Understanding Palantir's Path to GAAP Profitability
"Palantir Isn't Profitable"
One of the toughest arguments to deal with from Palantir bears is that the company has been around for over 20 years and has not produced a profit.
Unfortunately, this argument is only tough because of it's perception, not because of it's substance.
Yes, Palantir has been around for 20 years and has not produced a profit. The important thing to understand is why they haven't produced a profit, and the reason for this is because they didn't need to.
Palantir was being subsidized by the CIA's venture capital arm to build out some of the most important mission-critical technology for the government to use in defense. As a result, profitability was not the goal. The goal was actually building technology that was highly differentiated from any other defense contractor in the market and being able to meaningfully implement that technology in a user-friendly way.
Palantir pulled that off, and around 7 years ago decided to begin attacking the commercial markets. So, realistically it has been around 7 years of non profitability vs 20 and in those 7 years, they actually built out a pathway for the company to go public and scale to growing over 30% year over year.
Stock based compensation is the main reason the company isn't profitable yet. SBC is when the company pays their employees in equity, resulting in more dilution and less profitability since now those additional shares become a major expense for the company. If Palantir had no stock based compensation in 2021, they would have had a 29% margin on their revenue, bringing in $500M in profit off $1.5B in revenue.
So, why is SBC necessary? Alex Karp, CEO, has been incredibly vocal about why they have excessive stock based compensation. The main reason is because they are fighting to keep some of the best talent in the world to not go to Google and Facebook.
They don't have the ability to pay the strongest salaries, so they need to find another way to actually get employees to care about working in the company, and giving them some skin in the game is always a natural way to get people to want to stay to cash out on the upside of the company growing.
Now, the good news is that SBC reduced in Q1 2022. It was around 193M in Q1 21', and reduced to about 150M in Q1 22'.
So, stock based compensation is going down. Alex Karp told us in the Q4 21' earnings presentation that it will naturally go down over time as the company begins to normalize, but it was and still is needed to keep employees motivated and at least acquire the talent necessary to be able to deliverer the strongest technology products for the long term.
GAAP Profitability is what wall street cares about. These are generally accepted accounting principals, and they are the most accurate way for analysts to understand how much actual money is being made by the company after their expenses are dealt with.
Palantir in Q4 21' had a -14% GAAP profitability percentage, meaning they lost 14% of the money they brought in. They had a 29% operational margin (if you take out SBC) which means they would have profited by 29% without certain expenses, but with those expenses, they actually lose money.
Well, in Q1 22', Palantir's GAAP profitability reduced from -14% to -9%. This is good, because it means that now Palantir is only 9% away from breaking even and eventually reaching true profitability, where as the quarter before they were 14% away from reaching any form of profitability.
Their gross margins have remained stable at a strong 81%.
So, how does Palantir ultimately reach GAAP profitability? I suspect it wont happen in 2022. If we are lucky, we may see it in Q1 of 2023, but more likely can expect it in Q2-Q3 of 2023. The answer is simple: they need 1.) reduce SBC 2.) invest in their salesforce to drive more top line revenue 3.) control costs to reduce their expenses and keep their operating margin near 30% or higher.
The answer is simple, but the execution of it will be harder and investors need to be patient with Palantir to be able to achieve these things. If they are able to land the Federated Data Platform from the NHS, more US Gov contracts from the new defense spending bill, more penetration into Europe, and potential upside from defense spending due to the Russian invasion of Ukraine.
There are many catalysts in place to lead to GAAP profitability, but we need to give them time to get here, especially given where the macro conditions currently are in the overall economy.
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