Head of Equity Strategy
Summary: Snowflake is the first pure play cloud infrastructure company as the three big players (Google Cloud, AWS, and Azure) are all part of bigger technology companies. This combined with explosive growth and a red-hot IPO market have caused the company to raise its IPO price due to significant demand for its shares. The current mid-price values the company at $29.1bn and the offering has attracted large investors such as Berkshire Hathaway. All great businesses these days come with a high valuation and Snowflake is no exception.
The first pure play on enterprise cloud infrastructure is something that should catch the attention of investors as this fast-growing part of the global computing industry has catapulted Amazon into being one of the most valuable companies in the world. Snowflake fits all the parameters of the red-hot IPO market of today being a US technology company, offering cloud infrastructure, is a pure play and has high revenue growth rate amid with negative cash flows from operation. Even Berkshire Hathaway that has completely lost the biggest shift in the global economy since the economy transitioned into the petrochemical world has committed itself to acquire shares in Snowflake sealing the IPO as one of the biggest this year.
The business – can it beat the big players?
Snowflakes main product is its Cloud Data Platform which unifies data for enterprises across many cloud platforms ranging from Google Cloud, AWS, and Azure. The integration means that companies can easily move and switch data being different cloud providers and carry out its various data processes (see picture). This means that while many of the other cloud providers come with constraint within their own environment Snowflake comes with flexibility and can consolidate all cloud solutions. This means that one team can use Google Cloud and another AWS, and then use Snowflake to integrate it all into one workflow upstream in the organization.
Snowflake tabs into the growing world of data as more and more businesses become digital and with that transition producing ton of data which need storage and subsequent data analytics. If you believe the world be more data-centric in the future, then you should naturally be positive on Snowflake’s business as it will ride the data trend. The platform is used across many industries from financials services, manufacturing, health care and technology. The latest number of customers from 31 July 2020 is 3,117 up from 1,547 a year ago with very high retention ratios and businesses adding more business after being a customer.
As the numbers below show the business growing rapidly with revenue growth rate of 174% y/y in FY19 expected to decline somewhat to 122% y/y for the FY20 ending on 31 January 2021. Revenue the last 12 months was $402.7mn generating $245.7mn in gross profit. Snowflake is aggressively increasing its sales and marketing expenses to propel growth leading to significant operating expenses translating into a negative EBITDA of $343.5mn expected to grow to an even wider negative EBITDA of $382mn for FY20. On a cash flow basis, the operating cash flow was closer to break-even with cash from operations of $45mn in the six months ending 31 July 2020. A big part of the discrepancy between the cash flow and income statement numbers are the expenses related to the company’s stock compensation programme. On a positive note, the company has zero interest-bearing debt and thus not negatively impacted on the business from higher interest rates although it could hurt the valuation via higher discount rate of future cash flows.
Growth fuels red-hot valuation
The initial S-1 filing was published on 8 September 2020 indicating a price range of $75-85 per share but recently the company has raised the price range to $100-110 due to high demand for its shares. The offering is 32,761,904 new shares with 28,000,000 allocated for the public and the remaining in a private placement with Berkshire Hathaway and Salesforce Ventures at the IPO price. In addition, an overallotment option of 4,200,000 shares has been offered to the investment banks. Excluding the overallotment option, the total outstanding shares post the IPO are 277,290,066 which at the mid-price translate into a market valuation of $29.1bn. Including the latest figures we have on cash and investments the proceeds of $3.44bn will increase the cash and investments figure to $4.33bn. With zero interest-bearing debt Snowflake’s enterprise value (equity value plus net debt) will be $24.8bn.
Based on our estimate for FY20 (ending 31 January 2021) revenue of $588mn this translate into a forward EV/Sales ratio of 42.2 which is up there with highly valued companies such as Zoom which trades at 38.6 on forward EV/Sales. As we wrote about in May a high EV/Sales ratio is what characterizes a ‘bubble stocks’, but high EV/Sales stocks have significantly outperformed low EV/Sales stocks since early 2013. In other words, growth stocks have done much better than value stocks. Snowflake benefits from the red-hot IPO market, strong sentiment for US technology stocks and a rosy outlook for the cloud infrastructure industry underpinning the expected revenue growth outlook.
Snowflake is a rare opportunity for investors and could potentially be an acquisition for a company lagging in the cloud industry which could be a company such as Oracle. Intel is another option that could integrates the software solution into its existing datacenter business making a vertical integration. Despite the growth outlook and our positive view on the business the valuation seems aggressive but on the other hand the company does not need many quarters at this growth rate to push the valuation into a more comfortable territory. We are positive on the Snowflake IPO but recommend investors to participate in the stock with the awareness that volatility will be high, and investors should think about having tight risk limits (stop loss).
Risks
The following paragraph describes some of the key risks that investors should be aware of. Snowflake is a relatively young company and operating in a very tough competitive industry which could suffer longer term from a ‘race to the bottom’ on pricing of cloud services. The company is still not profitable on a cash flow basis and thus the business considering its valuation has a huge risk of experiencing sharp selloffs if the company misses earnings and revenue expectations.
Snowflake is in the odd situation that it is both a customer and competitor to the big players (Google Cloud, AWS, and Azure) which could become an operational issue in the future. Security breaches on the Snowflake platform could significantly impair the business and the trust from its customers and future customers. Higher interest rates in the future could severely hit valuation as future cash flows what have a lower present value.
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