This article was originally published on Forbes on Jul 18, 2024,05:46pm EDT

We are no strangers to Palantir’s story, saying as far back as September 2020 prior to Palantir’s public offering that the “commercial sector is the growth story” for the company as it expands beyond government clientele. Heading into 2024, Palantir was exhibiting “multiple signs of acceleration” stemming from strong growth in its US commercial segment, driven by AIP, Palantir’s Artificial Intelligence Platform that lets customers lever Palantir’s AI and ML tools and harness the power of the latest large language models (LLMs) within Foundry and Gotham.

AIP and US commercial growth are still the main storyline for Palantir investors to watch moving through 2024, given the two are the pr imary growth drivers this year. A closer look in Q1 reveals that momentum is not slowing down for AIP, and US commercial revenue growth remains intact. Government revenue also bucked its trend of decelerating growth throughout 2023, rebounding from under 11% YoY growth in Q4 to 16% YoY growth in Q1.

However, Palantir’s management shed light on some potential hiccups in AIP’s sales cycle, which we outline below. Meanwhile, the market is pricing in a perfect story this year, which puts pressure on the stock to execute.

US Commercial Business Remains Strong

Palantir’s US commercial segment remained strong in Q1, with AIP driving strong customer growth as revenue growth accelerated on a sequential basis. Management continued to drill home AIP’s momentum in the quarter by saying: “US commercial business continues to see unprecedented demand driven by momentum from AIP.”

Palantir reported $150 million in US commercial revenue in Q1, an increase of 40% YoY.

Source: I/O Fund

US commercial revenue rose 40% YoY and 14% QoQ to $150 million in Q1, accelerating 100 bp on a QoQ basis. While this was technically a deceleration from 70% YoY growth last quarter, that came against an extremely weak comp, with the QoQ growth acceleration more reflective of Q1’s strength.

Management explained that the segment is “where we're seeing the greatest transformation. While Q1 is seasonally our slowest quarter, AIP adoption by new and existing customers helped drive notable growth in customer acquisition and revenue in our US commercial business.”

Palantir added 41 net new US commercial customers in Q1, an increase of 69% YoY and 19% QoQ.

Source: I/O Fund

Palantir added 41 net new customers in the segment, an increase of 69% YoY and 19% QoQ. This accelerated from 55% YoY growth in Q4. We also saw customer additions broaden beyond the US this quarter – the commercial segment (including international) reported total net new adds of 52. As a whole, commercial customer count rose 53% YoY and 14% QoQ to 427 customers.

This means that the commercial segment, driven by US commercial, once again dominated net new adds in the quarter. US commercial contributed 41 (and commercial 52) of Palantir’s 57 net new additions, or ~72%, compared to more than 90% of net new adds last quarter; the entire segment still contributed more than 90% of net new adds with international growth.

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AIP Interest Remains High

As has been the case since its launch just over a year ago, Palantir is continuing to witness elevated interest and high demand for AIP, and is offering developers a free trial to explore and build on AIP, but it is limited in user size and Ontology quantity.

Management said that “continued interest in AIP is loud and clear,” and shared an update on AIP bootcamp progress, saying that they have sustained the “high volume of bootcamps with over 915 organizations participating to date to meet inbound demand.” Palantir had completed 560 bootcamps across 465 organizations by February, tacking on an additional 450 organizations in just the past five months. Palantir did not share an updated bootcamp total.

Palantir also said that AIP was aiding in customer conversion and expansion, aligning with trends observed earlier in the year, where management said AIP bootcamps were “quickly converting to paying customers” or expanding existing customers’ contracts. US commercial deals rose 94% YoY to 136, and total contract value (TCV) increased 131% YoY in Q1 to $286 million. Overall, commercial TCV bookings increased 187% YoY to $505 million, with the US driving more than half of that.

In addition, Palantir said that it is “seeing substantial deal cycle compression. As one example, a leading utility company signed a seven-figure deal just five days after completing a bootcamp. Another customer immediately signed a paid engagement after just one day of their multi-day bootcamp and then converted to a seven-figure deal three weeks later.” We have seen Palantir’s quarterly deals accelerate following AIP’s launch, but we have also seen a larger proportion of deals on the smaller end, between $1 million and $5 million.

Palantir signed 87 deals in Q1, of which 27 were >$5 million and 15 of which were >$10 million.

Source: I/O Fund

Questions In Converting Customer Interest to Contracts

Despite the optimism and reiteration on elevated interest in AIP, CEO Alex Karp shared one key shortfall that the company has – which is difficulties in selling AIP.

Karp explained that Palantir is “at the way early days of figuring out how to actually get customers to buy our product. We are good at educating customers on what is the art of the possible, and then some portion of those customers buy it. So, I expect as we get better and better at that, our numbers will increase. But it is really early days. It's not — we're not flawlessly executing on our sales motion.”

