With the imminent IPO of Snowflake Inc., we dig into details of Snowflake’s S-1 IPO prospectus. Furthermore, with Warren Buffett’s $750 million bet on the company, it warrants investors to at least take note whether to invest in Snowflake.
In this article, we analyze Snowflake’s fundamental business, its opportunity set, competitors, share structure and insider ownership. Additionally, we draw parallels between Snowflake’s financials and its competition, wherever possible. Lastly, we can share our view on things to consider whether to invest in Snowflake.
What is Snowflake?
How does Snowflake make money?
In today’s world, the ability to monitor and make business decision is crucial to a company’s success. With big data hitting full throttle, real-time analytics and data management have never been more important!
Luckily, Snowflake happens to be in the business of data cloud. Equivalently, it offers analytic data warehouse architecture, provided as a Software-as-a-Service (SaaS). This also is commonly known as Data Warehouse-as-a-Service (DWaaS).
Importantly, its data cloud platform allows customers to execute data-driven analysis & strategic business decisions, build & share structured-data and applications. Snowflake’s revenues are then generated via customers’ on-demand usage, or pay-as-you-go.
What makes Snowflake different?
Snowflake differentiates itself by providing a data warehouse that is faster, easier to use and far more flexible than traditional data warehouse offerings.
More specifically, there is no hardware and software, both virtual and physical, needed to be install, configure or manage. In addition, ongoing maintenance and management are fully covered by Snowflake.
Snowflake also runs completely on cloud infrastructure. Most components of Snowflake’s services run in a public cloud infrastructure. This promotes efficiency, ease and scalability.
Snowflake's unique data architecture
Snowflake’s data architecture consists of three key parts: database storage, query processing and cloud services.
Once data has been loaded, Snowflake reorganizes data into its internal optimized, compressed, columnar format. Next, Snowflake stores this optimized data in cloud storage.
Snowflake acts pretty much like a one-stop shop. In addition to data optimization, Snowflake manages all aspect of how data is stored. From the organization, file size to compression of data, these lie in the hands of Snowflake.
Snowflake processes queries uses “virtual warehouses”. This is a cluster of compute resources that provides the resources, such as CPU, memory and temporary storage, to perform the required operations.
The cloud services layer is a collection of services that coordinate activities across the platform. These services tie together different components of Snowflake to process user requests, from login to query dispatch. Services in this layer includes authentication, infrastructure management, metadata management, query parsing & optimization and access control.
The industry, key drivers and the opportunity set
Snowflake operates in an emerging growth space. According to the prospectus, the addressable market opportunity for its Cloud Data Platform is ~$81 billion as of January 31, 2020. Ultimately, we believe that big data analytics requirements will fast-track demand for services such as Snowflake’s Data Cloud platform.
Here are few key drivers on why we forecast significant industry growth to persist in the medium term.
- Data is key in business success. More important than ever, data is at the heart of business innovation. Companies across all sectors and actively seeking ways to transform their businesses by capturing, analyzing and mobilizing data. Consequently, cloud adoption is accelerating and diversifying.
- The need for efficient and effective data management platform. The proliferation of data provides valuable insights for organizations, which includes summarizing key performance statistics, understanding consumers’ behavior, product strengths and its capabilities. In fact, many organization have attempted to capture the value in the past, but with little success due to the lack of cost-effective data management capabilities and resources. With continuous advancement in the cloud-based space, we expect demand for user-friendly cloud platforms such as Snowflake’s to grow considerably.
- Technology consumption is moving from fixed capacity to a pay-as-you-go model. An agile business calls for the need to be flexible. As a result, business models are evolving from a fixed capacity (often leads to overpaying for companies) to a utility model, where customers pay only for the resources they consume.
- Leveraging from its network effects. Snowflake benefits from powerful network effects, which creates accelerating demand for its platform and provide it with competitive advantages. The basic idea is that as more customers adopt its platform, the more they can share and receive data, enhancing the value of insights delivered by the platform.
The chart below illustrates the data sharing between Snowflake accounts from Feb 1 to July 31, 2020. The blue circle at the center of the cluster represents the hundreds of Snowflake customers that consumed the Starschema COVID-19 data set. This shows how data added to the Data Cloud by one customer can benefit the entire ecosystem. As more data is migrated to the Data Cloud, more intricate insights and knowledge can be harness from within.
