We invest in companies, not stocks. That’s easier said than done, as there’s always a temptation to focus on what a stock price has been doing lately. The recent AI hype spurred by ChatGPT sent shares of C3 (AI) soaring. As shareholders, we’re not happy about that, because C3’s share price is now disassociated with the intrinsic value of the company. Sure, that may prove helpful if some private equity firm is trying to do some bottom feeding, but as a rule, we believe hype does a disservice to serious long-term investors. So, when Palantir recently popped after the release of their year-end results, we were interested to see if things at the company have changed much since the last time we checked in nearly two years ago.
Palantir’s Red Flags
In our piece on An Enterprise AI Showdown – C3 Stock vs. Palantir Stock we talked about Palantir’s heavy dependency on the U.S. government, their CEO’s propensity to wax political poetic with shareholders, and their self-limiting decision to only do business with U.S. allies. A lesser concern was their decision to invest in a bunch of disparate SPACs and start round tripping revenues, a decision that clearly hasn’t been working out well so far. Let’s revisit our biggest concern – Palantir’s overreliance on the U.S. government.
Commercial revenues are on the rise for Palantir which is great, but we’d like to see the majority of total revenues coming from commercial customers before we’d consider investing in the company. Since commercial revenues are growing quicker than government revenues, shouldn’t it just be a matter of time? Not necessarily (more on this in a bit).
Speaking of revenue growth, guidance for 2023 at the midpoint reflects 15% growth which is acceptable given the current macroeconomic headwinds that might be affecting the commercial side of the business which constitutes 44% of revenues. Over the past several years, year-over-year revenue growth has slowed as one would expect from any company that’s increasing in size.
Palantir’s ability to milk their existing customers seems mediocre at the moment – a 115% net retention rate for 2022 (anything in the 120s would be considered average).
“We were profitable for the first time in our company’s history last quarter,” read the first sentence of the CEO’s annual letter which seemed a lot more tame this year. For a company with $2.6 billion in cash, profitability isn’t at the top of our priority list, but it underscores the importance of having strong gross margins (Palantir’s are upwards of 80%). While the letter read well, the conference call quickly veered back into a constant undertone of us vs them.
Palantir’s Painful Earnings Call
Mr. Karp relentlessly drives home how important it is the West (however he’s choosing to define that) dominates the world. We’ve covered more than 460 companies and have never seen a CEO commandeer a call to obsess over how much his company’s product contributes to global warfare and politics. Here are just some of the statements taken from the earnings call which is riddled with Mr. Karp’s philosophical musings (based on the Motley Fool transcript).
- …people have seen the impact of the digitization of warfare and Palantir’s central role in the world.
- …in the context of changing the course of history in Eastern Europe
- …countries that depend on our product for their survival
- …the biggest event in digitalization AI is actually on the battlefield
- …simply look at events in Eastern Europe.
- In the war context, how do you know if the AI made the decision…
- …to continue to supply to our allies across the world
- …excited about bringing the fight to our adversaries
- …the world is recognizing our crucial contribution to the West. We see this in war.
- …continue crushing in the service of what we believe is important, Western institutions and that they survive and thrive better than our adversarial institutions.
- The war in Ukraine proves this.
- And so, our basic view of Palantir is we are in this to make institutions of the West stronger.
- …whether it’s wars in the East or balloons over our society.
- This is a world that is dangerous, that needs AI-driven and, in general, software-driven weaponry.
- …our Ukrainian allies are willing to talk about it and see its value.
Every time one of his executives tries to bring the conversation around to things like financial and operational performance, Mr. Karp takes over the mic and steers the ship right back towards this existential battle of good versus evil. It’s distracting, and it does the company no favors. Recent concerns voiced by zee Germans suggest that Palantir’s big data dragnet is being cast a bit too widely. In Palantir’s own words:
It’s only the tip of the iceberg when it comes to the company’s eagerness to court controversy.
Palantir’s Political Positioning
Discussing the various levels of concern one ought to have over conflict in Eastern Europe – from mildly following the news in Ukraine, to blindly posting blue/yellow flags everywhere – starts steering this car dangerously close to the edge of the American political cliff. As “he who shall not be named” found out, as soon as you start taking sides, you’re considered the spawn of Satan. Here at Nanalyze, we welcome everyone and greet them on equal grounds, regardless of their political beliefs. So, we’ll try to tread delicately.
