Palantir, which went public in September last year, has become a hotly contested stock, with analysts having widely differing views on what the stock is actually worth. Much like the company’s namesake which is a reference to the magical stones in JRR Tolkien’s “The Lord of the Rings”, which allow users to peer through time and across realms, Palantir’s primary software programs Gotham and Foundry, gather and process enormous amounts of data in order to identify connections, patterns and trends that human analysts might have missed. Backed by the CIA’s venture capital arm- In-Q-Tel, the company’s technology has been used in a wide variety of situations, from screening air travellers and synthesising battlefield intelligence to helping banks detect money laundering and assisting governments with their COVID-19 response. So what is Palantir’s business model? Where does its revenue come from? How many customers does it have? What are the risks it faces?
Deep Dive is a brand new series that will dissect businesses and delve into their business model, financials, the risks they face and much more. In the first edition of the series, we’ll be analysing Palantir Technologies.
The brainchild of Alexander Karp, co-founder of PayPal-Peter Thiel and Stephen Cohen, Palantir was founded in 2003. Not long after the 9/11 attack, it occurred to Peter that PayPal’s anti-fraud algorithms could be of use to the US government to combat terrorism. So, in 2003, Thiel and a group of software engineers set out to create a prototype, thus giving rise to Palantir.
In-Q-Tel, a venture-capital firm that finances the development of technologies that can help the CIA was one of the first outside investors and was estimated to have provided US$ 2 million. The investment gave Palantir access to CIA analysts, allowed it to better compete for government contracts and gave it an edge during future fundraisings. The CIA remains a client.
With more data created now than ever before, governments and corporations are rushing to harness it to yield powerful insights. An organization deals with various types of data such as phone numbers, photos, text messages, clicks, tax returns and more often than not, these are formatted differently and siloed in separate databases.
Palantir builds virtual pipelines and synthesizes the data, and later, it visualizes the data in the form of spider diagrams, graphs, artificial intelligence models, geospatial analysis, timelines and heat maps. Palantir’s software is highly flexible; while working for the U.S. Department of Health and Human Services last year, the company merged around two billion data points related to the Covid-19 outbreak in a span of three weeks. By April, a dozen countries were using its technology to track and contain the outbreak. On its website, the company lists 21 diverse solutions from auto racing to insurance to legal intelligence.
Released in 2008, Gotham was meant for the intelligence sector. By collecting and analysing information from disparate sources such as airline reservations, cell phone records, and financial documents, Gotham enabled users to identify patterns hidden deep within datasets. Defence agencies in the US began using Gotham to help protect soldiers from improvised explosive devices and investigate potential threats. Nowadays, Palantir is used for counterterrorism by many Western governments. It is interesting to note that Palantir has claimed that it does not do business in countries that it considers adversarial to the US and its allies, namely Russia and China.
Upon realising that its technology could also help leading companies across industries, Palantir began developing its second software platform- Foundry, which was launched in 2016. Foundry has emerged as a central operating system not only for specific companies but also for entire industries. European Aircraft manufacturer Airbus hired Palantir in 2016 when it was ramping up production of its new A350. Palantir merged 25 data silos and integrated more than 400 sets of data, cutting the time taken to fix production mistakes by a week helping Airbus save several hundred million dollars.
SaaS or Consultancy?
As Palantir offers solutions in a diverse set of industries, it has to tweak its software for each use case. It uses what it calls “forward-deployed engineers” who assist clients with customizing the software to their needs. Palantir, which deploys around half of its 2000+ engineers to client sites, has led observers to conclude that it is as much a consultancy as it is a software maker. Palantir, which wants to be viewed as a SaaS company, is not quite there yet. SaaS companies build ready to use software products that can be used by a functionally infinite set of users, think Zoom’s video conferencing app and Microsoft Office. For Palantir to truly function like a SaaS company, it would have to largely automate the process of synthesising and analysing messy data sets, which is a very high bar for AI. Instead, its platform requires “RFOP” or “rooms full of people” working behind the scenes to clean, label, and interpret the data. The company’s services are expensive, charging customers anywhere between US$ 10 million to US$ 100 million annually. The high installation and maintenance costs have forced companies such as Hershey Co, American Express, Coca-Cola, Nasdaq and Home Depot to walk away. Palantir has addressed these concerns by prioritising automation and tweaking the software, so that remote installation and updating is possible.
For acquiring and growing customer accounts, Palantir has three phases- acquire, expand and scale. Customers may move back and forth through these phases, slowly or rapidly or may skip certain phases altogether as assessment of the merits of further investment and relationship needs change.
