I’m contractually obligated to mention here that Palantir’s name is a reference to magical stones in the novels of JRR Tolkien, which allow users to peer through time and across realms. Less often mentioned is that when Tolkien’s characters use the Palantir stones, they are typically deceived by what they see (pdf).

The business problem

Ideology aside, Palantir’s financial prospects are hardly golden. Before the listing, valuations were expected in the $20 to $40 billion range; about half way through the second day of trading, investors valued the firm at $21 billion. That’s about 20 times the company’s forecast 2020 revenue.

Palantir wants to be valued like a “software as a service” (SaaS) company—the darlings of investors, these firms build a software product which can then be used by a functionally infinite set of users. Think Zoom’s video-conferencing software, or Microsoft’s Office apps: it takes money up front to build the software, but much, much less to acquire new users. Palantir’s two data management platforms, Gotham and Foundry, are marketed this way.

The issue, however, is that both platforms appear to require significant customization and engineering support for users. Palantir brags that its engineers are on the front lines in places like Afghanistan alongside its users, which sounds badass, and is also very expensive to scale. The company’s prospectus says it is not throwing people at problems, and it predicts that the costs of its services will continue to fall, particularly as revenue from on-going customers continues to grow.

Palantir has spent $1.5 billion on its platform thus far, engineering that may set it apart from potential competitors. However, in attempting to win market share in industries ranging from finance to aerospace engineering (current customers include Credit Suisse and Airbus), it may find itself competing with internal solutions developed and marketed by specialists. SpaceX developed a novel systems engineering and integration platform to build its rockets, while asset management giant Blackrock built Aladdin, an investment management platform now used by Apple, Microsoft, and Alphabet.

Consider the numbers: Public SaaS companies have traded at valuations averaging 16 times their previous twelve months of revenue—but these firms are generally growing fast, with revenue increasing at 50% or more year over year, and are profitable. Palantir has averaged 20% annual growth over the last five years and never been in the black.

Sometimes love is having to sue your customers

Palantir is part of a relatively young class of venture-backed companies seeking to make a business out of working for the US government, alongside SpaceX and Anduril, a national-security company founded in part by former Palantir employees, if you couldn’t guess from yet another Tolkien allusion.

These companies share something in common, according to Katherine Boyle, a partner at the venture fund General Catalyst, and Anduril board member. Traditional government contracts state both the problem and the requirements for the solution, which newer firms with Silicon Valley mindsets often see as inhibiting innovation. But trying to convince the government to change how it writes contracts often leads to conflict, as traditional contractors with significant political influence fight to preserve traditional methods.

Palantir and SpaceX have both fought for contracts that emphasize commercial buying, with fixed prices and limited requirement-setting. It has been contentious: SpaceX sued the US Air Force in 2014 to compete for rocket contracts, eventually winning billions in launch business.

In 2016, Palantir sued the US Army over a contract to provide “battle management software.” Palantir won the right to compete, a victory the company’s prospectus suggests will significantly increase the amount of government contracts it can win.

The CIA plays venture capitalist

One of the first outside investors in Palantir, back in 2006, was a little shop called In-Q-Tel. It’s not your typical fund: It’s non-profit, and it was founded by the CIA. (And yes, the Q is for James Bond’s Q.)

The US intelligence agency, once responsible for creating spy satellites and supersonic planes, felt it was losing its high-tech touch in the nineties as information technology became dominated by the private sector. Venture capital was where the tech was, and the CIA decided to go there, launching a fund led at first by former Lockheed Martin CEO Norman Augustine.

At the beginning of 2018, the most recent year it has publicly reported data, In-Q-Tel reported about $450 million in investments;  the fund appears to aim mainly at seed and early-stage investment rounds in companies that manage big data, launch satellite sensors, develop nanotechnology, and organize geospatial imagery.

“We have a board observer position, and we are able to influence where it goes with its product,” an early In-Q-Tel leader said. “There is the aspect that at the end of the day, we want the technology, obviously. That’s sort of our, for a lack of a better term, our special sauce, if you will, of getting in there with that venture relationship.”

For young companies daunted by federal procurement rules, the CIA venture fund was a key way to develop the understanding needed to compete for government contracts. The imprimatur of the spy agency also gives these firms a sexy gloss that helps them raise new money from traditional private investors.

Palantir, explicitly founded to work with US intelligence agencies, was an obvious candidate for In-Q-Tel’s investment. It’s fascinating, then, that Palantir’s relationship with US spy agencies appears to have soured in recent years: It’s not clear either the CIA or the National Security Agency is using the company’s platforms.

A lesson in marketing

Palantir’s greatest success—and the one most reflective of the Silicon Valley ethos the company may or may not be abandoning—was in how it got the military to buy its platform.

As the lawsuit story above highlights, going through the front door wasn’t exactly an easy option. But successful startups find a way in, and one move was providing free training and software to soldiers. Palantir’s Gotham platform was used in Afghanistan by soldiers combining maps, intelligence reports, and records of roadside bombings to plan their missions.

This helped win over the rank and file, who appreciated the more intuitive tools and support offered by Palantir’s engineers. It’s not unlike how instant messaging platform Slack spread initially, winning over individual teams rather than corporate IT departments. Senior Army officials were perturbed because the freebies likely violated government contract rules—but they wound up putting Palantir on a small contract to solve the problem, effectively paying for the company’s marketing.

The act-first, ask-questions-later approach offers shades of Uber selling rides without regulatory approval in cities, then using its customer base as leverage to win the right to operate. For Palantir, getting troops in the field to use its platform paid off when Army officials saw that their troops were more comfortable with it, compared to a kludgier product delivered by traditional military contractors.

“I walked away convinced that Palantir is much easier to use,” Heidi Shyu, the Pentagon official in charge of buying gear for the military between 2011 and 2016, told New York Magazine.

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