Palantir is on Fire - How to Assess the Potential from Here

1 Peter Chapter 3 verses 8-9 state, "Finally, all of you, be like-minded, be sympathetic, love one another, be compassionate and humble. Do not repay evil with evil or insult with insult. On the contrary, repay evil with blessing, because to this you were called so that you may inherit a blessing." For me, when times are good and things are going well, it's a lot easier to digest these verses and act them out. However, when difficulty hits, I tend to lose sight of of these principles and inevitably, end up doing the opposite, before realizing what I've done.

Palantir Technologies (PLTR) has been on a tear the past month and has taken the investment world by storm. Since November 4, 2020, the stock price for Palantir has increased by 175% or so as it trades today, November 27, 2020. The company faced immediate pressure its first trading day as news broke that Alexandria Ocasio-Cortez, AOC, asked the SEC to investigate Palantir before it began trading. As the market has digested the company's prospects, it has clearly warmed up to the potential.

Similar to the Bible verses above, it's always important to remain humble and consider the key factors in attempting to assess Palantir's valuation today versus tomorrow. A lot has been written on deconstructing what Palantir is, and what it is not. It is important to recognize Palantir's market and competitors, among other factors, but I am going to focus on the company's valuation and growth potential from this point forward.

I always focus on the primary metrics to drive my investment performance, namely, Revenues and Operating and Free Cash Flow, OCF/FCF. At the same time, I also consider a company's net cash position, shares outstanding, and other key metrics driving the business. Taking these into account, here's Palantir's snapshot from a trailing twelve-month, TTM perspective today:

  • Revenues: $1 billion

  • Gross Margin, GM: 64%

  • OCF/Percentage: $57 million / 6%

  • FCF/Percentage: $134 million / 13%

  • Net Cash Position: $1.7 billion

  • Average Revenue of Top 20 Customers: $23.6 million

  • Average Revenue per Customer: $5.8 million

  • Contribution Margin: 47%

  • Shares Outstanding: 1.7 billion

There's a few things I'll talk about here. First, Palantir's Revenues are split between Government and Commercial segments. The Government segment has witnessed substantial performance, up 70% in 2020, while commercial performance has been strong as well up 30%. Both of these segments are expected to continue to witness robust growth in the near-term.

Next, GM has declined, while operating expenses have concurrently increased. This has primarily been driven by Palantir's increasing Stock-Based Compensation, SBC, expenses. Reconciliation on the Cash Flow Statement, CFS, gives us a more clear picture of the magnitude of these impacts.

The last and most important thing I am paying attention to from these metrics is the OCF/FCF inflection that is occurring. Before Palantir went public and after I scrutinized their prospectus, it was clear from the June 2020 quarterly information that Palantir had the opportunity to generate a 10-15% CF margin. Once public, management confirmed this with their pre-quarterly filing information. Palantir is on track to see inflection in CF based on this through 2020 and beyond.

The reason why Palantir's FCF is higher by a large amount versus the OCF is that I include all financing activities, only excluding IPO proceeds and debt (including adjustments/costs). These range from Exercise of Stock Options, to Lease Payments, and Other items.

Taking it to the next step, I am modeling the same key metrics through 2022 for Palantir as follows:

  • Revenues: $2 billion

  • Gross Margin, GM: 68%

  • OCF/Percentage: $400 million / 20%

  • FCF/Percentage: $450 million / 23%

  • Net Cash Position: $2 billion

  • Average Revenue of Top 20 Customers: $23 million

  • Average Revenue per Customer: $6.2 million

  • Contribution Margin: 50%

  • Shares Outstanding: 1.8 billion

Right now we are nearing the end of November 2020. Palantir has guided for Revenues of $1.4 billion next year, but it is important to get ahead of the upcoming two-year forecast for 2022. A big mistake in my opinion would be to continue to value Palantir based on next year's results, which would give us a less clear projection of where the stock value possibly lies. In essence, it is always good to have around an 18-month horizon for where the stock price may be headed over the next couple years.

Today, Palantir has an Enterprise Value, EV, near $50 billion, with the Stock Price, SP, around $29. This affords the company a nearly 50 times EV/Revenues and 900/375 times multiple for the SP to OCF/FCF per share. This is all based on Palantir's TTM information snapshot above. These numbers suggest clear overvaluation, but before I get too worried, I need to take a look at the comparable future forecast valuation based on the company's growth potential.

Based on the 2022 forecast information, if I assign Palantir a 30 times EV/Revenues and 175 times OCF, I can justify a SP at around $40 per share - a 33% premium. If I were to assign a 20 times EV/Revenues and 100 times OCF, the SP value would be around $24 per share - a 20% discount. These are pretty wide ranges, which typically translates to higher volatility for the SP in the near-term.

From a relative perspective, Palantir is still cheaper from an EV/Revenues multiple than say Snowflake, Inc. (SNOW) or Datadog, Inc. (DDOG), but is much more expensive than a company like Splunk, Inc. (SPLK). It's a little tricky to compare OCF/FCF on these names as all are witnessing varying degrees of performance based on their business models.

Upon deconstructing Palantir's current valuation against key multiples, the stock clearly trades at a premium today. What I think the most important point from all of this is, is that Palantir is on the verge of accelerated growth for Revenues, and inflection for OCF/FCF. These are two things that I look for in strong growth opportunities. These are also items that lead to volatility as markets have a hard time getting a handle of valuation versus future potential. What is not likely, is for Palantir to be trading 10-15 times EV/Revenues, nor below 100 times OCF over the next couple years. Longer term, these numbers will inevitably materialize assuming the growth story remains strong.

I recognized Palantir's potential early as it began trading. The news from AOC pushing the stock price down initially was a gift and I have built a core position in Palantir as it is now a top-five holding in the portfolio. I am not a buyer at today's levels, but I do suspect that a price approaching and sustaining the $40 per share level over the next 12-18 months will not be unreasonable.

Lastly, news just broke as I was writing this regarding Citron Research announcing that it is short Palantir with a $20 price target. I have a very low opinion of Citron Research, and feel that they are simply trying to the push the SP to a buying level they would prefer. In the event Palantir's SP did drop towards $20 or below, I would likely consider averaging further.

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