Initiating coverage on Palantir Technologies (PLTR) 36.45 with a buy rating. The company is engaged in building software to assist in counterterrorism investigations and operations. On Friday it was announced they are being added to the S&P 500. Many Institutional investors, such as mutual funds and pension funds often track the S&P 500 index because it is a widely recognized benchmark for U.S. the stock market to buy the stock once it is added. This should provide a boost to PLTR. But that isn’t the only reason. Its position as a leader in the AI and data analytics space, with extensive government and commercial ties, ensures recurring revenue and strong customer retention. As Palantir expands into commercial sectors, its Foundry platform shows significant growth potential across healthcare, energy, and finance industries. Combined with its transition to sustained profitability and high free cash flow generation, Palantir is poised to capitalize on the increasing demand for AI solutions. Despite a high valuation, Palantir’s unique capabilities and strategic advantages offer a nice upside to this stock.
Palantir Technologies, a pioneer in data analytics and AI-driven solutions, caters to both government and commercial clients worldwide. Known for its Gotham and Foundry platforms, Palantir’s advanced solutions aid in complex decision-making processes, real-time analytics, and predictive capabilities, establishing it as a critical player in sectors requiring high-stakes data interpretation.
Operating Segments
Palantir operates through its Government and Commercial segments. Its Gotham platform, primarily used by government agencies, supports critical national security efforts, while Foundry, Palantir’s commercial platform, has gained traction in industries like healthcare, finance, and energy.
Unique Moat
A distinguishing factor for Palantir is its high customer retention, especially within the government sector, where it boasts a 98% retention rate. This high lock-in rate not only drives recurring revenue but also acts as a competitive barrier, as Palantir’s integration into client workflows becomes deeply ingrained. In the commercial sector, Foundry’s adaptability across multiple industries enhances Palantir’s moat, allowing the company to tap into new revenue streams as the demand for data-driven solutions expands.
Opportunities
The global AI market is projected to grow significantly, creating new opportunities for Palantir’s platforms. Its expertise in machine learning, predictive analytics, and data integration is highly sought after, especially as industries look to AI for optimized decision-making. Palantir’s ongoing expansion in the commercial sector, which now makes up 60% of its revenue (Q2 2024 Earnings Report), positions it well for sustained growth.
Competition and Threats
Despite Palantir’s advantages, it faces competition from companies like Snowflake and C3.ai in data solutions and AI-driven analytics. Additionally, high operational costs and economic headwinds like rising interest rates and potential budget cuts in government spending could impact its growth trajectory. However, Palantir’s strong relationships with both the U.S. government and corporate clients provide resilience against these challenges.
Financials and Balance Sheet
Palantir’s strong balance sheet and profitability milestones reflect its resilience. For Q2 2024, Palantir achieved free cash flow margins of 25%, underlining its financial strength (Q2 2024 Earnings Report). Moreover, Palantir’s high gross margins of 80%+ give it a significant advantage over peers who are yet to achieve profitability.
Peer Analysis
A peer multiples comparison underscores Palantir’s relative strength:
- P/S Ratios: Palantir’s P/S ratio of 20x is high but still below Snowflake’s 30x, which reflects the premium placed on AI and data analytics companies.
- Profitability: While competitors like Snowflake and C3.ai are not consistently profitable, Palantir’s strong free cash flow generation enhances its financial flexibility.
Big Hedge Fund Buying
Recently (the quarter ended June 2024), several notable hedge funds have increased their positions in Palantir (PLTR), signaling confidence in its growth potential. Noteworthy buyers include Renaissance Technologies, which has been known for its data-driven investment strategies, and Citadel Advisors, a prominent player in the hedge fund space. Additionally, Viking Global Investors has also shown interest, suggesting a trend among institutional investors seeking exposure to Palantir’s innovative capabilities in AI and data analytics. And Stanley Drunkmiller, after selling his entries stake, repurchased almost everything.
Potential Upside: Large Short Position for Palantir
The high short interest in Palantir Technologies (PLTR) presents a compelling potential upside for the stock, which can be highlighted through several key factors:
- Short Squeeze Potential: A large number of short positions indicates that many investors are betting against Palantir’s stock price. If the company reports strong earnings or positive news that contradicts the bearish sentiment, it could trigger a short squeeze. In this scenario, short sellers would be forced to buy shares to cover their positions, leading to a rapid increase in the stock price. Historically, stocks with high short interest often experience significant volatility, and Palantir could benefit from this if it can deliver positive catalysts.
- Market Sentiment Reversal: As more investors recognize Palantir’s strong fundamentals, including its leadership in AI and robust revenue growth, positive sentiment could shift. This shift could lead to new buying pressure from long investors, further fueling the stock’s price increase. If short sellers begin to cover their positions in anticipation of rising prices, it could create a feedback loop that drives the stock even higher. For example, recent developments in AI applications across industries could enhance market perceptions of Palantir’s value.
