Palantir: Emerging As a Platform
Q3 2023 ER Update with 21% Discount on Paid Subscription
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Onto the update now!
Edited by Brian Birnbaum and an update of my original Palantir deep dive and my Q2 update.
1.0 AIP is Speeding Up Deployment
This quarter AIP (Palantir´s Artificial Intelligence Platform, that enables users to naturally interact with the company's products via large language models) has led to a leap in distribution efficiency, which promises an inflection point for the commercial business and for the company overall.
Though known as a federal contractor, especially for military purposes, Palantir’s commercial business will be responsible for turning it into an AI juggernaut. Improvements in commercial distribution represent the backbone of my Palantir long thesis.
In my Q2 update I explain how AIP is to Palantir what the mouse was to PC companies a few decades ago. AIP enables customers to interact with the product ontology far more naturally, which ultimately lends more efficiency to deployment.
In Q3 AIP, led to a distribution breakthrough, meaningfully accelerating Palantir´s commercial sales pipeline. Palantir has been conducting AIP boot camps with customers who leave with “a series of use cases that are production ready or near production ready that [they] can go forward with.”
“This difference has been so profound that we shifted the entire commercial organization to focus on one to five-day long customer boot camps, where organizations exit with a scalable use case on their actual data that they built for themselves. Customers leave so excited with this definite optimistic view of what can be accomplished and how they'll drive transformation in their organizations.”
-Shyam Sankar, Palantir CTO during the Q3 2023 call.
Although there are many moving parts, the Palantir´s evolution is best described by the growing ease with which it deploys its offerings. As I explain in my deep dive, by productizing its offerings, Palantir can eventually attain a near frictionless level of deployment, thus becoming a platform.
According to management, AIP is now being used by nearly 300 organizations, implying nearly 300% growth QoQ. This pace of evolution is more customary of a platform than of a service company and thus represents a milestone. The advancements in healthcare, analyzed later in Section 2.0, point to the same reality.
As Palantir continues to move in this direction, its operating leverage will rise, producing more attractive unit economics and financials across the board. If the company is protective of shareholders, over the long run, productization of Foundry should produce much higher levels of free cash flow per share.
Revenue growth re-accelerated on the back of our U.S. commercial business, driven by our intense focus on AIP, while margins continue to expand, demonstrating the transforming unit economics of our business.
-Dave Glazer, Palantir CFO during the Q3 2023 conference call.
This quarter, commercial revenue was $251M, coming in well above the $234m consensus. According to management growth is due in part to AIP´s “transformation of the way [Palantir] partners with and delivers value” to customers. In hindsight, I believe we will look at this quarter as an inflection point.
Additionally, this quarter the commercial business has reached a $1B annualized run rate milestone.
US commercial business revenue is up 33% year-over-year. Excluding strategic commercial contracts, it grew 52% year-over-year and 19% sequentially. U.S. commercial customer count rose 12% quarter-over-quarter and is now ten-fold what it was just three years ago, coming in at 181 customers.
Note: Palantir is unwinding its strategic commercial contracts (contracts based on the controversial SPAC deals). The revenue from these contracts is smaller every quarter and that is why the company issues growth metrics excluding them.
Revenue from strategic commercial contracts was $15 million or 2.6% of quarterly revenue, down from $19 million in the prior quarter.
We anticipate fourth quarter revenue from these customers to continue to decline to between $13 million to $15 million, representing 2.3% of expected fourth quarter revenue.
-Dave Glazer, Palantir CFO during the Q3 2023 conference call.
Deal count for Palantir´s U.S. commercial business is 2.4x what it was in Q3 of last year. U.S. commercial TCV (total contract value: the lifetime value of a contract) closed at $252 million, up 55% year-over-year on a dollar-weighted duration basis. In turn, three-fourths of the QoQ growth stems from customers that started with Palantir in 2023, reflecting a good ability to land and expand for Palantir.
Note: since Palantir is my most widely read deep dive, I thought that it would only be appropriate to offer you a 21% discount on my paid subscription, so that more of you can enjoy my Q3 update.
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2.0 The Government and Healthcare Business
While the government business is growing slowly, Palantir is becoming increasingly profitable. Palantir’s growing presence in healthcare supports the idea that government growth is merely in a downcycle while distribution keeps speeding up.
Growth of Palantir’s government business has turned tepid. The segment remains a blindspot for me. While I first invested in Palantir motivated by the upside of the commercial business, I also understood early on its ability to sell across administrations, providing the federal segment an aspect of asymmetry.
We've worked under four administrations, and have seen consistent continuity across that.
-Shyam Sankar, Palantir CTO during the Q3 2023 call.
