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Buffett-backed Snowflake: great company, completely the wrong price
As one of the hottest names to join the stock market in 2020, investors have bet big on US-listed cloud data analytics business Snowflake.
Its software allows organisations to manage and analyse large quantities and diverse types of data across the cloud in a single, easy to use platform. Think of it as a layer of tools that sit on top of the cloud infrastructure provided by Amazon’s AWS, Google Cloud and Microsoft’s Azure.
We are living through an exponential explosion of data, with 40 times more bytes in the digital macrocosm than stars in the observable universe. Finding ways to crunch these vast numbers and package them into useful insights is Snowflake’s opportunity.
Set up in 2012, and launching its data warehousing platform three years later, Snowflake has been growing at an astonishing clip even by tech sector standards.
Revenue for the three months to 31 January 2021 (its fourth quarter) hit $190.5 million, representing 117% year-on-year growth.
But analysts believe the true indicator of Snowflake’s growth potential is contracted future commitments from customers, or what the company calls remaining performance obligations. This jumped 213% in its fourth quarter to $1.3 billion.
Snowflake is not only adding new customers at a rapid clip, but it is also better monetising its existing users. Snowflake’s net revenue retention rate, which is the percentage of revenue retained from the prior year after factoring for upgrades, downgrade and churn, stood at 168%. This indicates that its 4,100-plus existing customers continue to spend more.
Seventy-seven customers spend more than $1 million a year with Snowflake, up from 65 in October.
BEST OF FRENEMIES
There is fierce competition from the likes of US-listed peers Oracle, MongoDB, Teradata and privately-owned Databricks, for example, but also from the cloud platforms it uses; Amazon’s Redshift, Microsoft’s Azure Synapse, and Google’s Big Query, creating a ‘frenemy’ relationship, as investment bank UBS calls it.
Snowflake acknowledges the risk that Amazon, Microsoft and Google could use control of their public clouds to embed innovations or privileged capabilities for their competing offerings or bundle their competing products.
Yet this ‘frenemy’ relationship is not unique. Importantly, UBS says the cloud platforms get far more from Snowflake spending on compute and storage infrastructure resources than they lose in the form of lost data warehousing revenues.
Snowflake has the advantage of being platform agnostic, more flexible by separating storage from computing and is seen as easier for customers to use.
$81 BILLION OPPORTUNITY
The company’s addressable market has been estimated at $81 billion, which is just as well since Snowflake is a stock that will be driven exclusively by red hot growth for the foreseeable future because normal valuation metrics are all but redundant.
In a research note by analysts at UBS in March, price to earnings, EBITDA (earnings before interest, tax, depreciation and amortisation) margins, return on invested capital and return on equity were all rated ‘not meaningful’ for this year, nor will they be until around 2025/6. Operating cash flow will be negative until 2026, UBS forecasts.
That makes valuing Snowflake very tricky.
WARREN BUFFETT IS A FAN
The stock listed at $120 in September 2020 after Snowflake raised $3.4 billion of growth funding.
The business was valued at $33 billion upon joining the stock market, making it one of the largest software IPOs (initial public offerings) ever and almost three times its February 2020 valuation.
Investors chased the stock regardless, including world-famous Warren Buffett, who saw enough to buy a 12% stake worth $570 million in a huge departure from his normal cash and profits-first investment strategy.
By the end of its first day of trading the stock had jumped 110%, and by December it had hit $390, more than three times its listing price.
Various factors have since served to pull the stock down from those lofty peaks to $233.75, still nearly twice the IPO price. Yet even now Snowflake trades on almost 62 times the $1.09 billion of sales it is forecast to make in the financial year ending 31 January 2022. If that doesn’t knock your socks off, the fact Snowflake isn’t forecast to make a net profit until January 2025 just might.
A sky-high stock rating leaves Snowflake vulnerable to a big share price decline if it cannot meet growth forecasts or on any other negative news. UBS has a 12-month price target of $275, implying a January 2023 enterprise value to sales multiple of 49, about twice its high-growth software peers.
Ten years from now, we might look back and realise Snowflake’s share price in April 2021 was a bargain, but it’s impossible to say.
Still years away from profits and positive cash flows, and at the mercy of wild market mood swings, we side with the view of Randall Dishmon, manager of the Invesco Global Focus Fund (BJ04HD6), that Snowflake is a potentially great company but on a valuation that is too rich to warrant buying now.