Palantir: Reversing the trend with a rebound in growth, is AI the hero once again?

The global number one "AI military stock" Palantir Tech.US released its third-quarter earnings report for 2023 before the US stock market opened on November 2nd Beijing time. Overall performance-wise, the revenue met expectations, with significant profit exceeding expectations. The reduction in marketing and promotion expenses and some equity incentives in the third quarter resulted in a 5% increase in operating profit margin, reaching 7.2%.

1. In terms of revenue, the growth rate in the US government sector was average for the quarter, but the official government website also showed that Palantir signed many new contracts in the third quarter, which are expected to gradually contribute to revenue in the future. Surprisingly, there are signs of a better-than-expected recovery in the commercial market revenue that the market is particularly concerned about.

This accelerated growth in comparison to the previous period is contrary to the trend of customers continuously optimizing expenses in the industry. Therefore, we expect that the heat of AIP may have contributed to this in the third quarter.

2. On the profit side, the gross profit margin remained stable, with improvements mainly coming from the compression of marketing expenses. Although there was a significant increase in net customers in the third quarter (41 companies), it is temporarily uncertain whether the optimization of marketing expenses is due to the scale effect of Palantir's products, as the marketing expenses for acquiring customers and the actual conversion of customers may not belong to the same quarter.

However, we all know that the third quarter is still an important promotion period for AIP, but marketing expenses have decreased compared to the same period last year. Therefore, Dolphin Research believes that in addition to cost control on existing products, AIP may be attractive enough to reduce some unnecessary sales expenses.

3.Therefore, Dolphin Research suggests focusing on Palantir's revenue side, especially forward-looking indicators such as Remaining Performance Obligation (RPO), Billings, and customer numbers, which can reflect future growth. However, based on the above three indicators, the net increase in the third quarter was average, with most of it within expectations.

In summary, Palantir's performance in the third quarter was satisfactory, and the guidance for the next quarter did not disappoint. The annual profit guidance is expected to increase along with the better-than-expected performance in the third quarter. Among them, the surprising recovery in the commercial market is worth paying attention to in terms of sustainability.

In addition, although the profit side is not the top priority at the current stage, achieving GAAP profitability for four consecutive quarters is commendable, and Palantir may attract some passive funds due to its potential inclusion in the S&P 500 index.

However, in the medium to long term, if the issues of geopolitical sensitivity and the difficulty of scaling in the commercial market are not resolved, Dolphin Research tends to think that Palantir's valuation is still relatively expensive (FY24e YoY 20%, Forward PS 14x). It's just that in the short term, with ongoing global conflicts, continuous additional contracts from the US military and government, and occasional resurgence of AI themes, the investment sentiment towards Palantir is clearly more positive.If the subsequent liquidity expectations continue to improve, it is not ruled out that the overbought state will be maintained.

The following is a detailed analysis:

1. Income matches guidance, short-term anchoring relatively clear

In the third quarter, total revenue reached $558 million, a year-on-year increase of 16.8%, showing improvement compared to the previous quarter, and basically in line with expectations.

Due to the high cost and customization of Palantir products, it is difficult to see significant fluctuations in both "new customer conversion" and "customer churn". Therefore, the company's short-term revenue guidance is generally accurate, and the range of fluctuation is small. Therefore, the revenue is basically consistent with market expectations, and the magnitude of beat or miss can be ignored.

In terms of business segments, government revenue increased by 12.5% year-on-year, with a slight slowdown compared to the previous quarter. However, what surprised Dolphin Research is that commercial revenue increased by 23% year-on-year, showing a clear sign of recovery compared to the past four quarters. This also exceeded market expectations. Dolphin Research believes that due to the industry's trend of optimizing software spending, Palantir's accelerated growth against the trend may also be attributed to AIP.

The company disclosed that as of the end of Q3, there were approximately 300 enterprise customers worldwide who have adopted the AIP platform.