If Mr. Karp is taking an “us vs them” approach to operating one of the most powerful intelligence platforms that’s been developed, everyone should be made aware of who is “good” and who is “bad.” Our piece on the dangers of Chinese stocks details the extent of corruption in that country, and makes it clear that the Chinese Communist Party isn’t a good entity to conduct business with. Palantir’s choice to impose limitations on access to their platforms in China seems justified, but what about the world’s other 193 countries? Is Palantir’s fearless leader now the judge of good and evil?
We acknowledge that the participation of private corporations, whose leadership is unelected and therefore not directly beholden to the public, raises important questions regarding the appropriate means of holding private actors performing government functions accountable.
Credit: Palantir
It’s not cut and dry as to which countries are good or bad in Eastern Europe, no matter what narratives the media wants to craft, but let’s set aside for now. If Mr. Karp wants to steer his ship in the direction of what’s good for the “West,” should he not spell out which countries belong to this elite group and what offenses might cause one to lose membership? In the latest earnings call, Mr. Karp says the following:
- The weakness in our business is just non-U.S. commercial. That grew around 12% last year. I think outside the U.S., they’re a lot less friendly to new innovations.
The last sentence seems purposefully dismissive. We’ve been scouting global tech startups for half a decade now – from Russia, to Indonesia, to Saudi Arabia, to the Caucasus. The desire to innovate is everywhere, though perhaps no country has innovated like the United States to date. Could this weakness in non-U.S. commercial be related to Palantir’s obsession about the U.S. and its allies, rather than a desire by others to pursue innovation?
If Palantir wants to take such strong political and philosophical viewpoints of the world, then investors and customers deserve some clarity on what is “good” and what is “bad.” So far, the list looks something like this:
- GOOD: Ukraine, Japan, United Kingdom
- BAD: China, Russia
That leaves 189 countries in limbo. If a country decides they want to continue doing business in Russia, like many Czech firms have, will they be on Mr. Karp’s naughty list? What if the next U.S. administration decides they’ll stop pumping billions into the war in Ukraine and spend the money at home instead? Will Mr. Karp blindly follow the will of the U.S. government as the leader of the Western world (however that’s defined)? When he talks about “our Ukrainian allies,” it implies that it’s not just about American ally ship. Palantir claims that they are “responsible for most of the targeting in Ukraine,” and talks up how important their software is for global defense systems. What position is Mr. Karp is taking on some of the world’s biggest spenders on defense, like Saudi Arabia, or India?
One thing is clear in the recent earnings call. Palantir will not be decreasing their dependency on the U.S. government. Here’s an example of just how opaque investors can expect things to be going forward.
Dr. Karp, as it relates to the government business, I’m curious if you could just give us an update. I think last year, you had mentioned there were a handful of transactions that got pushed, and ultimately not exactly sure what happened there.
Brent Thill — Jefferies — Analyst
The only update is this call is coming from Washington. It’s coming from Washington because regulators, people in Congress, and people in the military also have seen what’s going on. And there’s just a different level of interest in what we provide. It’s just — and now, what does that mean year to year? I don’t know. I do know that the CAGR on our U.S. government has historically been over 30%. And I think there’s a debate among people who support us or don’t support us whether that’s going to be in the future, it will – the future will represent the past.
Alex Karp — Chief Executive Officer
It’s understandable why Palantir will be spending more time in Washington now that they’ve established the The Palantir Foundation for Defense Policy & International Affairs, “a nonpartisan organization dedicated to advancing national security through academic and technical research, support of emerging technologies, and policy development.” One wonders where Mr. Karp puts shareholders in his hierarchy of priorities right now. We’ll check in a year from now once that 15% year-over-year growth has been realized to see what updates 2024 brings.
Conclusion
This was a difficult piece to write because it starts approaching very controversial topics about politics, philosophy, and right vs wrong. Three-quarters of the way through the earnings call, we were more focused on evaluating our own beliefs on the merits of Western thinking than considering Palantir’s growth potential.
As investors, we don’t like to wade through controversy in order to cover a company. Mr. Karp does his company no favors by going on these rants during the earnings calls about the battle of good vs evil. Until Palantir’s fearless leader starts focusing more on operations and less on philosophy, we’re continuing to avoid Palantir stock.
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