Palantir Q4: Boot Camp Sales Model Make It A Game-Changing AI Software Investment

When I last wrote about Palantir as a Buy (NYSE:PLTR) on October 20, 2023, there was growing bearishness surrounding the stock. One of the issues critics had about the company was its long sales process that allows a potential customer to trial its offerings. These trials could take up to six months to complete, were costly and inefficient, and sometimes failed to result in a sale. When I wrote that article, Palantir was coming off a quarter in which it only produced revenue growth that had dropped to 13% year-over-year. Considering that this company brands itself as a big beneficiary of growth in Artificial Intelligence (“AI”), and other beneficiaries of AI have reported a surge in sales growth, some investors became concerned with the decelerating revenue growth since July of 2021 and pointed the finger at everything from the company’s go-to-market plan leading to poor customer acquisition to something being wrong with its sales teams.

However, management has changed its sales model since my last article and has reported rebounding year-over-year revenue growth of 17% and 20% in the third and fourth quarters, respectively. In addition, fourth-quarter results show Palantir producing its fifth straight quarter of GAAP net income profitability. The stock was already in line for potential inclusion in the S&P 500 last quarter, as the company only needs four consecutive quarters of profitability to become eligible. Investors can look for additional potential upside once included in the index.

This article will discuss the improvements in Palantir’s commercial sales model, how it differentiates its products from competitors, the latest earnings report, risks, valuation, and why I think the stock remains a Buy.

How the company differentiates its AI products

AI has changed Palantir’s potential upside. Before the AI revolution, it had to navigate a long sales process that could take months to years to get a signed contract for its software. Then, after making a sale, Palantir could take a few weeks or months to set up its software and integrate it into a customer’s system. The introduction of its new Artificial Intelligence Platform (“AIP”) has shifted the landscape for the company. Management quickly discovered that the company could drastically shorten the sales process and have AIP running on a customer’s system in a few hours.

Ever since OpenAI introduced ChatGPT in late November 2022, generative AI products have become extremely popular, with many different companies participating in the gold rush to produce their take on this new AI segment, from the major cloud providers like Microsoft (MSFT), Amazon’s (AMZN) AWS, Alphabet’s (GOOGL) (GOOG) Google Cloud, and Salesforce (CRM) to smaller AI companies like Anthropic and Hugging Face. What differentiates Palantir’s AI products from those of these many competitors?

First, Palantir doesn’t build general-purpose large language models (LLMs) like Bard or ChatGPT. Instead, the company uses a K-LLM kernel to amalgamate a pool of responses from multiple LLMs into the best possible answer. Chief Technology Officer (“CTO”) Shyam Sankar talked about K-LLMs in the company’s third quarter 2023 earnings call:

Why use one LLM when you can use K [K-LLM]? The art is in synthesizing the outputs from this committee of experts to create a rich topology of answers to the prompt. LLMs are statistics, not calculus. It’s more like predicting the weather than predicting an eclipse. And that’s why we’re focused on proof, not proofs of concept. AIP gives our customers the infrastructure they actually need to ship production use cases quickly.

Source: Palantir Third Quarter 2023 Earnings Call.

What CTO Shyam Sankar means by being “focused on proof, not proofs of concept” is that Palantir believes many products based on the more popular LLMs are closer to the proof-of-concept stage rather than at the stage where a company can make valuable products. Chief Executive Officer (“CEO”) Alex Karp is often derisive of many of the more popular generative AI company’s products without naming names. For instance, in the third quarter 2023 earnings call, he said:

AIP and U.S. commercial, not only is disrupting the market, it’s setting a standard that I don’t believe any other software company will be able to reach partly because they misunderstood the value of LLMs and their relative importance and lack of importance, partly because they don’t have decades of experience on the frontline as we do in the military with managing the core ways in which you make these things precise, the way in which you provide governance. Also because the playbook backed by venture capitalists and supported by analysts has always been make the thinnest technology possible that is misaligned with your enterprise and hire the most and best salespeople so the enterprise gets moderate value while having its high revenue exported in a parasitic manner to the cheers of insiders and the pain of retail investors and we obviously rejected that.

Source: Palantir Third Quarter 2023 Earnings Call

In the above paragraph, CEO Alex Karp conveys that many companies have overemphasized the importance of LLMs. He believes that his competitors overlook some of the more essential parts that make generative AI valuable, like tight integration with a customer’s platform, governance, security, customizability, and making the answers to queries so precise that the customer can produce AI applications with a high return on investment, instead of products not ready for prime time.

