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Palantir Inventory: The Delusion Of Overvaluation (NYSE:PLTR)

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With the new year just fourteen days old, Palantir (PLTR) shares are already down 12%, continuing a sell-off that began back in November 2021. I see no good reason or justification for the sell off, as Palantir will continue to grow its sales rapidly and new service offerings will drive the company’s commercial growth. That Palantir is overrated is a myth!

diagramData from YCharts

Commercial sales growth could accelerate with new product launches

There are few industries that have such fantastic growth prospects as the big data and analytics industry. Companies are collecting more and more data from customers and their operations and need software solutions and artificial intelligence support to monetize this data in the most efficient way.

What I am most excited about as a Palantir investor is Palantir opening a new frontier of growth in the big data world. Palantir will begin rolling out its Foundry for Crypto in fiscal 2022, which will provide a way for banks, FinTechs and other companies involved in the crypto economy to validate customer information and implement anti-money laundering tools. With the crypto universe still highly unregulated, Palantir’s Foundry for Crypto could make a big difference in legitimizing this industry.

Blockchain technology and cryptocurrencies are here to stay, and Palantir has a great opportunity to grow a multi-million dollar revenue business in a very short space of time. Major customers for Palantir’s Foundry for Crypto will likely be financial institutions and crypto trading marketplaces like Coinbase (COIN), which have a huge customer base. Adoption of Palantir’s Foundry for Crypto platform by leading market institutions could significantly accelerate Palantir’s commercial revenue growth.

Due to the opening of a new business segment, I see good prospects for Palantir for an increase in sales in the foreseeable future. Palantir’s commercial revenue growth accelerated throughout fiscal 2021 on strong customer acquisition and increasing adoption of the Company’s products and services. Palantir commercial revenue growth accelerated from 19% in Q1 21 to 28% in Q2 21 and then to 37% in Q3 21. Palantir’s revenue acceleration in the commercial business was why Palantir increased its free cash flow and raised its revenue guidance for fiscal 2021. As the commercial segment continues to grow at an accelerated pace, Palantir has twice raised its free cash flow guidance for fiscal 2021. The company is now expecting free cash flow to exceed $400 million for fiscal 2021 after raising guidance by 33% in Q3’21.

Palantir is not overvalued based on the expected increase in free cash flow

Palantir’s business reached a critical juncture in fiscal 2021, and the evidence is the company’s expanding free cash flow margins. As the company scales its services and takes more clients through its onboarding process, Palantir should see a significant improvement in its free cash flow margin going forward. Palantir’s free cash flow for Q3 ’21 was $119 million, representing a 30% free cash flow margin. I believe that Palantir could grow its free cash flow margin to 40% by 2025, which means the company will become a seriously profitable business within the next four years.

Free cash flow from Palantir

Palantir

I also expect Palantir to grow revenue faster than the 30% it has cited as its long-term growth target. This is because Palantir gets more customers and over time those customers spend more money on the company’s products and services, which means monetization improves. Assuming Palantir can grow revenue at a 35% annual rate over the next four years, Palantir expects revenue of $5.0 billion and free cash flow of $2.0 billion through fiscal 2025. The calculation below is based on the assumption that Palantir’s free cash flow margin will increase from 30% in fiscal 2021 to 40% by fiscal 2025. Over the next four years, Palantir should be able to grow its annual free cash flow by at least a factor of 4X.

Rev and FCF estimates

Fiscal year 2021

Fiscal year 2022

Fiscal year 2023

Fiscal year 2024

Fiscal year 2025

Revenue ($B)

$1.50

$2.03

$2.73

$3.69

$4.98

European daylight saving time. Free Cash Flow Margin

30.0%

32.5%

35.0%

37.5%

40.0%

Free cash flow (USD millions)

$450

$660

$956

$1,384

$1,992

(Source: Author)

And investors shouldn’t forget about this potentially massive stream of income…

The “forgotten” SPAC shop

Palantir has developed a clever revenue growth strategy that combines benefits in SPAC investments with long-term software maintenance contracts. Palantir invests capital in startups looking to fund growth, and in return the company receives equity and a signed contract to deploy its software platforms. I rarely see this deal discussed, but it offers Palantir significant valuation potential. In Q3 21, the company’s total investment in startups was $226.5 million. Palantir only needs one big exit from one of these SPAC investments below to generate a massive windfall.

Palantir Investments

Palantir

Risks with Palantir

The biggest risk I see for Palantir stock comes from continued selling pressure, which is the result of a profound misunderstanding of how the company’s business model works in practice. Palantir’s business is evolving and the progress is measurable and undeniable. Evidence of this is Palantir’s free cash flow margin improvement and accelerated (commercial) revenue growth. Sales can only accelerate if more companies adopt Palantir’s services. Customers are also increasing their platform spend, meaning that every customer that signs with Palantir will have greater value for the company going forward, unless of course they terminate their relationship. As the company recorded 34 net customer additions in Q3 21, there is no indication that customers are dissatisfied with the services received. Palantir’s overall customer base grew at a massive rate of 20% sequentially in Q3 21, demonstrating significant momentum in customer enrollment.

I’m willing to change my mind about Palantir if the company’s actual revenue growth rates and free cash flow margins fall below my estimates.

Final Thoughts

Based on free cash flow estimates that do not include payouts from SPAC divestitures, Palantir shares trade at 16 X FY 2025 projected free cash flow, assuming a 10pp improvement in FCF margin over the next four years. This margin improvement could result from the launch of new high-margin products such as Foundry for Crypto, the accelerated launch of Foundry for Builders, and higher product spend per customer. It’s a myth that Palantir is overvalued and the stock has significant recovery potential in fiscal 2022!

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