Is the Palantir Technologies and Microsoft deal a game-changer?

It could be argued that the most significant secular headwind to emerge since the beginning of last year has been the rapid adoption of artificial intelligence (AI). This is creating an ongoing paradigm shift in business as companies consider how best to take advantage of 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. In addition, its ability to find patterns in data and streamline routine and time-consuming tasks is being billed as the “fourth industrial revolution” and could radically change the way we do business. Managers around the world are working to secure their share of the potential profit.

Now Enterprise Software and Cloud Titan Microsoft (MSFT 0.83%) and a pioneer in the field of artificial intelligence and data analysis Palantir Technologies (PLTR 2.49%) joined forces to develop cutting-edge AI solutions for the U.S. government.

Dynamic Duo

In a press release on Thursday, Palantir and Microsoft announced an expansion of their existing partnership to “bring some of the most advanced and secure cloud, AI, and analytics capabilities to the U.S. defense and intelligence community.”

The partnership aims to create a “first-of-its-kind, integrated technology stack” that includes Microsoft’s Azure Cloud and OpenAI services and Palantir’s Artificial Intelligence Platform (AIP) in a secure government cloud.

By joining forces, Palantir will deploy Gotham, Foundry, Apollo, and AIP on Microsoft Azure Government, Government Secret, and Top Secret Cloud platforms. Palantir will also deploy Azure’s OpenAI service in these secure cloud environments.

The integrated solution will enable government users to build AI systems for a variety of use cases, including logistics, contracting, prioritization, operational planning, and more.

This agreement is notable for including Palantir’s AIP. Management found that many users were reluctant to get into AI because they simply didn’t know where to start. The company began hosting boot camps, or sessions where users were paired with Palantir engineers to build these systems to solve real-world problems.

The program has been a huge success, with many customers signing large contracts within days or weeks of attending the boot camp. This strategy could work just as well for government users.

A win-win situation for both parties

Both Palantir and Microsoft have made names for themselves in the rapidly evolving field of artificial intelligence.

The success of Palantir’s aforementioned strategy was evident in its latest results. In the second quarter, revenue of $678 million increased 27% year over year, and Palantir generated a profit for the seventh consecutive quarter—but there was much more going on under the hood.

The company’s government revenue, which is typically erratic, rose 23% year over year, while commercial revenue rose 33%. That performance was driven by Palantir’s U.S. commercial segment, which became Palantir’s fastest-growing business, with revenue up 83% year over year and forecast to grow at least 47% by 2024.

AIP has been a driving force behind this growth. Palantir recently revealed that it has hosted boot camps for more than 1,025 organizations over the past year, far exceeding its original plan of 500. The results have been staggering, with Palantir providing multiple examples of seven-figure deals signed within days or weeks of completing a boot camp, helping to illustrate just how effective this innovative strategy has been.

Microsoft, for its part, has been quick to embrace generative AI and has developed Copilot, a suite of AI-powered assistants designed to simplify and streamline time-consuming administrative tasks. In the fourth quarter of fiscal 2024 (ended June 30), Microsoft reported that the number of people using Copilot at work more than doubled compared to the previous quarter. This helped drive solid growth, as revenue of $64.7 billion increased 15% year over year, while earnings per share (EPS) of $2.95 increased 10%.

Microsoft’s biggest growth driver was its intelligent cloud segment, which grew 19% year over year and now accounts for 44% of total revenue. The heart of the segment is Azure Cloud, which grew 29%. The company also noted that eight points of that growth was due to AI services. Microsoft also said that demand continued to outpace “our available capacity.” It’s worth noting that Microsoft’s cloud growth continues to outpace its rivals, with AI accounting for most of the credit.

This shows that both Palantir and Microsoft are benefiting from the enormous capabilities of generative AI, even as rivals lag behind.

Will this deal be 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 that the collaboration will enable. Microsoft’s government-approved secure cloud will host Palantir’s decades of AI experience and its cutting-edge AIP. Additionally, Palantir’s boot camp strategy could attract users and use cases that might otherwise be missed.

Given the growth prospects and potential for AI-driven profits, each of these stocks represents a compelling opportunity.

Microsoft currently trades at 30 times forward earnings, a small premium to the 28 times forward earnings multiple. S&P500.

At 82 times forward earnings, Palantir may seem prohibitively expensive, but that metric doesn’t factor in the company’s accelerating growth. Using a price-to-earnings-to-growth (PEG) ratio gives a more accurate picture, revealing a multiple of 0.3—where any number below 1 suggests the stock is undervalued.

This agreement benefits both partners across the full spectrum of their AI offerings. Microsoft can leverage Palantir’s existing AI partnerships with U.S. government agencies, while Palantir benefits from expanding those existing revenue streams, as well as accelerated adoption of AIP in the defense and intelligence communities. As such, this agreement could could actually be a game changer, but only time will tell.