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| Source: https://www.sequoiacap.com/ |
The hottest debates on Wall Street right now revolve around the possibility of an economic recession and the potential AI bubble. About a month and a half ago, Sequoia Capital, a venture capital firm based in Silicon Valley, published an article titled "AI's $600B Question." The core argument of the article is that the current $600 billion Capex for AI infrastructure is excessive, and even considering the revenue generated from its utilization, there's gap of approximately $500 billion. This suggests an unsustainable situation, with the AI bubble heading towards a turning point.
This argument holds weight. Big tech companies are pouring massive amounts of capital into building AI infrastructure, but a clear blueprint for returns on these investments isn't likely to materialize within next few months. If spending continues unabated without a corresponding increase in revenue and profits quarter after quarter, investors might perceive something amiss, leading to sell-offs and a potential stock market crash.
These concerns have extended to Big Tech earnings calls, prompting numerous questions. Google, too, is channeling a substantial amount of its cash flow into Capex, and faced inquires about it. Sundar Pichai's response was that in times of transition, underinvestment is riskier than overinvestment. A prime example of a company falling behind in the tech industry due to underinvestment is Intel. Despite its once-dominant position in the CPU market, fueled by its technological prowess, Intel's focus on cost-cutting over investment in talent and process technology has led to its current predicament. Big Tech giants like Google, Meta, Microsoft, and Amazon undoubtedly yearn to hold the reins of power in this evolving landscape.
The current advancements in AI technology are indeed remarkable. The question, however, lies in their sustainability. To justify the substantial investments in AI infrastructure, there needs to be evidence of sustainable growth and tangible outputs that match the level of investment. While these concerns are widespread, there seems to be a company offering solutions - Palantir. Palantir has delivered impressive earnings and revenue surprises in both the first and second quarters of 2024, resulting in a YTD stock price surge of nearly 94%, almost doubling its value.
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| Source: Palantir IR |
In the second quarter of 2024, Palantir's commercial revenue saw a 33% increase, and when narrowed down to the US, an even more impressive 55% growth. Government revenue also showed a healthy increase of 23%, showcasing continued strong performance. Palantir reports seeing tremendous demand in enterprise AI and anticipates sustainable growth.
If you're reading this with the intent of investing in Palantir, I assume you've already done extensive research and are familiar with the specific figures. I'll skip reiterating those details, as you've likely seen them ad nauseam. Instaed, let's focus on how Palantir is currently addressing the AI bubble concenrs.
There's undeniable enthusiasm surrounding generative AI, but many investors are apprehensive about the bubble, questioning how this technology can truely enhance productivity. They're right. While generative AI is a powerful tool, its adoption won't magically transform everything overnight. It's akin to the introduction of Excel or Powerpoint; they didn't instatnly double or triple productivity. Generative AI undoubtedly has its merits. It can accelerate coding for developers and act as a valuable assistant for senior-level professionals. However, it's not enough to justify the current overinvestment in AI. We need to see more significant productivity gains.
This is where I believe Palantir provides a solution, Palantir's origins lie in big data. Peter Thiel, its founder, established the company with the vision of creating solutions that leverage advanced information technology to tackle complex problems. Ultimately, his goal is reindustrialization. Despite the rapid advancements in internet technology since the dot-com bubble, traditional businesses haven't seen dramatic improvemnts in their operations or productivity. Palantir aims to integrate its solutions into these businesses to catalyze reindustrialization. Even before the advant of AI, Palantir was achieving this. Their journey began with US government contracts, and I Believe the Airbus case best exemplifies their vision. Palantir's technology enabled Airbus to consolidate its entire supply chain into a single data model. This allowed them to identify and eliminate bottlenecks across the production process, reducing costs, shrtening lead times, and ultimately boosting the A350's productivity by 33%. Remarkably, this was achieved even before the development of AIP.
During the earning call, CTO Shyam Sankar highlighted the recent launch of Warp Speed from their AIP product pipeline, emphasizing its role in supporting America's reindustrialization. Elon Musk's innovative SpaceX, for instance, doesn't rely on existing ERP systems; they've build their own. Why? it's likely because conventional software couldn't effectively address the inefficiencies prevalent in the industry. Even Tesla, in the automotive sector, eschews traditional manufacturing techniques, striving to eliminate inefficiencies at every turn. This is key. Legacy industries still heavily rely on manufacturing technologies that are decades old. These methods might have been efficient in their time, so no one thought to improve them further. However, Peter Thiel recognized that with the tremendous advancements in information technology, there are vast inefficiencies lurking with these businesses. Addressing these issues would lead to significant industrial progress, and Palantir refers to this as reindustrialization.
Palantir has created an AI operating system. This system serves as a platform for integrating data from various industries, enabling it to operate seamlessly. The vast amounts of data within this system generate numerous connections, revealing the true meaning behind the data. It's a process where businesses gain self-understanding within this operating system. Palantir doesn't merely offer insights; it facilitates a transformation of the entire business process. Consequently, businesses can reduce costs and enhance productivity.
Let's revisit the title of Sequoia' article: "AI's $600B question." I believe Palantir can provide the answer. Their solutions will permeate numerous manfacturing and energy sectors within the US, driving significant productivty improvements. Palantir's technology will identify and address countless bottlenecks and inefficiencies.
The proof of Palantir's effectiveness lies in its growing customer base within the US.
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| Source: Palantir
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If this growth trajectory continues, it will serve as compelling evidence that Palantir's solutions are indeed driving productivity improvements for businesses. Once they achieve substantial success in the US and successfully reindustrialize American companies, we can expect a ripple effect, with customer numbers and revenue steadily increasing in US-allied countries.
Evaluating Palantir's valuation at present is challenging. However, if we consider SAP, the largest ERP company in Germany, as a comparable competitor, its market capitalization stands at 242.1 billion euros, translating to rougly 267.1 billion dollars. Currently, Palantir's market cap is at 71.8 billion dollars. While I cannot predict the limit of Palantir's growth, I believe that if their vision of reindustrialization comes to fruition, they have the potential to surpass SAP's market cap. This suggests there's still room for growth exceeding fourfold.
While I can't foresee how Palantir's stock price will fluctuate in the next year, if their reindustrialization ambitions are realized, its current price could be considered undervalued. However, this is contigent upon the successful execution of their vision.
It's important to note that Palantir currently commands a high earnings multiple, which could lead to significant volatility.
Please remember that all investment decisions carry inherent risks, and the responsibility lies soley with the investors.
Thank you for reading.
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