Capital Allocation Decisions:
Capital Allocation Decisions:
Role Of A CEO:
A CEO within a company, basically has two main objectives. Firstly is that of successful running of operations, in conjunction with the deployment of cash generated by operations. The five main methods of capital allocation includes:
- Investing in existing operations
- Acquiring other companies
- Issuing dividends
- Paying down debt
- Repurchasing stock
For Palantir, it seems that their focus on capital allocation is not upon the issuing of dividends, purchasing of stock, or acquiring other companies, but instead is centred on investing in existing operations and paying down debt.
There are some concerns that I personally have regarding managements capital allocation skills, especially when it comes to investing within companies. For example, Palantir recently invested into 20+ early stage companies, and SPACs. It turns out that this decision to investing in these companies was one of regret, and thus indicates poor judgement on the behalf of management.
Realized and unrealized losses on the SPAC portfolio reached 75% at the end of September, or about $333 million, according to my analysis of Palantir’s latest accounts.
The SPAC misadventure features in several class action lawsuits by investors that the company intends to defend “vigorously,” according to its third-quarter accounts. Palantir declined to comment.
One SPAC partner, custom-parts manufacturer Fast Radius, filed for bankruptcy this month just months after going public. Hence Palantir is unlikely to receive the bulk of the $45 million revenue anticipated from that contract and its $20 million investment is probably worth zero.
The original thesis of investments into these speculative SPACs, was similar to that as seen within the Government sector in which Palantir battle-tested their product, and therefore had the ability to iterate and perfect their product.
Palantir, since inception, have battle-tested their software within the context of intelligence agencies, and the Governmental sphere. This is because, throughout the Government sphere, Palantir over an 18 year period were trailing, testing, and adapting their software within some of the harshest conditions possible.
For SPACs, investors originally believed that this program was similar to that as seen within early stage Governmental work. Via the SPACs, this is a methodological approach for testing, trailing, and adapting the product for the needs of smaller companies, therefore allowing for the gradual increase in TAM.
Whilst this point still – I believe – holds truth, it is clear to see that the monetary investments into these companies, was a poor decision.
If anything these SPAC investments highlight the clear unconventionality of Palantir management and sometimes this unconventionality does not succeed.
On a positive note, it does seem that the bulk of Palantir’s capital allocation is focused upon existing operations, and the deepening of their competitive solution. It seems that these investments within operations are successful, especially when one considers the quality of Palantir’s customers and revenue.
In consideration of the low price point for Palantir, hitting almost $5 per share in recent trading days, investors are questioning why management are not purchasing shares.
Shares of SoFi are in focus following a $5 million purchase by CEO Anthony Noto. The purchase marked Noto’s first purchase of SOFI stock since June 16. Furthermore, the purchases were enacted on Dec. 9, Dec. 12, and yesterday, Dec. 13.
A stock buyback is when a public company uses cash to buy shares of its own stock on the open market. A company may do this to return money to shareholders that it doesn’t need to fund operations and other investments.
While dividend payments are perhaps the most common way to return cash to shareholders, there are advantages to stock buybacks:
- Directly boost share prices. The main goal of any share repurchase program is to deliver a higher share price. The board may feel that the company’s shares are undervalued, making it a good time to buy them. Meanwhile, investors may perceive a buyback as an expression of confidence by the management. After all, why would a company want to buy back stock it anticipated to decline in value?
- Tax efficiency. Dividend payments are taxed as income whereas rising share values aren’t taxed at all. Any holders who sell their shares back to the company may recognize capital gains taxes, naturally, but shareholders who do not sell reap the reward of a higher share value and no additional taxes.
- More flexibility than dividends. Any company that initiates a new dividend or increases an existing dividend will need to continue making payments over the long term. That’s because they risk lower share values and unhappy investors if they reduce or eliminate the dividend going forward. Meanwhile, since share buybacks are one-offs, they are much more flexible tools for management.
- Offset dilution. Growing companies may find themselves in a race to attract talent. If they issue stock options to retain employees, the options that are exercised over time increase the company’s total number of shares outstanding—and dilute existing shareholders. Buybacks are one way to offset this effect.
Whilst stating this, it does seem that Palantir & the management with their iconoclastic view, are much more focused upon strong products and services, in comparison to share valuations. This has been reiterated multiple times by Palantir management – namely the focus on the long term vision – and thus the building of the greatest products.
Peter Thiel reiterated multiple times that Palantir needs to focus on the creation of products in which are 10X better than competitors. Thus, this ties in with the notion that Palantir is focusing their capital allocation upon existing operations, in comparison to less useful methods for long term competitiveness, namely stock buybacks.
Open innovation is the practice of early stage products collaborating with super fans, or other companies. Companies should favour open innovation, as it can lead to an array of benefits. A closed, secretive model is usually inferior. With open innovation, companies can jointly develop new ideas, technologies, or markets, with customers.