The “Boot Camp” sales model

One of Palantir’s most significant advantages in selling its AI software over competitors is that management quickly learned that the best way to prove it has the best AI solutions in the industry was not by sending out huge sales teams armed with PowerPoint presentations to try to convince a potential customer’s C-suite that it theoretically has a better AI solution. Instead, management developed the “Boot Camp” concept, bringing an enterprise IT (information technology) department and other company stakeholders into a workshop, where they learn how to use AI to solve their specific real-world business problems. Palantir’s representatives demonstrate and train potential customers to use AIP to create production-ready AI applications. Its sales process has become much easier as potential customers see a real-world solution instead of a PowerPoint theoretical solution. During the second quarter of 2023, the company started to roll out the boot camps.

Potential customers can complete boot camps in two to five days, in contrast to a trial period lasting several months, reducing the time needed to move from initial contact to contract negotiations to final sale to onboarding and training a new customer. In addition, boot camps have better “unit economics” throughout the sales process, meaning they cost the company less for each sale they make. These boot camps appear to be going over well with attendees. Chief Revenue Officer (“CRO”) Ryan Taylor said on Palantir’s third quarter 2023 earnings call:

In these boot camps, our customers attack problems that have immediate impact and learn how to deploy AI into their unique operating environment in a matter of days. Our customers’ results speak for themselves. One attendee said that we achieved more in one day for them with AIP than one of the top three hyperscalers had accomplished over the last four months, and then presented their work with Palantir instead of the hyperscaler to the CEO the very next day. Another attendee said, we basically built 10x faster with 3x less resources, and yet another claimed, we have built in a day what they wouldn’t be able to get internally in months, and then it probably still wouldn’t meet the requirements.

Source: Palantir’s Third Quarter 2023 Earnings Call.

Evidence is starting to show up that these boot camps are working fantastically. You can see the positive influence of the boot camps in the company’s fourth quarter 2023 U.S. commercial revenue, customer count, number of deals closed and Total Contract Value (“TCV”). The following image shows these results.

The following chart shows the overall and commercial customer counts (U.S. and international).

The company overall produced larger deals during the fourth quarter. Palantir closed 103 sales of at least $1 million, 37 above $5 million, and 21 above $10 million. CEO Karp said on the earnings call about these numbers, “It’s almost inconceivable to do that many contracts given the way our product used to be.” He sees the new AIP product as the company’s future, and management is reorienting much of what the company does around this new product. The stock was up 31% the day after earnings partially because investors are excited about what the boot camps and AIP can do for Palantir’s growth moving forward, as the company has only just started using the boot camps.

Fourth quarter and annual 2023 results

Palantir reported fourth quarter 2023 revenue of $608 million, 20% over the prior year’s comparable quarter and 9% sequentially, as revenue continues to reaccelerate, driven by its U.S. commercial business growth. The revenue results beat analysts’ expectations by $5.55 million. These year-over-year revenue growth results are likely around the bare minimum investors wanted to see. The company would likely need to produce revenue growth of at least 30% year-over-year to convince the most hardened skeptics that AIP and the boot camp model are successful. However, these fourth-quarter results have surprised some people on the positive side. For instance, Seeking Alpha reported that Wedbush Securities analyst Dan Ives wrote in a note, “With a US commercial business that grew an eye-popping 70% in 4Q (up from mid 20% a few quarters ago) and commercial customer count that grew 44% as the AI Revolution is driving [AI Platform] deal flow to a level we did not expect until 2025.“

In the Annual Letter from CEO Alex Karp, he attributed the company’s solid rebound in revenue growth to “the strength of our software and the surging demand that we are seeing across industries and sectors for artificial intelligence platforms, including large language models, that are capable of integrating with the tangle of existing technical infrastructure that organizations have been constructing for years.“

Palantir recorded $1.15 billion in TCV bookings in the fourth quarter, up 192% year-over-year and 38% sequentially. These numbers indicate potential solid future revenue growth. In another piece of good news, the company’s net dollar retention (“NDR”) ratio is turning around. In the Fourth quarter of 2022, the company reported an NDR of 115%. By the third quarter of 2023, NDR dropped to 107%, a concern since a declining NDR indicates existing customers are spending less on the company’s services year-over-year due to either dissatisfaction with the service, the prices being too high or a loss of a significant customer. Palantir’s fourth quarter 2023 NDR increased 100 basis points to 108%. Management noted that the number excludes new revenue from customers acquired in the last 12 months. So, you can expect NDR to improve over time as the company begins reporting numbers that capture the acceleration in the U.S. commercial business in future quarters.

