Mark Cash, Morningstar equity analyst, joins Yahoo Finance’s The First Trade with Alexis Christoforous and Brian Sozzi to discuss Palantir’s debut on the New York Stock Exchange.

Video Transcript

BRIAN SOZZI: We're just moments away from data company Palantir's debut on the New York Stock Exchange. Our next guest is pretty bullish on this company, valuing Palantir at $28.2 billion in equity. Mark Cash is Morningstar Equity Analyst, and he joins us. Now, Mark, I'm a little surprised by the valuation you have put on Palantir. Most estimates I've seen about 22 billion. Right now, they're not making any money. Their corporate governance sucks. Make your case.

[LAUGHTER]

MARK CASH: Hey, all right, good morning. Thanks for having me on, Brian. That's one way to put it. So looking at it really, I think [INAUDIBLE] looking evaluation first, you got to look at the growth drivers. So they're already a big company, and growth has accelerated. So over 40% of a big base going to eclipse that $1 billion mark this coming 2020. But also look at the transition, so it's really moved from this consulting-like firm to marvelous SaaS based firm. The margins have picked up dramatically in recent quarters, so really has changed the strategy of really putting all these boots on the ground with customers. A lot of up-front costs has been extracted over the years in what they've learned in how to deploy more efficiently.

So really, it's been a big change in how they're going to market, and we think you looking at the longer term, a lot of that what they've learned has a lot of built up operating margin built up, and we're going to start seeing that take hold as we go into the 2020 decade is the way I look at it. Your point about the, you know, corporate governance, yeah it's interesting. You really have to be, as an investor, you really got to be comfortable with knowing the founders are going to have an out-sized say in the strategic direction of the company. And so, I mean, they're not holding anything back about that, so I think you've just got to be comfortable with it.

BRIAN SOZZI: Why should they be comfortable putting their confidence in three founders who have waited 17 years to go public in what has been a hot IPO market for tech companies, and the company's not profitable yet.

MARK CASH: Yeah, I think, well, there's a couple of things. One is you're looking at strategic change. I think if they were trying to go public as a government contractor, that could have been problematic for them. I think making the shift, I also think getting that key lawsuit win against the US Army and having that upheld in 2018 gives them a huge growth driver within the government sector. But also, I think something is misunderstood about Palantir is they do play in 36 industries.

More of the revenue comes from the commercial side of things, and also 60% the revenue comes from the government-- I'm sorry, from the international space. So they are pretty well diversified. They're not solely a government contractor. So I think growing that customer base, now is kind of the right time to enter the public market.

ALEXIS CHRISTOFOROUS: Mark, are you concerned at all that this is a company that has never turned a profit? And when you look at financial documents, net loss of 580 million in 2018 and 2019. Nearly 165 million, I think a little more than that now so far this year. Should investors, you know, pause a little bit with a valuation like that being put on a company that's yet to be profitable?

MARK CASH: Sure. I mean, it's not surprising. Maybe the length of time is a little surprising, but being in the tech industry, we do see this a bunch. We look at them as more of a land and expand model, so they are putting a lot about front cost to establish themselves, and a lot of that margin comes through, you know, as you progress. And we're already starting to see, if you look at the last couple of quarters, they do have positive operating margins on an adjusted basis, and so they've made big strides in that. Gross margins have ticked up, operating margins have increased, so, you know, huge, huge strides as of late, so that's probably why they're timing this direct listing to coincide with the big strides they've made.

BRIAN SOZZI: Mark, a lot of investors have gotten completely hosed on Nikola. Now, I'm not comparing Nikola to Palantir, two totally different companies, but they put a lot of trust in that upstart tech play. We have learned that Palantir has-- they have continuously updated this prospectus before they have gone public. Are you confident that they are disclosing what they need to disclose to investors?

MARK CASH: Well, first thing, and this goes back to, you know, the comfort level is we'll never know absolutely everything that they do. Some of that is confidential, but, you know, I think when you're talking about the S1, I think if you look at the progression of the S1s, they've actually showing you more information over time it's been more helpful. You know, if you looked at they keep updating the share prices, the private trading that was happening, so I think it was very useful to get a comfort level with the company. They also released, you know, being a direct listing, they released some type of Q3, Q4 guidance and also an update on kind of 2021 outlook for revenue growth, which they didn't have to do that, but I think that gives investors more comfort. I think the Investor Day they did and the Q&A session with analysts was also indication that they are trying to put on, you know, a better face and make people more comfortable with the name.

INES FERRE: Mark, Ines here. The reference price for Palantir is 725. Do you think that it could have been perhaps higher if it weren't for this governance issue? And also, I noticed in your note that your addressable market you feel that it's less than what Palantir feels that it is. They claim it may be 119 billion. Can you expand a little on that?

MARK CASH: Yes, so on the first one, for direct listings, these reference prices don't really indicate the price it will start trading, so I wouldn't read too much into that. I think we'll see what happens, you know, as it starts trading, I would expect it to be higher, as I've indicated in that note. But on the second part of your question, could you just repeat that? I'm sorry.

INES FERRE: Yeah, it's on the addressable market.

MARK CASH: Yeah, sorry. Thank you. Yeah, so, you know, they put 119 billion out there. I mean, as with other every company, they're going to have a huge TAM. But I think if you start looking at it, the way we looked at it is really what kind of companies need their kind of solution? So companies that have big data integration, big analytics needs, that's not the whole market. So I think we really had to size that down into OK, who could really need these solutions? And that's why we paired it down throughout closer to like a $20 billion TAM right now instead of the 119 billion they had put on it.

BRIAN SOZZI: Mark, what's the one thing they need to do over the next 12 months as a company to be successful and to reach the valuation that you put forward?

MARK CASH: It definitely top line growth is going to be important for them. You've got to keep that momentum going. I also think showcasing margin leverage is important, so they have done a good job of lowering upfront installation costs. That's important, but I think, you know, looking out further into the decade, they need to keep the growth range definitely above that 30% as we look at the next five years I think to really capitalize an opportunity ahead of them. I think they do have a very unique product in the market, but they need to capitalize and start getting into, you know, getting into other industries that are, you know, starting to need data integration like this.