Palantir Technologies (NYSE:PLTR) went public on Sept. 30 via a direct listing, one of the few companies that have chosen to take this route. But after reading through the public S-1 filing with the SEC I find little reason to own PLTR stock.
This is despite the fact that I find the company very interesting. The following CNBC analysis of the company’s history and operations shows its uniqueness.
I respect its contrarian attitude towards the typical Silicon Valley mindset. They go against the grain, so-to-speak, in that they are one of the few dedicated defense and law enforcement software companies.
However, what bothers me is that real cash profits are scarce in the offering documents. Moreover, the company does not present much in the way of profit forecasts or free cash flow focus.
Another Beltway Bandit
I worked in the Pentagon for a good while at a senior policy level under the Reagan administration. This was in a very sensitive area and I had a top secret and other high-level classification areas of access. Moreover, I was involved in high-technology transfer issues.
Typically, I came across and health with similar companies like Palantir, albeit much smaller. We hired these companies to do “specialized” research. The companies always structured their contracts to a particular task at hand. But their contract always seemed to “extend” (just like Palantir calls it in their S-1 filing), even when the original task was completed.
We used to call these companies “beltway bandits.” That is because their offices were usually in the nice office buildings surrounding the Washington D.C.-area beltway highways. They all had lucrative contracts. The companies never really wanted to go public though, since they did not want to show the profits they were making.
Moreover, everyone wanted to go work for them when their government jobs became too boring (not me, I went to work on Wall Street).
But I digress. Here is the point. Palantir can’t really show significant profits. Otherwise, its government contracts would look overpriced. And that would mean inquiries, GAO (Government Audit Office) audits, downsizing, and potential cancellations.
Moreover, the U.S. government really has no sense of scale in its software purchasing. For example, the same software contract for the U.S. Department of Defense might be sold with the same estimate manhours of work to the CIA. This is despite the fact that the second contract only needs tweaking from the first. In fact, one of Palantir’s goals is to reach “scale” of work in its government work (see page 7 of its prospectus).
What To Do With PLTR Stock
Palantir talks a lot about its contribution profits and its contribution margin. But these are not profits that the company can distribute to its shareholders. Contribution profits are gross profits less marketing spend and sales expenses that can “contribute” to overhead expenses.
This is not the same as cash flow. One of the reasons to not invest in PLTR stock is that there is no free cash flow (FCF). For example, in the year ending 2019, Palantir lost $165.2 million in cash flow from operations (CFFO). You have to go all the way to the end of the S-1 filing, on page F-11, to find this.
Now CFFO less capital expenditures result in free cash flow. In 2019 the company spent $13 million in capex. Therefore, its FCF was -$178 million.
PLTR stock has a market capitalization of about $16.3 billion, depending on whether you include the company’s numerous options and RSU’s (restricted stock units). Therefore, its FCF yield is -1%.
That is not too bad an overvaluation. For example, with several years’ growth, the company might eventually make positive free cash flow. That will likely justify the present high valuation of PLTR stock.
My problem is that there are huge incentives that might prevent the company from ever showing large FCF margins. As I pointed out, that could potentially lead to scale back decisions from its base government contracts.
Bottom line: avoid PLTR stock until it is willing to show positive FCF.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.