The best part is that the top-line revenue growth did not come at the expense of profitability. Palantir’s Adjusted gross margin was up 400 basis points year-over-year to 84%. The following shows the company’s adjusted operating margin improved 1700 basis points year-over-year to 34%, and operating income improved 158% year-over-year to 209 million. Adjusted operating numbers exclude stock-based compensation.

Palantir produced its fourth consecutive quarter of GAAP (Generally Accepted Accounting Principles) operating income of $66 million at an 11% margin. Net income was $93.391 million, and diluted earnings-per-share was $0.04.

The company has a sterling balance sheet with $3.7 billion in cash and short-term investments against no debt at the end of the December quarter. The chart below shows that the fourth quarter adjusted cash from operations was $301 million at a 50% margin, and adjusted free cash flow (“FCF”) was $305 billion at a 50% margin. Both metrics were substantially higher than the year-ago period. Non-adjusted FCF on a trailing 12-month basis was $697.1 million. The company has plenty of resources to reinvest in building up the AIP business.

The following image shows management’s guidance. The show’s star was the company forecasting fiscal year (“FY”) U.S. commercial growth of 40%, above analysts’ estimates. Palantir also projects full-year 2024 revenue in a range of $2.652 billion to $2.668 billion or 19.5% growth year-over-year at the mid-point.

Although everything looks like it is going its way, some people still do not like the company and have found things to nitpick within Palantir’s fourth quarter 2023 results, which didn’t convince everyone that the stock is worth buying or holding.

Some concerns people have with the stock

RBC Capital analyst Rishi Jaluria continues to rate it as an underperform with a $5 price target while expressing his concern that Palantir’s forecast for revenue growth in 2024 might be overly optimistic and unrealistic. Other critics have other issues with the company: the government segment, its largest revenue source with 53.2% of revenue in the fourth quarter, produced lackluster revenue growth of only 11% year-over-year, below analysts’ expectations. Additionally, some feel that further upside in the government business is limited. Palantir refuses to sell its software to countries against its political opinion and cultural values, self-limiting its opportunity to the U.S. government and its allies. Even when the company makes a government sale, the sales process can be lengthy, sometimes taking years, and the AIP boot camps aren’t conducive to how governments buy software.

On the commercial side, Palantir has a reputation for providing high-quality products. Still, some companies may prefer competitors’ offers that may be faster to set up, easier to learn, and less costly. Some critics have argued that Palantir’s commercial market is limited because its products may be too pricey for smaller companies, which may also not require all the features the platform provides. Palantir has attempted to address these concerns by making its products more modular. However, buying smaller modules of Palantir’s complete product might defeat the purpose of purchasing the product in the first place by providing less than full functionality. Next, European companies have been reluctant to use AI-based products, or at least that is what CEO Alex Karp hinted at when he made the following comment on the fourth quarter earnings call:

There are some caveats. Europe has decided that they are not going to engage in this revolution.

Source: Palantir Fourth Quarter 2023 Earnings Call.

Last, the company relies on boot camps to make commercial sales, and the company may need more qualified experts to run these boot camps to capitalize on the opportunity. So, there is a question about Palantir’s limits in scaling the boot camp concept.

Valuation

If you look at most valuation ratios on the surface, it seems like the market is vastly overvaluing the stock. Seeking Alpha Quant rates its valuation a D. The stock looks less than appetizing for investors if you look at the company on a price-to-earnings and price-to-FCF basis.

Let’s look at the company’s reverse discounted cash flow to see what FCF growth rate the stock price at the February 6, 2024, close implies.

Reverse DCF

Click to enlarge

Some may view an FCF growth rate of 24.7% over the next ten years as a far too aggressive assumption. According to annual analysts’ estimates, Palantir should grow EPS at an annual growth rate of around 18% between the end of 2023 and 2032. Although EPS and free cash flow are not the same, if we assume that FCF will grow at a similar rate as the 18% EPS growth rate, we get an intrinsic value of around $13.06 on a DCF basis. Some value the stock even lower. For instance, the Alpha Spread base case intrinsic value is $6.86.

