Shares of snowflake had a 30% drop afterhours last night upon reporting earnings. Slowing revenue growth was the concern. But, there's no doubt that one of last year's hottest IPO stocks, which grew revenues 100% since then... is an intriguing "buy the dip" opportunity.
Not to mention, the Oracle of Omaha, Warren Buffet himself, is an investor in this company... but had a private stake pre-IPO.
So, I'm going to try and find the "value" in this stock... Let's jump in!
First of all, what the heck does Snowflake even do? Legit question. So, for all of us non-data nerds (this is even beyond me) I'll explain at a very high level for us all to understand.
Snowflake is a data cloud company. It connects data – which is found through various cloud providers – and provides it to its customers in the best way for analysis. That's the explanation for the two-year old.
Now, assuming you're not two, let me go a little deeper.
Traditionally, data has been stored and accessed via databases store locally. But, the rise of cloud computing has moved an increased amount of data to the public cloud... through companies like AWS, Azure, and Google Cloud. Now, to analyze this data, especially for AI insights, you need data warehouse or data lake.
Snowflake offers a data lake and warehouse platform, which cuts the cost of ownership for enterprises and more importantly is interoperable among different public cloud providers.
In my eyes, the interoperability is the real moat for Snowflake. This allows companies to gather data from different public clouds, instead of sticking to one. It allows them to pull third-party data from various clouds as well.
So, for example, AWS has its own data warehouse, Amazon Redshift. Microsoft Azure also has Synapse Analytics, while Google has BigQuery. Now, I'm not going to sit here and pretend like I've used either of these; but from my understanding, they are limited to their own cloud data... essentially siloed.
This makes it very difficult for enterprises to change cloud providers, or maybe integrate data from third-parties, or an acquisition. They're essentially married to the cloud provider.
This also gives Snowflake's data sharing business – Snowflake Data Marketplace – a significant advantage. This is where data can be purchased for use in AI models by other companies. Why this is advantageous, is because now a company can be agnostic to where the data they are purchasing is located. For example, if I'm operating on Azure and I want to buy data that is housed in AWS, it'll be a pain in the ass to migrate and funnel the external data for my analysis.
Overall, Snowflake is a leader in the marketplace for interoperable big data analytics. However, I wouldn't conclude that is has an impenetrable moat. And I'll talk about that when we look at some of the Risks below.
Key Performance Indicators
First, we need to understand Snowflake's billing model. They are not a SaaS, and most of their revenues are consumption-based – based on usage of their cloud platform. They don't have long-term commitments, but there is still stickiness to their platform which you can see in their dollar-based net revenue retention rate – customers are staying on and spending more.
So product revenue is basically the main metric to evaluate here, along with Remaining Performance Obligations (RPOs) – deferred and committed revenue by its customers. As you can see, this is a huge number ($2.6bn, or 2x their fiscal 2022 revenues) and doubled over the last year.
It's also worth noting they have large customer momentum, and signed up more than half of the Fortune 500 companies. They are a dominant player in an industry with strong tailwinds.
Valuation & Forecast
The first thing we notice about Snowflake is that it's not profitable. It's been reporting significant losses. This isn't a company that I can immediately look at and say that it is on a path to profitability. Can it get there? Sure. But, it's impossible for me to know when.
Even on a quarterly basis, it's not like it's obviously trending towards break-even (or profitability). And I don't mean this in a negative way, because their operating leverage has been moving in the right direction, it's just a matter of setting our expectations and objectives for this potential investment. It also impacts the way I'm going to model it.
Though Snowflake is starting to now generate free cash flows, I won't be modelling it on a DCF basis because the uncertainty is very high at this point. There's no point. You can also see that the it's only generating positive free cash flow right now, because of its stock-based compensation. The spending model reminds me a lot of Salesforce. Which is why, even with a DCF analysis you're essentially you're calculating a FV per share based on share-based compensation which dilutes shareholder value. It just doesn't make sense to give that much weight imo.
Snowflake generated a total of $1.2bn for fiscal 2022, which is a 100% YoY increase. They guided to a 66% increase in fiscal 2023, which is about $1.9bn. Given they have $2.6bn in RPOs, I think they can easily achieve this number.
Big picture: they had some lofty goals presented on Investor Day 2021, which models $10bn as the revenue goal for 2029... which is a 35% CAGR. I think it's possible.
But, let's start with 2025 price target, assuming a 50% CAGR of revenues to $4.1bn... what multiple should be use? Based on industry averages relative to CAGR, and especially benchmarking CRM (Salesforce) I feel comfortable with an 18x P/S ratio. That gives us a price target of $240... which is only a 10% upside from here. There's no margin of safety.
That being said, I would consider putting in a limit order for $185.00 assuming we re-test the lows, which at least gives a minimum 30% return. But, I would only start a small position there, so I can add on potential further downside.
The biggest risk, for Snowflake, ignoring the macro-economic, rising-rate, geopolitical environment, is competitive threat. Though we haven't identified any specific players yet, the moat isn't strong enough to deter them. There is a chance that Amazon, Microsoft, or Google provides a similar service. But, that isn't a threat that exists today.
I found interesting this report by GIGAOM, which identified Snowflake as a more costly and slower performing solution than average – though better than Google. It also identified Avalanche (an Indian company) as a viable threat. But, I don't know if that would really be an option for Fortune 500 companies.
Overall, I believe Snowflake is providing a unique service and has a significant first-mover advantage. They have strong tailwinds in an industry that's growing exponentially. They're still so early in capturing market share, they have a lot of options to optimize for margins, including changing their business model to subscription (SaaS).
But, the real question is valuation. Even after this drop, I think it's still expensive. We do have to keep in mind the environment we're in right now, with QE coming to an end and valuations being compressed. I don't think the damage to Snowflake is done. I don't think the bottom is in.
I would wait to add a position, and start it at $185... and nothing higher.
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