I think this won't happen with Palantir. They started by creating a new market for enterprise software in Government with Gotham and have captured all the value there, ahem, a monopoly. I expect similar dynamics for Foundry and Apollo.
Palantir's success can be thought of as a black swan event. These events are extremely rare and have exponential payoffs or risks associated with them. No one thought they would be successful in Government, then commercial, and now Global. In my view, Palantir is an unstoppable force.
Palantir's leadership understands financial markets incredibly well and they have $2.5B of cash on their balance sheet. They are built for tough times.
Palantir has built a strong alignment of interests between its employees and Palantir, and between Palantir and customers, which is one of the principal reasons for Palantir's success(Think of it as a network effect between top talent who is motivated to solve challenges and customers with a lot of challenges). Also, Palantir is incredibly selective in choosing its customers and partners and looks for alignment in terms of values in general.
Another secret I would like to reveal is their SPAC investment portfolio. This is a soft partnership between Palantir and early-stage companies where Palantir has invested in these companies and in return, the SPAC companies have agreed to use Palantir to build their platforms on top of Palantir's platform. These companies are undervalued in the current market(due to negative sentiment associated with SPACs) but are of incredibly high quality. I have gone through all of these and have made investments in some of them. So overall Palantir invested about $400-500M in them I think the overall portfolio should 10X(if not more) in the next 5-10 years.
So when will Palantir Breakeven?
I wanted to articulate my thoughts on when Palantir could break even (GAAP) so I built the above model. I assume a 30% Revenue growth rate and 10% operating costs growth rate. I use Palantir's full-year 2021 Revenues of $1.5B as a starting point and Gross margins in the range of (78% - 85%).
Using this model, I think Palantir will definitely break even in 2025. Factors that can accelerate this breakeven are rapid gross margin expansion, deceleration of operating costs, and accelerating revenue growth rate. Correspondingly, Factors that can slow down this breakeven are gross margin contraction, acceleration of operating costs, and decelerating revenue growth rate.
Can Palantir be GAAP profitable?
I think they definitely can be GAAP profitable, they have shown their commitment to improving their operating leverage(while still investing in significant growth) through their margin expansion seen in the above image.
If you observe the above image we can see that Palantir's Stock Based Compensation has come down very sharply and I expect it to increase at a steady pace in the future, not like the DPO event outlier we saw earlier. This along with reducing operating losses and consistent adjusted operating margins gives us an insight that they have tremendous operating leverage coming in the future(an expansion from the negative operating loss(-9%) to 30% operating margins).
And last, but not least, I want to leave you with Alex Karp's thoughts on investing for the long term and whether Palantir is a good fit for your portfolio, watch it till the end.
I hope you enjoyed my thoughts on Palantir. It would be perfectly fine to lose your mind a little bit or lose some sleep over the weekend if you are excited about Palantir and would love to explore/research more after reading this post.
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Note: A lot of information in this article is compiled from Palantir's website, SEC filings, and recent presentations/conferences.
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Thanks, take care.
Chet @ Modern Growth Investing