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By Danny Vena, Fool.com
Arguably, the most important secular tailwind to emerge since early last year has been the rapid adoption of artificial intelligence (AI). This is causing an ongoing paradigm shift in business as companies figure out how best to benefit from these next-generation algorithms.
What sets generative AI apart from its predecessors is its versatility. These AI systems can be used to generate images, create stories, summarize data, and create presentations, all with a few simple prompts. Additionally, its ability to find patterns in data and streamline rote and time-consuming tasks is being heralded as the “fourth industrial revolution” and could dramatically alter how business gets done. Managers everywhere are working to secure their share of the potential windfall.
Now, enterprise software and cloud titan Microsoft (MSFT 0.83%) and AI and data analytics pioneer Palantir Technologies (PLTR 2.49%) have joined forces to develop cutting-edge AI solutions for the U.S. government.
A dynamic duo
In a press release on Thursday, Palantir and Microsoft announced an expansion of their existing partnership to “bring some of the most sophisticated and secure cloud, AI, and analytics capabilities to the U.S. Defense and Intelligence Community.”
The goal of the partnership is to create a “first-of-its-kind, integrated suite of technology” featuring Microsoft's Azure Cloud and OpenAI services and Palantir's Artificial Intelligence Platform (AIP) in the government's secure cloud.
By joining forces, Palantir will deploy Gotham, Foundry, Apollo, and AIP to Microsoft's Azure Government, Government Secret, and Top Secret Cloud platforms. Palantir will also adopt Azure's OpenAI service in these secure cloud environments.
The resulting integrated solution will allow government users to build AI systems for a variety of applications, including logistics, contracting, prioritization, action planning, and more.
What sets this agreement apart is the inclusion of Palantir's AIP. Management found that many users are reluctant to take the AI plunge because they simply don't know where to begin. The company began hosting boot camps or sessions that pair users with Palantir engineers to create these systems to solve real-world issues.
The program has been wildly successful, with many customers signing sizable contracts within days or weeks of attending a boot camp session. That strategy could work equally well for government users.
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Both Palantir and Microsoft have made a name for themselves in the fast-growing field of AI.
The success of Palantir's aforementioned strategy has been evident in its recent results. In the second quarter, revenue of $678 million grew 27% year over year, and Palantir generated a profit for a seventh consecutive quarter — but there was much more going on under the hood.
The company's government revenue — which tends to be lumpy — grew 23% year over year, while commercial revenue grew 33%. This was fueled by the U.S. commercial segment, which has become Palantir's fastest-growing business, with revenue that surged 83% year over year and is now expected to grow at least 47% in 2024.
The engine behind that growth has been AIP. Palantir recently revealed it has hosted boot camps for more than 1,025 organizations over the past year, far exceeding its original plans for 500. The results have been stunning, as Palantir provided multiple examples of seven-figure deals signed within days or weeks of boot camp completion. This helps illustrate just how successful this novel strategy has been.
For its part, Microsoft was quick to adopt generative AI and developed Copilot, a suite of AI-powered assistants designed to simplify and streamline time-consuming administrative tasks. In its fiscal 2024 fourth quarter (ended June 30), Microsoft said the number of people who use Copilot at work more than doubled quarter over quarter. This helped fuel robust growth as revenue of $64.7 billion grew 15% year over year, while earnings per share (EPS) of $2.95 grew 10%.
Microsoft's biggest growth driver was its intelligent cloud segment, which grew 19% year over year and now represents 44% of total income. At the heart of the segment is Azure Cloud, which grew 29%. The company also noted that eight points of that growth were the result of AI services. Microsoft also said demand continued to outpace “our available capacity.” It's worth noting that Microsoft's cloud growth continues to outpace that of its rivals, with much of the credit going to AI.
This helps to illustrate that Palantir and Microsoft are both profiting from the massive opportunity of generative AI, even as rivals lag behind.
Is the deal a game-changer?
One of the more intriguing prospects of this partnership is the complementary capabilities of these two AI superstars and the large number of applications the collaboration will enable. Microsoft's government-approved secure cloud will play host to Palantir's decades of AI expertise and its cutting-edge AIP. Furthermore, Palantir's boot camp strategy might attract users and use cases that might otherwise be missed.
Given their growth prospects and the opportunity to profit from AI, each of these stocks represents a compelling opportunity.
Microsoft is currently selling for 30 times forward earnings, just a slight premium to the multiple of 28 for the S&P 500.
At 82 times forward earnings, Palantir might seem prohibitively expensive, but those metrics don't take into account the company's accelerating growth. Using the forward price/earnings-to-growth (PEG) ratio provides a more accurate picture, revealing a multiple of 0.3 — when any number less than 1 suggests an undervalued stock.
This deal benefits both partners across the spectrum of their AI offerings. Microsoft gets to leverage Palantir's existing AI partnerships with U.S. government agencies, while Palantir benefits from the expansion of those existing revenue streams, as well as the accelerated adoption of AIP within the defense and intelligence communities. As such, this deal could actually rise to the level of game-changer, but only time will tell.
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