Analyzing Michael Burry’s Palantir Short Report – Nanalyze

When Michael Burry publishes a brief report about one of many hottest shares on Wall Road, everybody needs to learn it. We’ve analyzed dozens of brief studies through the years and none have been behind a paywall. However that’s the place Burry’s work sits, shielded from these not prepared to half with $39, the minimal it requires to learn this 10,000-page manifesto. So, we raided the workplace slush fund and skim each a kind of 10,000 phrases so that you don’t should. One of the best half? We’re going to do one thing that few appear able to doing. We analyze Burry’s factors of rivalry objectively in a concise method.

Swingers have, “the approach to life.” Inventory cults have “the group,” a loosely knit group of people that orbit round a set of key characters that pump a cult inventory relentlessly. They’ll drool over each press launch, proudly speak about all of the merch they’re being despatched, discuss with the corporate as “we,” and usually simply make a whole mockery out of accountable investing. No greatest practices are preached. It’s all about spending each dime on the sacred cow. And the worst aspect impact of this habits is irrationality.

Each bit of educational proof conclusively factors to inventory selecting being a extremely unhealthy concept. When you resolve to go down that path anyway, any criticism of the sacred cow you’ve hung your complete web value on can be seen as an enormous scary risk. That’s why you see so many Palantir immediate analysts responding with 10,000-word diatribes to Burry and difficult his integrity. (Not like his many critics, Burry has related business expertise.) Identical to the Streisand Impact, these critics are solely making folks extra excited about Burry’s viewpoints. Seems his 10,000 phrase manifesto is insightful, attention-grabbing, however largely unactionable.

Burry’s 10,000 Phrase Manifesto

The introduction begins with a reasonably honest evaluation of what Palantir $PLTR does, definitely yet another exact than the verbose explanations you’ll come throughout within the wild. He then questions why an organization filled with geniuses took so lengthy to begin making a living, and calls out some situations previously when they might have used false advertising and marketing to guard their picture. It’s no completely different from after we referred to as out Palantir for sweeping their net retention rate (NRR) metric below the carpet when it fell to 107%. Since then, it’s risen to 139%. (Extra on this in a bit.) The manifesto goes on to explain Karp’s quirkiness, the corporate’s propensity to blow via money, and retains citing the guide The Thinker within the Valley together with some anecdotal supply whose contributions Burry can’t confirm. (You see anecdotal proof introduced loads briefly studies and we largely ignore it.) Ten pages in we lastly encounter one thing attention-grabbing.

The R&D Spending Downside

There has all the time been some confusion round Palantir’s “forward deployed engineers” or FDEs who’re no completely different from Salesforce consultants that work onsite if you’re deploying a worldwide CRM system that takes the higher a part of a 12 months. For classy enterprise software program implementations, there can be plenty of conventional consulting taking place. As an alternative of breaking this work out right into a “companies” bucket, Palantir classifies this work as “R&D” which one may argue distorts profitability. This begs the query – simply how a lot is Palantir spending on R&D as a proportion of income? About 14%, a quantity that’s declined from 28% in 2021. Examine that to your common SaaS corporations which spends about 25% of revenues on R&D and this looks like a nonissue.

Whether or not Palantir’s engineers are doing consulting or growing new variations of the product, it’s an applicable fee of spending that’s declining over time. And what precisely modifications when you stuff R&D spending into cost of goods sprevious (COGS)? Effectively, you’d have decrease gross margins which could command a decrease valuation a number of. (Extra on this in a bit.)

The SPAC Debacle

We’re solely going to say this level of rivalry as a result of it’s one thing we addressed years in the past. Palantir’s association with SPACs was one thing we disapproved of from the very starting as a result of we recognized them as autos that will do nothing however destroy shareholder worth, and that’s precisely what occurred.

Principally, Palantir bought their resolution to many of those SPACs in change for fairness as a substitute of {dollars}. A lot of that fairness turned out to be value far lower than what it was issued at, and Palantir had no proper to begin speculating on risky belongings as a substitute of simply taking the money (trace: it’s in all probability as a result of these offers wouldn’t have occurred with out these preparations). At one level additionally they held a speculative gold place, one thing that shareholders aren’t paying them to do. It’s like when a stagnant software program enterprise decides to place bitcoin on their stability sheet (cough, MicroStrategy, cough). Whereas the SPAC scenario turned out to be lower than very best for Palantir, it hasn’t had an enormous impact on their means to promote their enterprise AI platform. However is it actually “AI?”

