Is Palantir’s deal with Microsoft a game changer?

One of the main themes fueling capital markets to new highs this year is artificial intelligence (AI). While much of the AI ​​narrative is captured by the mega-cap tech giants of the “Magnificent Seven,” other players are emerging on the scene.

For the past two years, enterprise software company Palantir Technologies (PLTR -2.93%) has proven it can play ball on AI’s biggest stage, which has helped put the company on the radar of the tech sector’s biggest leaders.

Let’s dig into the new partnership with Palantir Microsoft and evaluate why this relationship could be transformative for Palantir.

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Palantir offers a range of data analysis capabilities through its various software tools. The company sells its products to both the private and public sectors. While Palantir’s revenue and profit metrics below look encouraging, there is a subtle flaw in the company’s operation.

PLTR Revenue Data (Quarterly) by YCharts

Palantir’s commercial business is its fastest growing segment. But a bifurcated look at the company’s entire business shows that about 54 percent of its total revenue this year came from government contracts.

Government affairs can be very nebulous, making forecasting difficult for investors. The heavy reliance on the public sector may be unattractive to some investors, as revenue and cash flow trends are often inconsistent.

However, I think Palantir’s deal with Microsoft could help alleviate some of those concerns.

How do Microsoft and Palantir work together?

Microsoft is an enormous company with operations spanning personal computing, workplace productivity, gaming and social networking. However, one of the company’s most important businesses is the Azure cloud computing platform.

Microsoft and Palantir recently teamed up in an effort to connect Azure’s cloud infrastructure with Palantir’s AI software. Specifically, Palantir’s Artificial Intelligence Platform (AIP) will be integrated with Microsoft Azure Government and Top Secret cloud details.

According to the press release, Palantir AIP is the first major partner to use Microsoft’s OpenAI Large Language Model (LLM) in a classified environment.

Image source: Getty Images.

Is Palantir stock a buy right now?

Palantir currently trades at a forward price-to-earnings (P/E) ratio of 90.6. Not only is that expensive even for a growing stock, it’s well above many of Palantir’s software-as-a-service (SaaS) peers.

Clearly, investors are betting on strong growth for Palantir going forward.

However, I would argue that much of this anticipated growth is rooted more in broad — if not vague — generalities surrounding the long-term outlook of the AI ​​movement. In other words, I don’t think Palantir’s deal with Microsoft and the potential opportunities at play play a big role in Palantir’s current price action.

It will be important for investors to see if Palantir management sheds light on the relationship with Microsoft should the company begin to generate more accelerated growth or potentially win larger public sector deals.

While the strategic relationship with Microsoft is encouraging and a sign of validation for Palantir’s capabilities, the partnership alone is not reason enough to buy the stock.

It is important to consider the long-term implications that could result from the agreement with Microsoft. I think Microsoft will eventually be a new source of lead generation for Palantir. Cross-selling into Microsoft’s existing government customer base could help Palantir even out its own business in the public sector. So for me, the business could very well be a game changer in the long run.