Palantir Technologies Inc. (New York Stock Exchange:PLTR) reported its third-quarter earnings results Monday morning. The company beat revenue expectations on the back of continued compelling business growth, but profitability was slightly worse than expected. Considerable uncertainties remain in the execution, but I think that Palantir Technologies is a company that offers significant long-term opportunities if things go well.
When Palantir Technologies reported its third-quarter results, the company beat revenue estimates but fell short of the bottom line:
Initial market reaction was negative with the stock down 2% at the time of writing, but investors can expect the stock to be volatile in the short term so this could change. Earnings per share were half of what was expected, but given the low absolute number, I think it wouldn’t have mattered much if the company had hit the estimates. Revenue performance was slightly better than expected, despite headwinds such as the exchange rate. Let’s dive into the details.
Business momentum remains strong, but execution is key
Palantir Technologies has long been considered a very government-focused company. Many saw this as a key risk, as changes in government strategy or spending could hurt Palantir. But over time, that has changed, as Palantir Technologies has seen faster growth in its commercial business relative to the growth it generates in its government business.
Palantir Technologies helps companies optimize their supply chains, helps mining and energy companies identify the best areas for exploration, helps companies identify risks to their business models to make them more resilient, etc. In short, Palantir can perform a wide range of potentially very useful tasks for all types of businesses, which is why its offerings are in high demand.
During the third quarter, Palantir’s business revenue increased 53% in the United States. Trading revenue growth in overseas markets was hampered by adverse exchange rate movements, as a strengthening US dollar means revenue generated in euros, yen, etc. they are worth less once denominated in US dollars. However, the US dollar is not likely to strengthen forever, so I think this headwind will probably die down eventually.
In terms of growth in the number of Palantir’s commercial clients, performance has been excellent: the company added 66% to its number of clients in the last year, mainly driven by additional commercial clients. Investors may now be wondering how Palantir can grow its customer base by close to 70% while generating around 20 years of revenue growth. There are several factors at play. First, the aforementioned currency rate headwind reduces earnings growth, all other things being equal.
More important, however, are two other factors. When Palantir adds a new customer, it is often a smaller project to start the relationship and see what works best for the customer. Once that is done and the project is successful, the client will be willing to work with PLTR on a larger project. Therefore, new clients often come with below-average deal sizes at first. But given that Palantir’s customer retention is high, which means customers must be happy with the results PLTR delivers, there’s a good chance that rapid customer growth today will add up to more significant revenue growth tomorrow. in the future, once the relationship is more established and customers make bigger deals with Palantir.
In addition to that, the lower revenue growth rate is also a result of how Palantir is able to recognize revenue under GAAP accounting standards. When Palantir closes a deal on a $10 million contract with a 5-year lifespan, it typically fails to record $10 million in revenue in the first year. Order intake, or the value of the closed deal, is therefore much higher than Palantir’s reported revenue. During the third quarter, Palantir closed $1.3 billion worth of deals, but its reported GAAP revenue was only $480 million. The value of the deals that Palantir has drawn up is therefore about 3 times higher than what Palantir reported in terms of revenue. I believe the reported revenue number seriously understates Palantir’s underlying business performance, that is, its ability to forge deals with clients on both the government and commercial sides. Since those deals will result in future revenue being recorded, considerable revenue growth has already been “locked in.”
From an underlying business growth perspective, I think the third quarter looked pretty good. Palantir’s trading business is growing at a compelling rate, the company is adding new customers at a massive rate, and the total value of the contract that Palantir closed is much higher than PLTR’s reported revenue, suggesting that there is business growth “hidden” that has not yet been registered. in GAAP numbers.
The underlying business growth is important, but other things are also important. Margins and dilution are two of the key elements when it comes to Palantir Technologies. Some investors believe that Palantir will always be a low-margin business, for stated reasons, such as that a lot of customization is needed for each client. But Palantir can actually increase your margins quite quickly. Over the past year, Palantir’s operating margin has expanded by 1,000 basis points, for example. Palantir still reports a negative operating margin, but the massive improvement over the past year suggests that there is a lot of operating leverage at work.
While many other tech companies, including big names like Meta Platforms (META), Alphabet (GOOG)(GOOGL), and Amazon (AMZN), have seen their margins decline over the past year, Palantir’s margins have improved tremendously. When that trend continues, Palantir will certainly be profitable in the not too distant future, even on a GAAP basis, while the company is already profitable on a non-GAAP/adjusted basis today. The company also raised its outlook for this year’s expected operating income, suggesting cost controls are in place and the company isn’t facing the same profitability issues as many other tech companies. Sure, Palantir isn’t ultra-profitable yet, but its profits will be higher than the company expected earlier this year, which can’t be said for the profitability performance of many other companies.
Operating cash flow, and also free cash flow, has been positive for quite some time. That’s great, as it means there’s very little risk of bankruptcy, compared to other “growing” names with high cash burn rates. On top of that, the accumulation of cash on the balance sheet gives Palantir Technologies some choice when it comes to future M&A and/or shareholder returns. At the end of the third quarter, Palantir’s cash position totaled $2.4 billion, excluding restricted cash, which is equivalent to about 15% of Palantir’s market capitalization – a fairly sizable cash reserve, much larger, in relative terms , compared to the likes of Apple (AAPL) and Microsoft (MSFT).
It should be noted that cash flow has benefited from Palantir’s share-based compensation (SBC). While SBC is not unusual for technology companies, and especially for smaller, “growing” technology companies, much attention has been paid in the past to the issuance of Palantir shares to employees and management. That is still happening, but at a greatly reduced rate. Over the past year, the number of Palantir shares increased by 5.5%, from 1,964 million to 2,073 million. It would be better, of course, if there was no dilution at all, but I don’t think a dilution of around 5% is too much of a problem for a company that is growing its number of customers and revenue at a much higher rate. If Palantir were a non-growth company, the 5% annual share count dilution would be a major issue. But given that business growth is many times greater than Palantir’s share count growth, I think there’s not too much reason to worry about dilution here.
It’s also worth noting that Palantir’s diluted share count has actually refused over the past year, from 2.34 billion to 2.14 billion shares, which should further ease concerns. Stock-based compensation expenses are also down year-over-year in both the third quarter and year to date, also suggesting that dilution isn’t the big deal some investors think it is. It is true that there is some dilution, but that is true for almost all technology companies. SBC is declining in absolute terms, basic share count is increasing only slightly, and diluted share count is declining; that doesn’t sound like a stock breakout problem to me.
I think Palantir’s performance in the third quarter was compelling. The massive closing of the contract value bodes well for the future, as does the growth rate of PLTR’s clients. Forex rates are a bit heady, but Palantir is generating compelling trade growth nonetheless. Margins continue to expand rapidly, which should lead to GAAP earnings in the not too distant future. With the dilution coming down considerably, it no longer seems to be the main issue some have made it out to be.
Palantir is currently trading at about 9x this year’s revenue and about 7x this year’s revenue when we adjust for its large cash position. For a company with over 20% revenue growth and tremendous business growth potential, I think that doesn’t sound like a very high valuation. It is true that there are some uncertainties about long-term performance, but the trends are positive and I think Palantir could be a very profitable long-term holding at current valuation.