(Disclaimer: Excel file attached below the post)
Snowflake (SNOW) had its stupendous IPO on Sep 16, 2020, and by the end of its debut trading day, the price was 112% more than its expected offering range of $100-$110/ share. The company sold nearly 28 million of its shares and raked in $3.4B, the largest software IPO ever. Company has some of the largest asset managers as investors, i.e., Salesforce, Altimeter, Sequoia, and Berkshire Hathaway. What is it about the company and its operations and future prospects that attracted and adorned it with the attention it got? This deep dive is meant to trace the company's history, its operations, the broader cloud market, and what the future might hold for the company.
A Brief History of SNOW
Snowflake was founded in 2012 by three ex-Oracle data warehouse experts, Beniot Dageville, Thierry Cruanes, and Marcin Zukowski. The company anointed Bob Muglia- a Microsoft executive- as its CEO, and successfully raised $26M in 2014 and came out of stealth mode. Snowflake managed to raise another $45M in 2015 and launched its first Cloud Data product. The company's future prospects and enticing story garnered multiple capital raises over the next few years, I think it reached series G; which probably means that plenty of VCs were able to attain its shares early on. Company juggled its C-suite and brought in Frank Slootman, ex-CEO of ServiceNow, as its CEO in 2019; Frank brought in Michael Scarpelli, his colleague from his days at ServiceNow, as the CFO. At the time of its IPO, it was considered one of the best unicorns within the software space, and had all its growth ahead of it. To better present the mania around the company at the time of its public offering, lets look at its share price change along with its trading volume since its inception into the public space.
SNOW- Historic Share Price and Volume
SNOW Vs. Competitors
Snowflake had an oneiric start to say the least; the stock closed more than 100% higher than its offering range on day 1.It came down to below $100/ share and then- with the rest of its peers- skyrocketed again in 2021to above $150/ share. I think that start itself was pretty much the sole unique thing in its history, because as is evident, SNOW has been motioning the same trajectory as its peers. The more I look at the above image, the more I am compelled to question its initial rise, was it because it truly had something unique? Was it because of the Warren Buffet and the Salesforce effect? Or was it something else? To further compound our understanding of the company, lets take a quick break and do a comparison with some of the vastly tracked indices.
SNOW Vs. Indices
The start is pretty self-explanatory, but the story a few months into its public journey is, at best, common. Why has the company failed to hold on to its early momentum? One answer could be that the initial boost was in part due to the usual craze hovering an initial offering, everyone thought that it was one of the next best things, and they all wanted a piece, not to mention the company's partnerships with Salesforce and Berkshire Hathaway also might have injected some fuel into the initial craze; but everything thus far tells me nothing unique about the company. I think we should next move on to its core operations and history and try to dissect its early boost, the subsequent fall, and then with everything under our belt, move on to its future and assess whether it is trading at a premium, and if so why?
The Business
Snowflake is in the business of cloud data warehouse services, which- in layman terms- means that the company helps its customers in collecting, compiling, and analyzing data along with using its immersive platform to provide insights and intelligence that then the companies can use to improve their own businesses and attract and retain customers. As per the company's own filings, "The platform supports a wide range of workloads that enable [their] customers' most important business objectives, including data warehousing, data lakes, and Unistore, as well as collaboration, data engineering, cybersecurity, data science and machine learning, and application development." The company processed on average 2.6 billion daily queries across all of its customers; which essentially means that the platform is being heavily used and utilized to drive data driven insightful business decisions.
Snowflake's platform, and the bundle of various facilities along with it, offer companies the chance to deal with big data in a way that they couldn't before, as well as offering solutions for siloed data and information. The company is hoping and counting on the wide spread acceptance of data cloud by corporations across the globe; the more data the companies store on its platform, the more information the company will have to exchange with other customers, data providers and consumers. The platform, as of this post, is being used globally by organizations of all sizes across myriad of industries and countries. As of Jan 31, 2023, SNOW had a total of 7,828 customers, an increase from 5,967 customers as of Jan 31, 2022. The company also boasts as having 573 customers that were on the Forbes Global 2000 list, and those high tier customers contributed 41% of the revenues in FYE '23.