However, you could also make the case for it being fairly valued or even undervalued if Palantir’s CEO Alex Karp’s vision for AI and the company comes to fruition. As of February 6, 2024, Palantir has a price-to-sales (P/S) ratio of 22.87, which I think is appropriate for a company that analysts expect to produce 20% revenue growth over the next several years. The market may have undervalued the stock if Palantir can exceed those growth estimates and eventually reach 30% revenue growth rates within the next several years.

The chart below shows that Palantir’s P/S ratio is well below its highest level of 38.57, which it achieved in 2021. The high inflation and rising interest rate environment didn’t help the stock in 2022. If the AI revolution proves to be a high-growth market area in the next decade, which some believe it can be, and interest rates drop soon, the stock’s valuation could grow much higher.

The company’s forward 2024 and 2025 PEG ratios are 0.256 and 0.533, respectively. Generally, PEG ratios below 1.0 indicate that the market may undervalue the stock.

So, depending on how you look at it, you could think the stock is overvalued or undervalued.

After the stock run-up, it’s still a buy

Palantir is a battleground stock. This company has many risks, and if you are a risk-averse investor who believes that the market has overvalued the stock, especially after its post-earnings run-up, you should avoid the stock. There were legitimate reasons that I have already outlined why some investors were increasingly shorting the stock into the third quarter of 2023, which the chart below shows.

Data by YCharts

However, you could make a serious case that AIP and the moves the company has made to achieve profitable growth have changed the future of Palantir and evaporated a few worries about the company that caused people to push up the percentage of shares of float short and percent of shares outstanding short across 2022 and 2023. As the chart below shows, those metrics dropped precipitously in the fourth quarter.

Suppose you believe Palantir’s AIP will become the dominant platform AI platform over the next several years. In that case, you might disagree with RBC Capital analyst Rishi Jaluria’s price target and downside opinion on the stock and have a more favorable view of its potential upside.

As for worries about Palantir’s government division, instead of looking at it as a drag on the company’s growth with limited upside, an investor could look at the existing government contracts as a stable recurring revenue stream that provides a solid foundation, even if government growth slows down. Additionally, although fourth-quarter growth looked lackluster in the segment, remember that the sales cycle with the government is lengthy, and revenue can be lumpy from quarter to quarter. Management expects U.S. government growth to reaccelerate later in 2024. CRO Ryan Taylor said during the fourth quarter earnings call:

In our government business, we are actively engaged across all theaters of crisis and conflict. The strength of our US government business is not reflected in the fourth quarter results, which remain muted. Some of this is due to the continuing resolution and timing of large potential contract awards. But it’s also a function of the department’s pace of scaling their AI and software efforts to match the realities of modern combat, particularly with JADC2 [Joint All-Domain Command and Control]. The department is responding to great power competition by ramping up investments in America’s unique strength, software.

Source: Palantir Fourth Quarter 2023 Earnings Call

JADC2 is a significant initiative by the U.S. Department of Defense to develop a unified AI-powered network connecting all sensors, data, and decision-making across all military branches. The goal is to create faster and more effective decision-making in battlefield situations. Palantir is uniquely suited for winning this type of contract, representing only one of many massive government contracts it has a solid potential to win within the U.S. government and internationally.

As for the commercial business, the fourth quarter results have disproved many of the worries that some analysts and investors expressed in 2022 and 2023. Additionally, this company has gone on a hiring spree, potentially neutering concerns about its ability to find enough qualified people to run boot camps. CEO Alex Karp said the following during his fourth-quarter 2023 earnings call prepared remarks:

By the way, for those listening who think our strategy is crazy, many of your best people are applying to Palantir now. So, while we may be crazy, we are being bombarded by people who want to work at this company, bombarded. I cannot — a day does not go by where I’m not getting a call, an email, 50 attempts to get into our company. We are razor, we are white-hot in recruiting. We’re 20-year company with the strongest recruiting I’ve ever seen from a company that’s historically had the strongest recruiting in the most competitive environment in the world, Silicon Valley. That is because we stand behind our values and because we intend to win with those values, which we’re approving.

Source: Palantir Fourth Quarter 2023 Earnings Call

If you are an aggressive growth investor with a five to ten-year investing time horizon, consider investing in the stock today, even after the recent run-up. Right now, I recommend a dollar-cost averaging strategy with an eye toward adding to the investment on substantial pullbacks. I rate the stock a buy.