Palantir In Not an AI Firm

You understand how to inform somebody is a Palantir shareholder? They’ll let you know. And you may drive most of those characters psychological by saying one easy sentence. “Palantir is just not an AI firm.” Earlier than it, a military of fintwat prognosticators can be attacking you with 5,000-word essays about how YOU JUST DON’T UNDERSTAND PALANTIR! Newsflash, people. It doesn’t matter what Palantir does when their income development appears like this:

We’ve stated the identical mantra again and again since we first began protecting Palantir and AI closely practically a decade in the past. The bottom reality to point out that you just’re “promoting AI” is income development. Plain and easy. Palantir’s income development is spectacular no matter whether or not the corporate has developed their very own LLM or not. They haven’t, and don’t must. They simply put a wrapper round your group, extract the info and apply which means to it (muh ontology), after which feed it to the LLM du jour. If somebody doesn’t like utilizing Grok as a result of Elon Musk is Devil, advantageous. They’ll use Gemini.

Burry’s critique of Palantir not being an AI firm factors to his want to fire up the hornet’s nest a bit. He’s in all probability going to run this playbook once more with comparable outcomes too. (Cough, ASTS, cough.) Intelligent advertising and marketing transfer, however once more, not one thing traders ought to waste time caring about.

Issues With LLMs

For somebody with a powerful background in investing, it looks like Burry needs to actually perceive the technical dangers akin to LLMs hallucinating. He postulates that Palantir’s rapidly coded wrapper merely passes via the LLM interpretations and incorporates no mechanism for monitoring how nicely LLMs operate.

Palantir brags about how briskly they onboard clients at their AIP demos, however these firms will quickly notice it’s not as simple because the brown-bag demo implied, says Burry. He additionally believes Palantir’s wrappers would possibly simply get replaced sooner or later, and that “bespoke failure mitigation will proceed to be crucial at nice expense.” In different phrases, that R&D spend will proceed to extend. Besides that it’s not, and clients aren’t canceling. Since Palantir’s NRR is now reflecting their firm in a good mild, they’re stopped tucking it away in a footnote.

If, as Burry claims, clients are operating into issues with Palantir’s resolution, then we might count on this to be mirrored in a declining NRR and gross retention rate (GRR).

The Fast Rise in Web Retention

Palantir doesn’t present GRR which implies a really robust NRR may masks underlying churn. Certainly, we see Palantir hitting a report NRR of 139% which is nicely above the common 120% you’d count on from a high quality SaaS agency. Burry gives an attention-grabbing chance for the explosive enhance in NRR that Palantir realized over final 12 months. It’s due to all these AIP bootcamps.

Clients who landed small through bootcamps at $500,000 and expanded to $2 million or extra inside twelve months present 300% or greater particular person retention on a trivially low base, mechanically inflating the blended determine.

He proposes that the decline in NRR was reversed artificially by signing up clients at decrease contract quantities, after which a lot greater quantities as proven within the above instance. This distortion is masking clients who’ve been on the platform for some time after which say “nah, it’s not for us” and cancel. He postulates that it usually takes some time for a corporation to confess its errors, so these cancels will begin exhibiting up within the subsequent a number of years. Burry argues Palantir’s clients will quickly notice they’re paying an excessive amount of for one thing that may be replicated internally, particularly with the developments we’re seeing in AI. Palantir may very simply begin reporting GRR to alleviate these issues. If it’s true they’ve hostages, not clients, then this easy metric reinforces that.

At all times determine key metrics to observe that can show a idea is coming to fruition. For Palantir, all the pieces comes all the way down to persevering with that robust income development. Profitability isn’t an enormous concern this early on. The extra they scale, the extra they’ll afford thinner margins and nonetheless be extremely worthwhile.