In terms of regions:

(1) In the government revenue of the United States, the growth rate in the third quarter was average, with a year-on-year increase of 9%. However, Palantir has recently obtained some new contracts from the US Army and US government agencies (see the following figures for government orders of Palantir USG and Palantir Tech), so it is expected to gradually confirm in the subsequent revenue. We are not worried about Palantir's competitive barriers in the US region.

International government revenue increased by 22%, mainly contributed by incremental revenue from government institutions such as the UK NHS.

(2) Business revenue is mainly contributed by local enterprise clients in the United States, with a growth rate of 33% in the US region and 16% in other regions.

2. Not a significant increase in contracts

For software companies like Palantir, future growth is the core of valuation. However, the revenue recognized each quarter is a lagging indicator. Therefore, we recommend focusing on the acquisition of new contracts, which is mainly reflected in the remaining performance obligations (RPO), current billings, and customer count.

(1) Remaining Performance Obligations (RPO)

In the third quarter, Palantir's remaining performance obligations amounted to $988 million, an increase of $20 million compared to the previous quarter. However, the main source of incremental growth this quarter came from long-term contracts, indicating that new contracts have indeed been signed, rather than the previous quarter where "long-term contracts" were converted to "short-term contracts" over time.

(2) Current Billings

In the third quarter, current billings amounted to $550 million, meeting market expectations, but the downward trend in MoM growth further expanded.

(3) Customer Count

Looking at the most intuitive measure of customer count, there was a net increase of 32 customers in the third quarter compared to the previous quarter, maintaining the same level of net increase as in previous quarters, and still mainly driven by enterprise clients. There was not much change in the overall increase, but it was slightly better than the market's expectation of a net increase of 25 customers.

Combining <1-3>, Dolphin Research believes that the forward-looking indicators show a clear growth momentum in the short term, but this does not mean that there will be no cumulative and qualitative changes in the future:

On the one hand, the AIP platform has not been commercialized separately and only serves as a promotional tool for existing products.

On the other hand, the trend of enterprise clients optimizing Capex is still ongoing. Even if clients are interested in the old products empowered by AIP, they may purchase in smaller quantities and the contract size does not fully reflect the demand.

Dolphin Research believes that as long as we pass through the bottom of the cycle of enterprise investment contraction, the second scenario has the potential to leverage Palantir's medium- to long-term growth space, rather than just short-term growth.

3. Exercise restraint in promotional expenses and achieve continuous profitability

In the third quarter, Palantir once again achieved net profit under GAAP, making it the fourth consecutive quarter of positive results. This meets the inclusion criteria for the S&P 500 index, and it is expected to attract some passive funds for investment.

In the third quarter, Palantir achieved a GAAP operating profit of $40 million, a year-on-year increase of 164%. The operating profit margin was 7.2%, and the adjusted operating profit margin, excluding SBC, was 29.3%. The trend of continuous improvement is impressive.

While ensuring that research and development investment remains stable, Palantir focused on optimizing sales expenses in the third quarter, and management expenses also decreased. In addition to optimizing the proportion of employee stock incentives to revenue by 1 percentage point, the reduction in promotional expenses in the sales expenses was the main factor.

With a stable gross profit margin and a significant improvement in the sales expense ratio, the company pays close attention to the contribution margin, which has increased to 57.5% in this quarter.

However, since revenue is essentially driven by the volume of signed contracts, each time a customer is successfully acquired, there will be upfront sales expenses. However, the period of customer acquisition and the actual conversion of contracts may not necessarily occur in the same quarter, which can occasionally cause short-term fluctuations in the sales expense ratio.

Nevertheless, the direct year-on-year and quarter-on-quarter decline in sales expenses in the third quarter is still relatively "aggressive". Under the premise that the product's business model has not undergone significant changes, whether there is a trend towards true economies of scale can continue to be observed.

Dolphin Research's historical research on Palantir:

In-depth

October 13, 2023: "Palantir: How is it priced with a high valuation?"

September 26, 2023: "Palantir: The 'Mysterious' Military Weapon Activated by AI"invite-code=032064)》

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