Arguably the most important long-term tailwind to emerge since early last year is the rapid adoption of artificial intelligence (AI), which is leading to an ongoing paradigm shift in business as companies figure out how to best 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. What’s more, their ability to identify patterns in data and streamline routine and time-consuming tasks is being called the “fourth industrial revolution” and could dramatically change the way business is done. Managers around the world are working to secure their share of this potential windfall.

Now, enterprise software and cloud titan Microsoft (MSFT 0.83%) and pioneer of AI and data analysis Palantir Technologies (PLTR 2.49%) have joined forces to develop cutting-edge AI solutions for the U.S. government.

Image source: Getty Images.

A dynamic duo

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

The goal of the partnership is to create the “first-of-its-kind integrated technology suite” in the government’s secure cloud, including Microsoft’s Azure Cloud and OpenAI services and Palantir’s Artificial Intelligence Platform (AIP).

Through the merger, Palantir will deploy Gotham, Foundry, Apollo and AIP on 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 enables government users to build AI systems for a variety of applications, including logistics, contracting, prioritization, action planning, and more.

What makes this agreement special is the inclusion of Palantir’s AIP. Management found that many users are hesitant to take the leap into AI because they simply don’t know where to start. The company began hosting bootcamps, or sessions that pair users with Palantir engineers to build these systems to solve real-world problems.

The program was a huge success, with many clients signing sizable contracts within days or weeks of attending a bootcamp. This strategy could work for government clients as well.

A win-win situation

Both Palantir and Microsoft have made a name for themselves in the rapidly growing field of AI.

The success of Palantir’s strategy is evident in its recent results. Second-quarter revenue of $678 million was up 27% year-over-year and Palantir posted a profit for the seventh consecutive quarter – but there was a lot more going on behind the scenes.

The company’s revenue from the government – which is typically irregular – grew 23% year-over-year, while commercial revenue rose 33%. This was driven by the U.S. commercial segment, which has become Palantir’s fastest-growing business. Revenue grew 83% year-over-year and is now expected to grow at least 47% in 2024.

The engine of this growth was AIP. Palantir recently announced that it hosted bootcamps for more than 1,025 organizations last year, far exceeding its original plans of 500. The results were astounding, with Palantir providing several examples of seven-figure deals signed within days or weeks of bootcamp completion, demonstrating how successful this novel strategy has been.

Microsoft, for its part, was quick to embrace generative AI, developing 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 said the number of people using Copilot at work more than doubled from the previous quarter. This contributed to robust growth, as revenue of $64.7 billion rose 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 percentage points of that growth came from AI services. Microsoft also said that demand continues to exceed “our available capacity.” It’s worth noting that Microsoft’s cloud growth continues to outpace that of its competitors, with much of the credit going to AI.

This shows that both Palantir and Microsoft are benefiting from the enormous possibilities of generative AI, even if the competition is lagging behind.

Is the deal a turning point?

One of the more interesting prospects of this partnership is the complementary capabilities of these two AI superstars and the vast number of applications enabled by the collaboration. Microsoft’s government-approved secure cloud will house Palantir’s decades of AI expertise and its cutting-edge AIP. In addition, Palantir’s bootcamp strategy could attract users and use cases that might otherwise be missed.

Given their growth prospects and the opportunity to benefit from AI, each of these stocks represents an attractive opportunity.

Microsoft is currently trading at 30 times forward earnings, just a small premium to 28 times S&P500.

At 82 times forward earnings, Palantir may seem prohibitively expensive, but these metrics don’t take into account the company’s accelerating growth. Using the forward price-to-earnings growth (PEG) ratio provides a more accurate picture, yielding a multiple of 0.3 – while any number below 1 indicates an undervalued stock.

This deal benefits both partners across the spectrum of their AI offerings. Microsoft can leverage Palantir’s existing AI partnerships with U.S. agencies, while Palantir benefits from the expansion of these existing revenue streams as well as the accelerated adoption of AIP in the defense and intelligence communities. This deal could actually be a turning point, but only time will tell.