The Numbers
The company reported revenues of $2.06B in FYE '23, a 70% increase over FYE '22's revenues of $1.22B. The company also reported cost of revenues of $717M and other operating expenses of $2.19B, yielding an operating loss of -$842M; other operating expenses included sales and marketing, research and development, and general and administrative, all of which have risen from prior years, a delightful thing for a company that is growing; It shows me that the company is expanding, both in terms of its revenues and expenses, and that the numbers tell the stereotypical story of any start up: compounding revenues associated with inflated losses.
For the past five years that I observed for this case study, SNOW's revenues have grown at a triple digit growth rate, except for FYE '23, which, as stated before, was 70%, not triple digit, but also not bad. Company grew its revenues from $96M in FYE '19, a 173% YOY growth, to $2.06B in FYE '23, the numbers tell me that they seem to have figured out an unmet demand in the industry. As is typical for any start-up and so called "unicorns", the company has been operating in losses for its entire operational history. Operational losses for start ups are expected, as in their early years, they endeavor to settle in, and invest heavily in their operations, and are concerned very little with profits as all of their profits are in the future along with their growth. It isn't all bad though, as companies often tend to increase their DTA, or NOLs, in case they incur losses, and SNOW, as of the writing of this post, disclosed NOLs of $1.57B on its FYE '23 10K.
The company has also been investing heavily in its operations as is evident from its capex spending, which was $25M for FYE '23, with D&A of $63M. I know, the D&A is more than capex and how is that possible for a start up? Well, it isn't; if one were to look at its historical numbers over the last few years, one would realize that D&A is ahead of its capex precisely because the company invested heavily in the preceding years, resulting in higher D&A compared to its capex. Additionally, the company's NWC has been increasing steadily over the last few years; NWC (difference between its operating current assets and current liabilities) was -$167M in FYE '20 (63% of revenues), fast forward to FYE '23, NWC was -$989M or 48% of its total revenues; which means that nearly for all of its operational history, the company has had more current liabilities than its operating current assets. Moving on to its latest quarterly report, The company had a cash and cash equivalents (which included short and long term investments) balance of nearly $4.5B, and no debt at all, current or long portion, except for operating leases. The company also reported revenues of $2.03B for nine month ended Oct 31, 2023, a vivid increase over $1.48B revenues for the nine months that ended on Oct 31, 2022. Furthermore, SNOW reported cost of revenue of $656M, and other operating expenses of $2.2B for the nine months ended on Oct 31, 2023, yielding an operating loss of -$819M, a bigger loss than -$602M the company incurred for the same time period of the prior year.
I think the numbers give us a clear picture of the kind of company we are dealing with, a company that is still in its infancy, and is investing as much as it can back into the business for its much needed growth. The compounding losses do not necessarily mean that there is something fundamentally wrong with the company or its business model, in this case, it simply means that the company has its growth and profits somewhere in the future. To understand the company's future, lets next look at the cloud data industry as a whole, and what its prospects look like.
Cloud Data Warehouse Industry
In order to better understand what the future holds for this industry, I think it would be prudent for us to step back a little and assess and analyze the world we currently reside in. We live in a world where all of our data is stored on one cloud or another, in one shape or another form. We all utilize our cell phones and the accompanying applications for our daily needs, we gladly accept help from all sorts of apps for the most mundane of tasks to operations that require thinking and analyzing; lets now expand our discussion to include companies, organizations, and enterprises. Companies have access to their own data, of course, but they are more than willing to pay for data and relevant consumer information from other companies and enterprises because everyone has come to realize the sheer importance of data in business decision making and other facets of our lives. Cloud technology, over the course of last few years, has emerged as sort of a phoenix rising from the ashes of physical data storage warehouses and facilities. Cloud technology is much easier for companies to deal with, and it entails less capex and maintenance on the companies' part. Enterprises and organizations are more than willing to pay for cloud services, and have not only access to their own data, but also a variety of other products and services that help them enhance their customers' experiences, better equip them with the tools needed for their respective industries, and give them invaluable insights into growing their customer base as well as retaining their existing consumers.
