PLTR Dilution: One Step Closer [Q4 Tracker]
The SBC path toward "normalization"
Editor: Emanuele Marabella
Hi, I’m Arny. Thank you for joining 1.400 investors spotting Palantir asymmetries. Please hit the ❤️ button if you like today’s article. To have full access to the article and support my research please consider upgrading to a paid subscription.
Stock-Based-Compensation (“SBC”) is often the key argument raised by PLTR 0.00%↑ opponents.
Here we assess the quarterly advancements toward the "dilution normalization.” Please refer to the previous articles to see:
how it works (When Will PLTR SBC Ease?);
how we should incorporate it into our models (Why 99% of PLTR DCFs Fail).
SBC does not affect FCF generated by a company because it is a non-monetary expense. However, it does affect investors.
Palantir relies heavily on SBC to compensate its employees. Therefore, it is crucial for us, as investors, to track the progress toward “normalization.”
Q4 Dilution Tracker
In absolute terms, SBC has steadily decreased and reached a relative minimum of $129mn.
This happened despite hiring aggressively as Palantir is hunting for talents while most tech companies, even the Big Techs, are laying off massively (PLTR Hunting Season is Open). As @Timothy38296021 pointed out, SBC is driven by executive incentive plans.
Palantir hired ~1000 employees in 2022, growing its workforce by +31%.
According to Palantir’s CFO, ‘23 growth in employees should be modest, “a couple hundred,” which should keep SBC under control.
“As we look ahead to 2023, we will continue to exercise spend discipline across the company, pace hiring, while continuing to invest in high-priority areas” - David Glazer, Palantir CFO
As a reminder:
SBC is fixed at the grant date. Therefore a declining stock price does not affect the vesting SBC.
However, it is important to notice that there is a risk related to the newly granted RSU. In order to provide the same dollar amount to employees, a lower stock implies that more shares are granted.
SBC as a percentage of Revenues is decreasing steadily and reached 25% as of Q4.
This percentage should decrease further and help attain GAAP Operating Profitability as Palantir scales (Palantir GAAP Profits: Fake Yet Good).
Palantir vs. Peers
Palantir SBC is clearly still very high compared with traditional companies.
However, compared with other peers in the Cloud space, we notice Palantir’s ~25% SBC as % of Revenues is well below C3.ai and Snowflake.
As of Q4, Palantir’s SBC as % of Revenue is similar to that of Datadog but still higher than the 19% of Servicenow.
How SBC Impacts Investors
In order to reach Operating GAAP profitability, Revenue must keep growing while SBC stabilizes or keeps decreasing.
As investors, our major concern should not be in the amount of SBC but in the net effect of the change in the number of shares.
Let’s assume a company grows 30%, like Palantir. The Growth per Share, or “Diluted Growth” for shareholders would be:
30% with no change in the number of shares;
~20% if the number of shares increases by 10%;
0% if the number of shares increases by 30%.
Value for shareholders is only created if the rate of business growth is greater than the rate at which it is being diluting.
Palantir’s dilutive effect from the increase in shares outstanding is decreasing.
However, it must be noted that there is a ~5% potential increase in shares from exercisable options, which is the difference between shares outstanding and fully diluted shares.
A wider divergence between the business growth and the dilution creates a greater benefit to investors.
This is why it is crucial for Revenues to accelerate (PLTR is Planting The Seeds for Exponential Growth) and the number of shares to “normalize” towards 3-5% at most.
You could find my DCF that incorporates the dilutive effects in the previous article (PLTR Reverse DCF: what does the current price imply?).
Incoming SBC
Unrecognized SBC is the amount of SBC that is yet to be recognized from the current SBC plans, which include Restricted-Stock-Units (“RSU”) and Options, as employees perform their job during the vesting period. Therefore, Unrecognized SBC hints at the direction of future SBC.
As of Q4, Palantir’s Unrecognized SBC decreased steadily, well below its peak of 20Q3.
Palantir currently has ~$1.5bn Unrecognized SBC. This is composed of $770mn RSU, with an avg. vesting period of 3 years and $720mn Options with an avg. vesting period of 8 years. Therefore, we could expect RSU recognition to generate ~$64mn SBC per quarter (799/12) and Options recognition to generate ~$24mn SBC per quarter (760/32).
As a result, we should expect at least ~$90mn SBC per quarter from the recognition of Unrecognized SBC.
I say “at least” because, as we go through the year, new grants will occur, both from existing employees and new employees, since Palantir has been hiring aggressively in recent quarters (PLTR Hunting Season is Open).
Conclusion
Despite the fact that SBC doesn’t impact FCF, the derived dilutive effect is a real headwind for investors.
Therefore, as investors, our duties are:
consider SBC when we perform valuations (Why 99% of PLTR’s DCF Fail);
verify that the growth keeps outpacing dilution;
track the rate of SBC as it heads towards “normalization” so that GAAP Operating Profitability can be achieved.
Yours,
Arny
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View expresses are my own and do not represent Financial Advice in any way.
I own (many) PLTR stocks.
great update, thank you, cheers!