Palantir is yet to achieve a developmental community, or test trial, for their software. Unlike other successful tools, Palantir is unique in the sense that developers can not use the program within a “freemium” tier model.
This may reduce the understanding of Palantir from an organisational point of view, and thus may dissuade the incentive to purchase the complex software.
In knowledge of the fact that Palantir is an invasive tool, and is viewed as very complex, the company needs to find methods in which they can mitigate this complexity, and therefore allow for easier understanding from an organisational point of view.
The launch of a “freemium” tier solution would be fundamental allowing free usage of Palantir by developers. Ultimately, this results within a larger incentive for companies to adopt Palantir. Developers, within their own time, can understand and get to grips with the complexity and the utility of Palantir. These same developers then, with better understanding of the software, can act as advocates for the solution. Once again, this increases the incentive for adoption.
The fact that Palantir is yet to implement this, raises concerns regarding management competence, and their agility within a complex technological environment.
Morgan Stanley recently noted that:
Cost pressures should make companies accelerate investments in automation and productivity-enhancing technologies. Many of these technologies are inherently deflationary. Within this note, we provide a shopping list of “deflation enablers.”
Persistent inflation in areas such as labor, supply chain/procurement, and energy give rise to transformational investment across industries. While cyclical forces tend to deter investment in an uncertain macro environment, we believe structural changes in demographics, energy policy and security, and an aging capital base make technologies focused on cost reductions and productivity more valuable.
Software is a “Deflationary Technology in an Inflationary World”.
“The case for digital transformation has never been more urgent or more clear. Digital technology is a deflationary force in an inflationary economy. Businesses, small and large, can improve productivity and the affordability of their products and services by building tech intensity.
The Microsoft Cloud delivers the end to-end platforms and tools organizations need to navigate this time of transition and change.”— Satya Nadella, CEO of Microsoft.
The fundamental purpose of software is to optimize business and consumer processes, automating them to be more efficient and effective. So in a larger sense, one can make the argument the entirety of the enterprise software industry serves the purpose of driving efficiencies within business to fight inflation (as Satya Nadella noted above).
For the purposes of this note, we’ve tried to narrow the focus to vendors whose software targets a specific inflationary cost pressure being seen in the market today.
C3, Palantir, Snowflake – Enabling More Efficient Supply Chains and Logistics with Better Use of Data. Consolidating multiple data sources and making it usable to solve some of the most difficult problems facing organizations and governments is the core functionality of all these vendors. In the context of this report, all three have talked to a significant use case within their customer base of driving logistics and supply chain efficiencies with their software.
To focus on one vendor in particular, Palantir’s core Foundry data platform accelerates the integration of data, allows simulations against that data, enables real-time alerting for any potential disruptions in the data which allows customers to optimize and find efficiencies in supply chains and logistics.
In other words, in consideration of the higher cost of capital, and labour, companies are going to be investing within deflationary technologies and software to gain competitive advantages and to increase efficiencies.
Whilst this sounds idealistic, in reality, Palantir must ease friction associated with adoption, in order to allow for hyper growth.
The creation of a true developer community, as well as a “freemium” trial offering, is foundational for this friction ease.
Based on the ideological arrogance of management in the past, Palantir for some time, proclaimed the lack of necessity regarding a sales force.
Alex Karp mentioned within the Palantir Q&A that the companies sales force still equates to around 1% of the overall employee headcount. In comparison, Snowflake have a sales and marketing team of 2,247 individuals. In fact, this is close to half of their overall employee headcount for Snowflake, which equates to 4,559 individuals.
Alex Karp mentioned on the earnings call that for Palantir, they currently only have 41 individuals within the company who are fully trained to sell the product. Whilst Palantir have pledged in the past to increase their overall sales team, this will take time. On average it takes around 9 months for an employee to become fully equipped to sell the Palantir software solution.
Therefore, from an optimistic perspective, the Palantir salesforce is still a bottleneck for the company. In the future, as the sales ramp up occurs, Palantir should see results comparable to other high growth software companies.
It can be fairly stated that in the past Alex Karp’s arrogance associated with the perceived lack of purpose for a sales team has damaged the company, and perhaps has given market share to other vendors. But, fundamentally the team recognised this error, and thus have made changes to address it.
A sales force ramp up for a complex software solution will take time, and often individuals who are selling the product must become more than sufficient in using the software solution. This takes time and investors must be patient.
In the end, it is highly unusual for an 18 year old software company to generate such growth, whilst also having a sales team of less than 1% of the overall headcount. Investors should be optimistic for the next year, in which the sales force ramp-up will have become more mature.
There are two major concerns I have:
- Lack of agility from management
- Arrogance from management
The truth is, this lack of agility, in conjunction with clear arrogance levels, resulted within Palantir loosing market share to competitive solutions – namely Snowflake.
If this lack of agility and arrogance continues, Palantir is likely to fall behind other fast-moving competitive solutions.
Once again, this highlights the iconoclastic nature of Palantir, and the management personnel whom are characterised as “outsiders”, or people that go against conventional normalities.