The global cloud data warehouse market size is expected to grow at a CAGR of 23.5% from 2023-2030. This growth is driven by multiple factors including the growth of data, access to data, cost effectiveness of cloud storage, various products and services that can deliver incalculable insights to businesses as well as new technologies such as 5G and generative AI that will boost internet usage in the years to come. I, personally, believe that the cloud storage data industry is barely out of its infancy, and given its promises and the endless possibilities that it provides corporations and organizations with will only fuel its growth further. The industry is also smeared with other enterprises that provide somewhat similar services to SNOW; these other companies include but are not limited to Amazon, Microsoft, Apple, Adobe, Oracle, and DocuSign. In order to stand out, SNOW will have to invest heavily in its operations and be willing to incur losses for the foreseeable future if it desires to hold on to its existing customers as well as expanding to other territories and industries.
The immense need for cloud storage also presents SNOW with another possibility within the industry: companies' willingness to utilize multiple cloud storage platforms instead of exclusively being on one. This gives companies, such as SNOW that are smaller in size in comparison with Amazon and Microsoft, a fair and equitable chance to compete for market share. I think that with enough invested in capital, SNOW might just be able to keep growing at a double digit growth rate. One last thing that I will mention for the future would be the hype around generative AI. I can not say that I agree with people that say, "AI is the single best technology in the history of mankind," but I also can't deny its significance and the innumerable benefits that it will bring to the world of business, but I have to say that I fail to see AI inducing any growth for our company, SNOW. I think that AI's impact- given SNOW's business model and the fundamental operations- will be incremental at best. As a matter of fact, I think that they might even be adversely impacted by it. Why do I say that? Well, lets think about the mania around generative AI, among other things, it is expected to provide better insights and analysis for companies to review, and if companies can manage to develop an in-house architecture of generative AI, then their need for a cloud storage platform that provides AI driven insights will dissipate. Anyways, we could talk on length about this and still not agree on most of the things, so lets move on to the crux of this post, the valuation.
Corporate Cycle
Before moving on to valuation and the numbers, I think that it is always a good practice to look at company's history, and try to locate where it is on the cycle because, I believe, valuation becomes easy once you know what stage of the cycle the company is in.
Corporate lifecycle
Having the benefit of studying the company, its financial statements, and the fact that it went public in 2020, I'd say that SNOW is in the childhood stage of the cycle. I do not see the company turning any profits for the next few years. I expect the company to put up double digit revenue growth along with higher costs and operating expenses. As it moves up the cycle, I suspect its margins will improve as management will get a better grasp of the costs along with consistent increase in revenues. I also expect the company to invest as much as it can for the foreseeable future for two reasons; first, I expect the company's current market share will come under threat as its grows for the next few years, and secondly, as it grows, it will need more and more facilities and other tools to provide products and services to its consumers and organizations world-wide.
Valuation
When valuing a company through DCF, there are a few items that one has to not only track but also have somewhat of a theory as to their predictions. One of the said items is revenue and revenue growth. In my base case, I expect company to grow at a CAGR of 28.4% over the next ten years; I expect revenues to grow from $2.06B in FYE '23 to $25.1B in FYE '33. I expect this growth to be driven by multiple factors; the first of which is the growth of the cloud data warehouse industry, second is the fact that companies are increasingly leveraging more than one platform for insights which provides SNOW with an avenue of growth, thirdly, I believe that as the company grows, it will innovate more and spend more on R&D and not only increase the number of its services, but also improve its offerings in terms of efficiency and compatibility, and lastly, I believe AI, no matter how much I dislike how openly it is being exploited, will play somewhat of a role in the company's growth, implicitly or explicitly.
