On Wednesday, Palantir Technologies (NYSE:PLTR) completed its long-awaited IPO. Things, however, didn’t go quite as planned. After an initial rise, PLTR stock dropped below $10, valuing the secretive data analytics company at $21 billion and frustrating many investors.
But don’t be fooled: Palantir stock may still reward investors handsomely.
Two weeks ago, I suggested that investors “back up the truck” if Palantir closed below $10.
And it’s happened. With insider selling temporarily pushing prices below that benchmark, here’s why PLTR stock looks like an urgent buy.
Direct Listing and PLTR Stock
In August, Palantir, a secretive multi-billion data analytics company, filed to go public via a direct listing. Rather than complete a traditional IPO, Palantir instead decided to simply list its shares, joining fellow companies like Spotify (NYSE:SPOT) and Slack (NYSE:WORK) in using the lesser-known process.
Direct listings have several advantages over IPOs. Companies don’t have to pay investment banks hefty IPO underwriting fees, and there’s no dilution of existing shareholders.
“In a direct listing, a company doesn’t issue any new stock and therefore doesn’t raise additional money,” writes Michal Lev-Ram at Fortune. “Instead, shareholders sell existing stock directly to the public, leaving investment banks to serve merely as advisers in the process and not underwriters.”
However, direct listings also mean the company cedes precious control of the initial trading. Without bookrunners to help balance supply and demand, too much insider selling could cause share prices to plummet in the short term.
And that’s exactly what Palantir Stock faced. In a massive rush to sell shares on Wednesday, insiders likely crashed Morgan Stanley’s trading platform. Employees reported system outages, overloaded phone lines, and other trading delays. A lot of insiders wanted out.
But why doesn’t all this selling worry me?
Palantir: The “Good” Kind of Insider Selling
Most successful VC-backed companies don’t go public for the cash. (Palantir had $1.5 billion of it before its listing, enough to cover their 2019 cash burn nine times over.) Instead, these companies list to allow early investors and insiders to sell their shares.
And this isn’t a bad thing. In Silicon Valley, rank-and-file employees are typically compensated in stock options as well as in cash. In 2019 alone, Palantir awarded $242 million of stock options, or almost 20% of its total expenses.
“Stock options are the most powerful incentive we have to attract employees,” said founder of Sun Microsystems, Andy Bechtolsheim, in 2004. “Why else would someone leave a large company and take the ris of joining a start-up firm?”
But that also means unlisted software companies build pent-up selling pressure. A software developer working for unlisted Palantir, for instance, might have thousands of vested stock options but find herself unable to convert them into cash.
So, when these companies eventually go public, there’s often a massive selling pressure by insiders. They may still believe in the company’s future (and many will still work there) but they either 1) need the cash for personal expenses or 2) want diversification in their portfolio.
While I’m often skeptical of companies with massive insider selling, recently listed companies are a rare exception.
What’s Palantir Worth?
At $9.90, Palantir’s stock looks far too cheap. Its direct listing allowed insiders to immediately sell 20% of their shares (with the balance subject to a 180-day lockup), which likely pushed shares down.
But there’s still potential for Palantir to rebound. Frost & Sullivan, a business consulting firm, estimates that the big data analytics market will compound at 30% per year through 2023.
Trefis Research, a financial research firm, estimates PLTR stock could be worth $15 per share, a 50% upside. And a 2-stage DCF model shows a similar outcome: If Palantir can grow at 50% in 2021, 13% 2029, and earn EBITDA margins of 22%, the company should be worth $30 billion today.
Should Investors Worry About PLTR Stock?
As I outlined in my Comprehensive Palantir Investment Guide, there are also some reasons to doubt the firm.
Firstly, its corporate governance system looks more like a privately-owned partnership than a public company; its three founders will retain indefinite control, even after PLTR’s listing.
Secondly, the company’s CEO, Alex Karp, is ruthlessly mercenary with accepting controversial government projects. The company took a digital profiling contract with the Immigration and Customs Enforcement (ICE) agency, for instance, without regard for its corporate image.
Finally, the company has a lot of growing up to do. Its tech-forward approach has helped attract top-tier engineering talent, but it now also needs to revamp management and sales as well.
But if the company can overcome these critical drawbacks, then investors stand to gain. It’s time to back up the truck – Palantir stock looks set to soar.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.