Palantir stock has surged on its growing role in an industry that the company's chief technology officer Shyam Sankar argues needs a "painful" reformation.
The U.S. military must embrace new technologies, especially cutting edge software, to remain dominant, Sankar argued in The Defense Reformation. Palantir is eyeing huge opportunities in the transformation, especially with the rapid advance of artificial intelligence.
Palantir stock has soared more than 300% in 2024 thanks to robust growth in the company's government and commercial business segments. The data analytics software maker gets nearly 60% of its revenue from government agencies. And Wall Street remains bullish on Palantir stock's growth outlook as Palantir CEO Alex Karp pointed to bigger opportunities presented by AI.
"The world is in the midst of a U.S.-driven AI revolution that is reshaping industries and economies," Karp said in a Nov. 4 letter to shareholders. "A juggernaut is emerging. This is the software century, and we intend to take the entire market."
'Software Eats The World'
Defense has become major Palantir turf. Palantir stock has outpaced legacy defense companies RTX, Boeing, General Dynamics, Northrop Grumman and Lockheed Martin.
The software giant's influence appears to be growing. Sankar is reportedly being considered by the incoming Trump administration for the top research and engineering job at the Department of Defense (DOD). Palantir could not immediately be reached for comment.
Palantir has effectively mined the AI opportunity with government customers for intelligence gathering, counterterrorism and military purposes. Its technology has been deployed on battlefields in Ukraine and the Middle East.
"There's an old saying that software eats the world," says Byron Callan, managing director at Capital Alpha Partners. "It's going to eat the military too."
Technology In War
The ongoing war in Ukraine offers a glimpse of how technology is remaking the battleground. "First is just the widespread use of drones and autonomous systems that are cheap," Callan says. He adds that rapid scalability and battlefield transparency through overhead surveillance have also emerged as key themes in modern warfare.
One of the challenges of getting the latest technology to war fighters has been federal bureaucracy.
"I think more and more the DOD is realizing that a high moat has kept technology out of the department," Callan says. "So they're trying to find ways to build bridges across the moat."
Part of that bridge building includes sweeping modernization efforts to scale adoption of AI and other digital technologies. Those lower barriers to entry could provide a tailwind for Palantir and other aspiring defense entrants. But Callan says restrictions will remain.
Recent news on PLTR stock gives evidence of the Pentagon's efforts to quicken the pace of technology acquisition.
On Dec. 3, the federal government issued Palantir a higher rating for secure cloud computing services. The higher authorization enables the U.S. government to process the most sensitive unclassified workloads in Palantir's cloud offering.
Palantir's Expanding Footprint
On Dec. 6, the company announced a partnership with federal defense contractor Booz Allen Hamilton to modernize IT infrastructure and "accelerate defense mission innovation." Earlier this year the company secured larger contracts with the DOD to expand its AI program called Project Maven.
In September, Palantir stock became the first defense name to be added to the S&P 500 in 46 years. Barron's reports that PLTR stock leads the list of contenders to join the Nasdaq 100 during its annual reconstitution. Changes to that index will be announced Dec. 13.
Palantir is a model of a modern major defense company, says Steve Grundman, an Executive-in-Residence at Renaissance Strategic Advisors and a Senior Fellow at the Atlantic Council, a foreign and defense-policy think tank in Washington. "There will be room in this industry, and arguably at the top of the food chain, for software intensive companies."
The company is also focused on growing its commercial market with expansions into health care, energy and manufacturing. Most traditional defense primes, as DOD contractors are referred to, do not have commercial businesses.
Revenue Growth Boosts Palantir Stock
To capture that market, Palantir is aggressively pursuing new customers and existing deal expansions with software boot camps for its Artificial Intelligence Platform (AIP).
That strategy resulted in Q3 earnings that handily beat estimates. Palantir earnings jumped 43% from the previous year to 10 cents per share. Revenue grew 30% to $725.5 million. The software maker saw accelerated revenue growth of 40% year-over-year in its U.S. government business unit.
But the U.S. commercial business segment also grew at a healthy clip, reporting revenue growth of 54% over the previous year. PLTR stock is targeting more than $687 million in U.S. commercial revenue for the year.
But overall decelerating revenue growth is an issue. Analysts at William Blair say the company is falling behind management's 2025 revenue target of $4.5 billion by the tune of $700 million.
Palantir stock is extended above a 29.83 entry point. Also, Palantir stock trades well above a 5% buy zone. Some investors may want to take profits.
Competition And Collaboration
Callan says the DOD's digital transformation has injected elements of competition and cooperation in the defense market.
On Nov. 7, Palantir and startup Anthropic announced a partnership with Amazon Web Services to provide U.S. intelligence and defense agencies access to the Claude 3 AI models. And in October, Palantir formed a partnership with defense firm L3Harris.
While Palantir has a head start in the market, it's starting to see competition for government contracts. On Dec. 4, The Wall Street Journal reported that OpenAI will work with defense tech startup Anduril to add its technology to U.S. military systems that counter drone attacks.
Callan cites AeroVironment as another example of a publicly traded AI company that could be a key player in the defense sector.
Defense Primes: Can Growth Rates Continue?
While Palantir wants to remake the defense sector in its image, traditional defense companies will still play a major role in the market. The war in Ukraine and rising geopolitical tensions have pushed the share value of these industry giants higher.
The Aerospace-Defense group, one of the 197 industry groups IBD tracks, has advanced 22% in 2024. RTX and Lockheed Martin stand at the front of the pack of the traditional defense primes, climbing 40% and 13%, respectively, this year.
Other standouts include RocketLab, Howmet Aerospace and FTAI Aviation. Those stocks have seen triple-digit gains in 2024.
Palantir's Sankar argues that defense primes should have to prove their market mettle by weaning themselves off taxpayer funds and developing competitive commercial businesses to fund R&D efforts.
It's not as if legacy primary contractors have their head in the sand about the changing landscape. Most incumbent defense companies, most notably Lockheed Martin and Boeing, have undertaken corporate venture arms to spur innovation and invest in startup technology.
"They are trying to get with this program," Grundman says. "Changing the way maybe not the company itself is capitalized, but the way its projects or its technology management systems are capitalized is one of those changes."
Callan says defense industry giants will continue to define the market for the decade to come.
"The real question is what are their growth rates going to be?" Callan says. "How are their capital allocation strategies going to change?"
Bye, Bye Buybacks?
One thing that may change is how primes manage cash to stay competitive. Defense stocks typically appeal to risk-averse investors who like reliable dividends and increased value from share repurchases.
Pure play defense names typically have the luxury of utilizing shareholder friendly cash deployment strategies because they don't have to put their own money into research and development.
Since December 2019, the five major defense primes have completed 71 stock repurchases worth $59.59 billion, according to data from FactSet.
Defense contractors' penchant for buybacks has drawn ire from the DOD for years. Aside from griping, Callan says the agency can't really tell defense primes how to run their business.
"They might be able to award more work to some of these smaller companies that are investing ahead of need and can deliver at a faster pace than some of the larger primes" Callan says.
But market forces could be a natural solution. The continued success of tech upstarts like Palantir and Anduril may pressure defense companies to invest more cash in tech development to remain competitive.
Diversification Will Define The Industry
If consolidation was a defining feature of the sector post-Cold War, the key trend now is diversification.
That diversity will not only play out in the number of firms among big defense contractors, but also in terms of how they fund their projects. Grundman identifies capital deployment as an important watch item for investors.
"Different companies will adopt different strategies and ultimately business models to respond to this perturbation in the industry," Grundman says. "I think on balance more of them are going to have to invest relatively more money into remaining competitive and on time."
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