The second of the aforementioned items is the reinvestment. I expect the company to invest more and more as it progresses towards maturity. I expect the company's capex to be 2.4% of revenues in FYE '24 to 7% by FYE '28; I also suspect that after FYE '28, the company's capex would start to taper off at which point its D&A will overtake its capex. Additionally, I expect the company's NWC to decrease as it moves up the cycle, which means that as it grows, it will see more and more cash inflows. Knowing what I know about the company and its future, as well as keeping macro economic factors in mind, I expect the company will grow at 3% into perpetuity. As mentioned before in the post, the company does not carry any debt, short term or long term, on its balance sheet and so its WACC is essentially its cost of equity, which I calculated to be 8.98%, I will further carry this cost of capital into the future and not get into the complications of changing WACC throughout the projected years or even for the terminal year, although I suspect it would be different as I expect the company to take on debt as it moves up the cycle. Converting all of my assumptions into numbers, I get the following price per share.
DCF
Sensitivity
Sensitivity, I believe, is one the paramount activities when valuing a company because it allows the inquisitor to not just look at the value based on his/her assumptions, but also how changes to various factors might affect the derived value; so, as such, I decided to look at what the share price might be given changes in WACC, perpetuity growth rate, revenue growth rate and operating margins. Below are the data tables with assumed changes in different variables.
Image 1
Image 2
As you can see, a slight change in one or more variables gives us vastly different values. The idea of these sorts of tables is to look at your assumptions and assess whether the changes are the ones you can comprehend and, if need be, defend. I for one, think that the long term growth rate of 3% is well within SNOW's grasp, and it is a matter of efficiency and a little bit of luck that they get to grow at 3% in perpetuity. Changes in WACC are very likely down the lane, because I suspect, as the company grows and matures, it will take on more debt, thereby changing its cost of capital. Image 1 give us a range of $118-$292 depending on what one thinks about the long term growth rate and the company's WACC.
Image 2 shows a range of $108-$454/ share, again, depending on what you think the company's revenues and margins will be in the final year. I think that my assumptions are not only intelligible but also reasonable because, in my base case, I am assigning the company a growth rate that I think the management will be able to manage and sustain; additionally, I believe margins of about 20% are also within the company's range given its business model, and the outlook for the industry as a whole.
As with all of my prior work, I conducted a statistical analysis of the company's share price given changes in its final year revenue growth rate, margins, and WACC. I ran a Monte Carlo simulation and decided to graph the distributions on not only histogram, but also the box and whisker chart. The results of the simulations are presented below.
Statistical Analysis
I ran 10K simulations assuming a 2% standard deviation in my final year revenue growth rate and the operating margins, as well as assigning a 1% standard deviation to the company's calculated WACC. The mean value across the 10K simulations was $169.86/ share, with a minimum of $85.06 and a maximum of $613.49. Some of you might be thinking why 2% and 1% in standard deviation, in the spirit of complete transparency, those numbers are completely arbitrary. I just know that there is no world in which the probability of me being correct is 100%, and so I have accepted my fallacies and assigned margins of error to see what the distributions might look like if I had selected different factors in my valuation. As you can see, most of the values lie between $137-$170/ share. The box and whisker plot on the right presents somewhat of similar results. Given my assumptions, the data tables, and the statistical analysis, I think that I am pretty content with my DCF derived share price of $163.60/ share.
Conclusion
As with any valuation, it is a case of not only numbers but narratives along with understanding of other factors. Valuations differ immensely depending on what one thinks about the company, its prospects, and the future of the industry. Based on my comprehension of Snowflake's business, its operating model, and the future of the cloud data warehousing industry, I believe that the company is trading at a premium. My recommendation would be to sell/hold if you own it, and maybe to put in a buy-limit order if you don't. But, don't take my word for it, download the excel file attached below and feel free to make it your own and incorporate your own narratives and assumptions, and see what share price you get.
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