Third quarter government revenue grew 12% year-over-year and 2% sequentially to $308 million. U.S. government revenue grew 10% year-over-year and 2% sequentially to $229 million. It’s strange to find growth slowing during a period of great geopolitical turmoil. Theoretically, nations should be striving to obtain an edge.
Naturally, this makes one wonder whether Palantir has lost its edge in the government space. This remains a possibility, but I see no tangible signs as of yet. Given the rather notable outcomes for customers in the commercial space, it seems more likely that slower government growth is the result of the market’s natural ebbs and flows.
On the contrary, Palantir’s growing presence in the U.S. healthcare market leads me to believe its edge has only sharpened. Palantir’s software is used by 16% of hospital beds across the US, up from roughly 1% a year ago. This is phenomenal progress, pointing to improvements in distribution.
Ramping healthcare operations in such a short period of time exemplifies improved deployment. Furthermore, I have serious doubts as to whether Palantir is charging healthcare customers, since growth has not affected the segment´s revenue.
Perhaps the growth is being driven not only by productization, but also by sampling, something that requires a watchful eye over the coming quarters.
In September, Palantir also launched Palantir Government Web Services, which enables defense companies to quickly operationalize their solutions via Palantir’s software. Allowing other organizations to piggyback Palantir’s software implies a great leap in productization.
Indeed, Palantir is looking more and more like a platform by the quarter.
International government revenue grew 21% year-over-year and 2% sequentially to $78 million, bolstered by our continued work in health care and defense.
-Dave Glazer, Palantir CFO during the Q3 2023 conference call.
3.0 Financials
Following its shift to profitability, Palantir is now eligible for the SP500. Still, rising SBC remains a concerning aspect of the earnings report.
Income Statement
As revenue continues to scale, total operating expenses remain flat, thus decreasing as a % of total revenue. A year ago in Q3 2022, operating expenses came in at 90.50% of total revenue and in Q3 2023, they came in at 73.50%. The company’s profitability is therefore a result of cost discipline.
I welcome this discipline in tandem with the aforementioned signs that Palantir is evolving into a platform.
Sequential acceleration in revenue seems due largely to re-acceleration of U.S. commercial business, enabled by AIP. Meanwhile, Palantir continues to look for commercial opportunities overseas, with conditions in Europe remaining stale:
Our international commercial business was up 15% year-over-year and 4% sequentially to $134 million as we continue to capitalize on targeted growth opportunities in Asia, the Middle East and beyond, while conditions remain challenging in Continental Europe.
-Dave Glazer, Palantir CFO during the Q3 2023 conference call.
Simultaneously, margins remain stable with no reason for concern.
Cash Flow Statement
Cash from operations is naturally trending up as Palantir continues to display increasing operating leverage. While total revenue is up 4.6% QoQ, cash from operations is up 47.8% QoQ. In turn, adjusted free cash flow is up 381% YoY, while revenue is up only 16.8% during the same period.
It seems the cost of acquiring additional revenue is coming down, with increases in the top line translating into disproportionate increases in cash flow. This is no doubt aided by Palantir’s cost discipline, but even more so by the rapid productization explored in Section 1.0 and 2.0.
I believe that, as AIP continues to progress, cash flow margins will also continue to expand. Palantir Government Web Services should also act as a tailwind, eventually.
Balance Sheet
Palantir ended the quarter with $3.283B in total cash and short term investments and no long term debt, together with $184.1M in capital leases. The balance sheet remains very strong and looks like it will only be getting healthier from here.
We continue to see a stabilization of SBC (stock based compensation) with respect to the 2021 highs. However, CFO David Glazer said in the Q3 conference call that they expect SBC to trend up once again in Q4 as Palantir continues to invest in AIP. If SBC gets out of control, it could erase shareholder returns over the long run.
Technical talent is highly contested, nonetheless, and the most reliable way to make a winning product is to empower employees by turning them into owners. It will be a hard balance to strike for management, but I get the feeling AIP’s operating leverage (and other productization initiatives) will yield returns that outstrip the cost of SBC.
6.0 Conclusion
From this latest analysis I get the feeling that Palantir is starting to emerge as a platform. Plenty of data points from the past quarter indicate that Palantir has improved its distribution meaningfully and is productizing quickly. At the current pace of improvement, I believe we’re only a few quarters away from the market’s understanding of this reality.
Slow government growth and SBC’s reversal to the upside remain a source of concern. Ultimately, I choose to trust management. I believe they have demonstrated the ability to make the right investments and make the business more efficient.
When the government business comes back, I believe Palantir will realize its inflection point. The commercial and government businesses are set to converge going forward in terms of revenue growth and, together with the rapid productization, are likely to yield outsized cash flow.
Until next time!
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