- Undervalued Growth Prospects: The high short interest may stem from skepticism about Palantir’s future growth potential and its ability to maintain momentum in a competitive landscape. However, if the company successfully capitalizes on opportunities in commercial sectors, expands its government contracts, and showcases strong financial results, it could challenge the negative narrative. A significant realization of its growth potential could prompt a reassessment of the stock’s valuation, leading to upward price adjustments as shorts scramble to exit.
- Broader Market Movements: In times of increased volatility or positive market trends, stocks with high short interest can see sharp price increases as sentiment swings. If the overall market shifts in favor of tech stocks or AI-focused companies, Palantir could see a corresponding rise in its stock price, especially if short sellers are caught off-guard by the sudden upward momentum. This broader market support can further amplify the effect of a short squeeze.
- Investors’ Interest in AI: As investor interest in AI technology continues to grow, stocks like Palantir that are positioned as leaders in this space could attract attention from institutional investors. Increased demand for shares can lead to price appreciation, especially if the current short positions remain substantial. The juxtaposition of increasing demand and ongoing short interest creates a volatile yet potentially lucrative environment for Palantir’s stock.
Risks
Interest Rate Environment
In a high-interest-rate environment, borrowing costs rise, which could impact Palantir’s operating expenses and make capital more expensive for potential acquisitions or R&D investments.
Unemployment and Economic Downturn
A potential rise in unemployment could slow the adoption of new AI and analytics tools in certain industries. However, Palantir’s government contracts may provide some insulation from economic downturns, thanks to consistent budget allocations for national security.
High Number of Shares Outstanding for Palantir
Palantir Technologies (PLTR) has a high number of shares outstanding, a factor that introduces several potential risks for investors:
- Dilution of Shareholder Value: Palantir has used stock-based compensation (SBC) extensively, especially for talent acquisition and retention. While this can attract top talent, it also increases the share count, diluting the ownership and potentially the value of existing shares. Dilution affects earnings per share (EPS) and can lead to lower-than-expected gains for shareholders, especially as EPS growth is an important factor for stock appreciation.
- Potential Limits on Stock Appreciation: With a large base of outstanding shares, the company requires significant earnings growth to boost EPS meaningfully. For a stock with a smaller share count, even moderate growth can drive larger EPS gains, creating greater upward pressure on the stock price. With Palantir, the large share count could mute EPS growth, potentially limiting price appreciation and making it harder to justify high multiples, especially given the competitive AI and analytics landscape.
- Overhang from Insider Selling: Many Palantir insiders received stock-based compensation, which can lead to selling pressure as lock-up periods expire or personal financial needs change. If insiders sell substantial portions of their shares, it can create downward pressure on the stock price, undermining investor confidence. This risk is particularly pronounced when there is a large number of restricted shares, as unlocking them could flood the market with additional shares, driving down share prices.
- Reduced Flexibility for Future Financing: Given Palantir’s already high number of shares outstanding, issuing additional shares to fund growth initiatives or acquisitions may become challenging, as it would further dilute existing shareholders. This could limit Palantir’s flexibility in using equity as a financing tool, especially if the stock price drops or fails to rise significantly. The company may need to consider debt financing, which could add interest expenses and reduce profitability, introducing financial risk.
- Lower Potential for Dividends and Share Buybacks: While Palantir is not currently a dividend-paying company if it were to initiate a dividend in the future, the high share count would mean lower dividend payments per share or higher total cash outlay, which could strain cash reserves. Similarly, executing meaningful share buybacks to reduce share count and counteract dilution would require a substantial financial commitment. For Palantir, given its high share count, achieving a significant reduction through buybacks would be costly and potentially detract from investments in growth or R&D.
In summary, Palantir’s high share count is a significant risk factor that could affect share appreciation, limit financing options, and create dilution risks for existing shareholders. Investors should consider these dynamics in evaluating Palantir’s long-term value, especially if stock-based compensation continues to be a core component of its compensation strategy.
Conclusion
Palantir faces risks associated with its high number of shares outstanding, the significant short position against the stock also presents notable risk with volatility. A positive shift in sentiment, fueled by strong performance fueled by enterprise growth developments, could result in a rapid appreciation of the stock as short sellers rush to cover their positions. Investors should weigh these factors when considering Palantir as part of their portfolio strategy, as the interplay between short interest and market performance could create substantial opportunities for upside. This is not a stock for conservative investors. I DO NOT OWN THIS stock. I look at it as a good trade to the upside. I think there are too many shares outstanding for a long-term hold of this stock, as the short sellers most likely will return one day. Keep a tight stop loss with this stock.