Palantir – F for governance.

Palantir takes unfair treatment of shareholders to a new level.

• Palantir’s S-1 and recent revisions reveal a voting structure that overwhelmingly favours its founders, ensuring that public investors are at great risk of paying the economic price of bad decisions over which they have no say.
• Palantir voting structure is very confusing to put mildly.
• On top of the now, unfortunately, usual A and B class of shares where B shares carry 10 votes and A shares carry 1 vote, Palantir will create a new distribution called F shares.
• These shares nominally have 10 votes, but this can vary depending on certain scenarios that depend on the relationship between the three founders and the Founder Voting Agreement.
• The net result is a hideously confusing arrangement but at least the end result is fairly clear.
• This result is that until all of the founders have died, the remaining founders will have complete control of this company and other shareholders will have none.
• This is by some margin the worst arrangement I have seen in the USA and is on a par with Baidu where the founder, Robin Li has absolute control of the company despite earning a lot less than 50% of the economic interest.
• It is also worse than Alibaba’s partnership arrangement and far worse than Tencent, which I have long held out as an example of good governance.
• I have long been a critic of these shareholding structures as they allow founders to escape appropriate punishment for their bad decisions.
• This most often manifests itself as multiple classes of shares where one class has many more votes than another and far too common.
• This allows founders to control the company despite having sold far more than 50% of the economic interest.
• This practice is common in small start-ups where speed and the ability to quickly pivot a strategy can be critical, but I have long believed it has no place in large public companies into which anyone can invest.
• Palantir makes this argument in the S-1 but thinking about this argument for a minute reveals its fallacy.
• Start-ups have to pivot quickly as they have limited funds and as they have little or no revenues, they have to quickly follow where the market takes them.
• Waiting around for investor consent can kill a company at this stage.
• Palantir has been around for 17 years, has over $1bn in the bank and will earn $1bn in revenues this year.
• Therefore, it is subject to none of the pressures that small companies are and consequently there is no rational reason for the founders to hold onto control.
• The founders are maintaining control because they want to (who would not?) and because the market will let them get away with it.
• I find that these distributions are more often than not detrimental to shareholder value.
• This is because founders have emotional attachments to their companies meaning that their judgement over long-term strategy is often not objective.
• A super-voting distribution allows a founder to spend other people’s money with no checks or balances.
• For example, a founder who owns 5% of the economic interest but 55% of the vote will only incur 5% of the losses that result from his bad decisions.
• Minority shareholders, who have no say in decision making, bear 95%.
• When times are good, no one cares but when things go wrong this will become important and I think that the shares will fall harder and further as a result of this structure.
• What Palantir intends to do takes this to a new level and is indicative of the irrationality that persists in the stock market today.
• The prospect of indefinite loose monetary policy and massive money printing has driven the technology sector to valuation levels we have not seen for 20 years.
• This means that investors are so desperate to get their hands on the shares of fast-growing technology companies that they will overlook dreadful governance and unsustainable valuations.
• In many ways, Palantir is not to blame for its dreadful governance as I think it is mainly the fault of the market is for letting it get away with it.
• The one piece of good news is that participation in these companies is entirely voluntary so investors that don’t like these types of share structures do not have to participate.
• Beneficiaries of pension funds do not have a direct say in how their money is invested but one would hope that the managers of their funds will take poor governance in some of their investments into account.
• When I look at a company, I have historically taken this into account by applying up to a 30% discount to the fair value of the shares depending on the degree to which smaller shareholders are being disadvantaged.
• In Palantir’s case, I would apply at least the full 30% discount to compensate investors for the added risk they are taking by owning these shares.
• It looks like Palantir will earn around $1bn in revenues this year which puts the company on a 2020 EV / Sales of 11.0x which is punchy but not in nosebleed territory.
• However, this is before I take the execrable corporate governance into account and on that basis, the mooted market capitalisation of $11.7bn looks too high.
• I would be more comfortable with something closer to $8.5bn.
• Caveat emptor.