While this could be viewed as a positive given the high interest in AIP, implying that Palantir is not closing as many deals as it potentially could, the market is pricing in perfection this year, and essentially looking for a beat and raise in every quarter this year. Having a sales model where management is still figuring out how to market and sell AIP to interested customers while the market wants acceleration sets the stage for a potential shortfall if Palantir cannot meet these elevated expectations.

International Headwinds Persist

Palantir is also facing some headwinds internationally, primarily in its European business.

International commercial revenue grew 16% YoY, but declined (3%) QoQ to $149 million, “as a result of continued headwinds in Europe and the revenue catch-up in Q4 that we noted last quarter.”

Management further clarified that they “do have headwinds in Europe, 16% of our business in Europe. Europe is gliding towards zero percent GDP growth over the next couple of years. That is a problem for us. There is no easy remedy for that.” Shifting into a low or no GDP growth environment may continue to pressure customer deal expansion and present headwinds to larger deal sizes if budget scrutiny persists.

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Market Pricing Palantir’s Stock for Perfection

With Q1’s beat in store and US commercial still strong, the market is looking ahead for a strong year – essentially pricing in beat and raises each quarter this year, though Palantir’s extended valuation for barely 20% YoY growth enhances downside risk to shares given the international headwinds and the noted friction in its sales process.

Palantir reported $634 million in revenue in Q1, and guided fiscal Q2 revenue between $649 million to $653 million, an increase of 22.1% YoY at midpoint. For FY24, management guided revenue of $2.677 billion to $2.689 billion, up 20.6% YoY, with US commercial revenue of $665 million, for at least 45% YoY growth.

This translates to $1.285 billion in revenue in 1H, and $1.398 billion in revenue in 2H. However, analysts are expecting Palantir to generate $1.414 billion in 2H, with FY24 revenue estimates ranging from $2.68 billion on the low end to $2.80 billion on the high end. That’s about 4.4% higher than Palantir’s guide, suggesting analysts are expecting business momentum to accelerate each quarter with a beat and raise, and increased FY24 guidance.

Palantir’s valuation leaves little to no room for error here, trading at elevated levels compared to AI-exposed large-cap enterprise software stocks with similar top-line growth and bottom-line margins. For example, Palantir’s stock trades at more than 24x forward sales, versus less than 14x forward sales for ServiceNow, which has been reporting revenue growth of >24% the last three quarters, versus 17% to 21% for Palantir.

Other ‘best-of-breed’ software stocks trade at lower multiples, despite having stronger top-line growth rates than Palantir – CrowdStrike has pulled back to below 21x sales after hovering at 24x. Snowflake and Cloudflare trade at 12.9x and 16.3x forward sales, respectively. Since the start of 2023, best-of-breed software has repeatedly struggled to achieve or maintain a valuation above 24x sales, with most rerating back to the 16x level.

While investors can argue that Palantir deserves an ‘AI premium’ from its product suite, investors will still have to value it as a mature company rather than a hypergrowth SaaS, as it’s no longer in that basket. This is the most expensive Palantir has been on a top-line valuation since November 2021, with revenue growth nearly 30 percentage points slower.

Palantir trades at more than 24x forward sales, a premium to best-of-breed software peers.

Source: YCharts

Down the line, Palantir trades at nearly 89x forward earnings (non-GAAP), again at its most expensive level in more than a year, with adjusted EPS expected to grow 32% YoY to $0.33. ServiceNow trades below 55x forward earnings for 25% EPS growth, while CrowdStrike trades similarly to Palantir at 85x forward earnings. Snowflake and Cloudflare, both not profitable on a GAAP basis, trade far above 100x forward adjusted earnings.

If Palantir’s adjusted EPS growth does slow to <20% as currently estimated by analysts, its premium multiple risks rerating lower.

Palantir trades at nearly 89x forward adjusted earnings, again at its most expensive level in more than a year.

Source: YCharts

In terms of cash flow, Palantir trades at more than 100x operating and free cash flow multiples, with an operating cash flow margin of 20% and an adjusted FCF margin of 23% in Q1. ServiceNow trades at less than half of Palantir’s multiples, despite having a superior margin profile, at a 52% OCF margin and 47% FCF margin. CrowdStrike trades at 67x OCF with a 42% margin, while Snowflake trades below 49x OCF with a 43% margin.

Source: YCharts

Across the board, Palantir trades at elevated valuation multiples, whether it be on the top-line, bottom-line, or on cash flows, not only relative to peers, but also relative to itself, trading at its highest levels or near its highest levels of the past twelve months.

Conclusion

Palantir continues to exhibit strong momentum in its US commercial segment, with Q1 results reflective of this with sequential growth accelerating alongside customer count. While AIP demand remains elevated and a core driver of Palantir’s growth, management highlighted a pitfall in that there is friction in selling the product, a key risk to watch moving forward as the market is looking for nothing short of perfection through the end of fiscal 2024.

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