All in all, we believe the structural tailwinds means Snowflake’s addressable market will grow quicker than Snowflake can actually grow its business. Such expanded opportunity set likely to hasten Snowflake’s path to profitability. We will explore the financials later in the article.
No proper investment analysis in complete without mentioning its key risks. Here are few that we think investors should keep in mind.
- Untested business model. Snowflake has a limited operating history and has yet to turn profitable. We expect operating losses to continue as it pursues growth. While common for tech companies, the expectation for Snowflake to perform is sky high, arguably reflected through its valuation.
- Increased competition. Despite its niche, Snowflake, by no means, is operating in an uncompetitive market. Unlike differentiated Peloton’s patented technology, Snowflake’s is less obvious. Snowflake’s competitors include but not limited to Amazon’s AWS (AMZN), Microsoft Azure (MSFT), Google Cloud (GOOGL, GOOG), Apache Spark, Alteryx Platform (AYX) and MongoDB (MDB). Given that Snowflake’s platform on the public clouds are provided by AWS, Azure and Google Cloud (which are also its primary competitors), there can be potentially adverse impact on Snowflake’s business should any of them decides to withdraw its commitment.
- Reputational risk. In recent years, the growth of cloud-based services put a spotlight on cybersecurity. According to research by Ermetic, a cloud access risk security company, and IDC, a global intelligence firm, nearly 80% of the companies surveyed had experienced at least one cloud data breach in the past 18 months. This may result in reputational damage and financial loss if not carefully addressed by Snowflake from the very beginning, in our view.
Snowflake's financials and valuation
Here’s a snapshot of Snowflake’s key financial data.
A few key highlights:
- Significant product revenue growth. Snowflake’s revenue in the six months ending July 31, 2020 has almost outstripped the entire 2019-2020 product revenue alone. Consequently, we expect full-year 2021 to deliver a growth in excess of 200%.
- Increasing gross margins with declining OpEx ratio. The latest numbers (six months ended July 31, 2020) showed the highest gross margin while achieving the lowest OpEx ratio, so far. We think these numbers will be volatile going forward given the tenure of the company. Nevertheless, this is an encouraging starting point.
- Growing customers revenue and retention. Customers with trailing 12-month product revenue > $1 million is growing steadily. It is encouraging to see the growing % of these group of customers as a whole.
At the time of writing, Snowflake has yet to be listed. The latest rumour we had was it raised its IPO price range to $100-$110 vs prior $75-$85. Taking the midpoint of the range ($105), this implies a valuation of close to $30 billion, or equivalently, a TTM revenue multiple of ~79x!
Optically, the valuation is hard to stomach. Nevertheless, the stock has a solid runway for growth, we expect a positive reaction to the stock price post IPO.
We argue that if you’re deciding whether to invest in a company and have limited time to do a detailed analysis, insider ownership may just provide you with what you need to know. Nevertheless, a complete fundamental analysis is the way to go, in our view. Here’s a table of its Class B stock holdings estimated before and after IPO.
What’s striking about the disclosure above is two-folds. Firstly, insider ownership remains high, which is a good thing. Secondly, the changes in pre and post IPO seems is small for both insiders and other significant stockholders, potentially implying insiders’ view that there is further upside in its price.
Typical for most tech companies, there are two classes of common stock: Class A and Class B. Class A common stock is entitled to one vote per share and Class B is entitled to ten votes per share.
According to the prospectus, post IPO and other transactions, Snowflake’s insiders and other significant stockholders (“insiders”) will own ~86.3% of Class B shares, giving them ~98.4% of voting power. Additionally, insiders in aggregate will beneficially own ~62.1% of total outstanding shares, amounting to ~70.1% voting rights.
Fundamentally, we believe Snowflake’s potential is enormous. The COVID-19 pandemic is a wake-up call for companies who have been kicking the can down the road on digitalization. With our belief that everyone will become a data consumer sooner or later, combined with the growing need for accurate, fast and secure business insights, this plays right into the hands of Snowflake.
The scalable platform Snowflake offers, resonates with many consumers today – pay what you use. This continues to present an attractive proposition for businesses seeking to transform themselves today.
Finally, while we have full confidence in the company, we maintain our discipline to pursue great companies at reasonable valuations. At present, the addition to our portfolio will remain a price consideration. We will of course update readers should we decided to add into our portfolio.
Till then, don’t “Flake it till you make it”.