Worldwide Growth

Burry accurately factors to issues round how Palantir’s vocal and controversial chief, Alex Karp, has sidled as much as the Trump administration which – some imagine – is contributing to Palantir’s incapability to increase abroad. Karp describes this as “a bandwidth drawback” to which Burry rapidly shouts, “Ah hah! You’re a consultancy!” Not essentially. A “land and increase” enterprise mannequin that requires “ahead deployed engineers” to assist implement isn’t any completely different to how Salesforce implementations require “Salesforce consultants” to be onsite for lengthy durations of time serving to firms with migrations and implementations.

As for Karp’s willingness to play politics, it’s a double-edged sword. The friendships he’s forming within the present administration might come again to hang-out him through the subsequent administration. You’ll be able to hear the rumblings from afar. “Palantir is an evil firm that the present administration makes use of for surveillance.” What if these murmurings change into extra vocal when the following administration comes into energy? Because of this Palantir’s reliance on the U.S. authorities is a priority we’ve been persistently elevating over time.

Business vs Authorities

We’ve all the time seen Palantir’s reliance on the U.S. authorities and the CEO’s willingness to have interaction in politics as huge crimson flags. This grew to become much more of a priority when Elon Musk revealed how his DOGE efforts threatened to chop an enormous swath of presidency spending which very nicely may have affected Palantir. Nevertheless, the numbers inform us this has been a nonissue. Authorities development has endured strongly which ends up in one other drawback. When will we see Palantir’s industrial revenues command a majority of complete revenues?

Progress has been sluggish with industrial revenues slowly edging up through the years to the place they sit right this moment – 48% of complete revenues. They’re not a majority, however are getting shut. Is that this acceptable? Maybe, when you think about that authorities revenues have stored rising strongly regardless of one of many largest axes that can in all probability ever be swung on Capital Hill – DOGE.

If Palantir can climate that turmoil, even thrive regardless of of it, then maybe their robust reliance on the U.S. authorities isn’t that huge of a difficulty. The subsequent milestone for this danger can be three years from now when the U.S. welcomes a brand new administration, however no want to attend till then to speculate. The bottom reality is all the time income development, and Palantir has that in spades. So why not go lengthy?

Palantir’s Valuation

This brings us to Burry’s most vital level of rivalry, in our eyes, which is valuation. As an alternative of utilizing valuation ratios, he gives his personal supporting proof that the inventory is value one thing like $46 a share. His strategies could also be completely different, however the premise is identical. When an organization’s valuation reaches stratospheric ranges – as Palantir’s has – then one among two issues will occur. Both fundamentals will catch up, or the valuation will revert to the imply. Under you possibly can see how Palantir’s easy valuation ratio has developed over time.

Our easy valuation ratio takes market cap and divides it by annualized revenues, whereas your typical value to gross sales ratio makes use of trailing 12-month revenues. That permits us to ascribe a “cheaper” valuation to firms which might be rising extra rapidly. We don’t spend money on any firm whose shares commerce at 3 times our catalog common which is round 7.6. Meaning Palantir would wish to commerce at an SVR of twenty-two.8 – or $53.47 per share – earlier than the valuation can be at an appropriate stage to contemplate investing in.

Some may need a better valuation cutoff, and that’s advantageous. However Palantir’s persevering with nosebleed valuations are – no less than in some half – brought on by Karp’s centered messaging which caters to the broad swath of retail traders, lots of which spend all their time cheerleading the corporate. Those that take the slightest essential strategy in direction of analyzing Palantir are labeled as evil shorts by Karp which is a crimson flag in itself. Like Musk, he’s a double-edged sword for his firm.

Conclusion

Burry’s manifesto was a well-written story that was attention-grabbing sufficient to learn, however not attention-grabbing sufficient to advantage paying for, or dropping all the pieces and writing prolonged rebuttals. That’s precisely what all of the Palantir perma-pundits did, and the drama they created labored completely in Burry’s favor. He obtained the eye/subscriptions/affect he was in search of.

Burry confirmed us he has the chops to take down firms that actually have issues versus one of the in style shares right this moment which is exhibiting great development acceleration. One of the best factor that might come out of this is able to be for Palantir’s valuation to drift again all the way down to one thing cheap through which case it’d make for a compelling solution to spend money on an enterprise AI resolution that’s rising like mad.