- Acquire: In the first phase, Palantir pursues new opportunities with minimal risk to customers through short-term pilot deployments of the software at low or no cost to them. If the revenue recognised as of the end of a calendar year is less than US$ 100k, the account is categorised as being in the acquire phase.
- Expand: The second phase involves a significant investment from Palantir as it seeks to understand the major challenges faced by its customers and ensures that its software delivers results. If the revenue recognised as of the end of a calendar year is more than US$ 100k and if the account has a negative contribution margin (Palantir defines contribution margin as revenue less cost of revenue and sales and marketing expenses, excluding stock-based compensation, divided by revenue) during the year at issue, the account is categorised as being in the expand phase.
- Scale: As Palantir deepens its ties with the customers, the investment costs relative to revenue generally decrease, and the value provided by the software increases as the customer’s usage of the platform increases. After having installed and configured the software, Palantir continues to provide operations and maintenance services. If the revenue recognised as of the end of a calendar year is more than US$ 100k and if the account has a positive contribution margin during the year at issue, the account is categorised as being in the scale phase.
Of the US$1,092.7 million in revenue as of December 31st, 2020- customers in the acquire phase accounted for 0.03% or US$ 0.3 million, those in the expand phase accounted for 1.86% or US$ 20.3 million, and those in the scale phase accounted for 98.11% or US$ 1,072.1 million.
In Q1 2021, Palantir posted a revenue of US$ 341 million, up 49% y-o-y but still ended with a net loss of US$ 123 million. Between 2019 and 2020, Palantir’s revenues have grown by 47%, whereas the cost of revenue and operating expenses have increased by 45% and 78%, respectively.
Between 2018 and 2020, sales and marketing expenses were on a downtrend. However, they were still the largest components of operating expenses, but this changed in 2021 as general and administrative expenses took over and accounted for 38% of the operating expenses. R&D expenses have been fluctuating between 26% to 29%.
Segment: Palantir primarily derives its revenue from 2 segments-
- Commercial: Primarily serves customers in non-government industries.
- Government: Primarily serves customers that are agencies in the US federal government and non-US governments.
Revenue from the commercial segment has been steadily falling from 57% in 2018 to 39% in the latest quarter, while revenue from the government segment has increased from 43% to 61%. The government segment has been heavily supported by the US Army contracts awarded in 2019.
Geographical: The three major countries from which Palantir derives more than 10% of its revenue are the US, UK and France. The percentage of revenue accruing from non-US countries has been on a decline. Revenue derived from the UK has halved, while revenue derived from France has fallen from a high of 11% in 2018 to a mere 6% in Q1 2021.
Palantir has forecasted revenues over US$ 4 billion for 2025, implying a 30% five-year CAGR.
- Though still a negligible number, Palantir’s customers have increased by 14% y-o-y from 131 to 149 in Q1 2021.
- In the trailing twelve months ended March 31, 2021, average revenue per customer has increased by 29%, from US$ 6.3 million to US$ 8.1 million. In comparison, the average revenue for the top twenty customers during the same period grew by 34%, from US$ 27 million to US$ 36.1 million.
- As existing customers expand their relationships, a limited number of customers account for a larger portion of the revenue. The top three customers accounted for 20% and 31% of the revenue in Q1 2021 and Q1 2020, respectively.
- The total remaining deal value was US$ 2.8 billion as of Q4 2020, out of which US$ 1.5 billion is from contracts with commercial customers, and the rest is from government customers.
Some of the prominent risks faced by Palantir:
- A small number of customers account for a large portion of the revenue.
- Palantir has been incurring losses since its inception and may not become profitable in the foreseeable future.
- The company’s platforms are complex and have a lengthy implementation process.
- By going public, it has opened itself up to increased scrutiny from the media. Unfavourable news or social media coverage can potentially harm its reputation and business.
- It faces intense competition from in-house software development projects, large enterprise software companies, government contractors, and system integrators.
- Palantir’s business is subject to complex and evolving US and non-US laws and regulations relating to privacy, data protection and security, technology protection etc.
Like its software, Palantir’s problems are complex, further compounded by the limited number of customers. For now, Palantir should focus on acquiring more customers in the commercial segment by tweaking its software and pushing for more automation. But with more automation, the axe falls on the most important safeguard against abuse of an individuals’ privacy- human judgment. Algorithms will now decide how deeply to pry into people’s lives. To its founders, Palantir’s a bulwark of liberal democracy; to Airbus, it’s a tool that enhances efficiency; to privacy experts, it’s a nightmare, ultimately just like the magical stones, people seem to see in it what they want to see.
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