Warren Buffett (Trades, Portfolio), arguably the most successful investor the world has ever seen, has never been fond of initial public offerings. During an interview with CNBC in 2018, Buffett said:
"In 54 years, I don't think Berkshire has ever bought a new issue. The idea of saying the best place in the world I could put my money is something where all the selling incentives are there, commissions are higher, the animal spirits are rising, that that's going to be better than 1,000 other things I could buy where there is no similar enthusiasm just don't make any sense."
That said, Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) has had some immense success in the very few IPOs in which the conglomerate took part in. For instance, Berkshire's investment in Brazilian fintech startup StoneCo Ltd. (STNE) in late 2018 has already yielded a capital gain of more than 110%.
The guru has now decided to invest approximately $570 million in Snowflake Inc. (SNOW) when the company goes public. Snowflake, in a regulatory filing, revealed an IPO price of between $75 and $85, and Berkshire has committed to buy 3.125 million shares at that price range and an additional 4 million shares from an existing shareholder.
The business
Snowflake provides a platform that enables customers to perform most critical data management tasks using a single login and runs on popular cloud software such as Azure by Microsoft Corporation (MSFT, Financial) and Amazon Web Services by Amazon.com Inc. (AMZN, Financial).
Source: Snowflake
The business is centered around the expectation that an increasing number of organizations across the globe would embrace data-driven decision-making solutions. In its prospectus, Snowflake discussed this business structure in detail and wrote:
"Our cloud data platform is the innovative technology that powers the data cloud., Our platform enables customers to consolidate data into a single source of truth to drive meaningful business insights, build data-driven applications, and share data. We deliver our platform through a customer-centric, consumption-based business model, only charging customers for the resources they use."
Snowflake charges customers on a pay-per-use basis whereas most of its competitors including the likes of Amazon bill users on a subscription basis regardless of the usage. This unique business structure of the company has not gone unnoticed. As illustrated below, Forbes listed Snowflake as the second most influential private cloud company in 2019 in its annual Cloud 100 list.
Source: Forbes
Berkshire's investment in the company improves the credibility of Snowflake as a reliable cloud data services provider, which would be beneficial for the company in the long run to onboard high-end customers that are likely to spend millions of dollars per annum in subscription fees. As one of the first players to provide a usage-based billing scheme, the company is already in a good position to challenge larger peers that have established themselves as the go-to solutions providers for businesses of every scale.
The numbers are improving, but Snowflake is still a loss-making business
Revenue has doubled in the first half of this year in comparison to the corresponding period last year, but the net loss has increased from $178 million for fiscal 2019 to $348.5 million for the fiscal year 2020. This goes on to suggest that the company is failing to expand its margins meaningfully at this point even though revenue growth is stellar, meaning Snowflake has to bring in a much higher dollar amount to breakeven.
Source: Prospectus
The company served 3,117 customers as of June 30, up from just over 1,500 on June 30, 2019. The business structure of Snowflake enables the company to grow revenue even if the number of customers remains static as the billing is done on a data volume basis.
Three things Buffett might have liked about Snowflake
Apart from the staggering growth projected for the data cloud industry, which is likely to be one of the first things Buffett and Co. might have analyzed about Snowflake, there do not seem to be many characteristics the guru typically adores in a company. Buffett famously said, "In the business world, the rearview mirror is always clearer than the windshield," suggesting that a business with a demonstrated history of making profits is preferable to one with sky-high growth expectations. Snowflake's history, arguably, is not one that would have had the guru rolling his eyes. A deeper look at the company, however, reveals a few things Berkshire lieutenants would have loved.
First, Frank Slootman's presence as the CEO of the company could have enticed the guru to invest. Slootman is widely praised for his stint at ServiceNow Inc. (NOW, Financial) from 2011 to 2017, during which the company grew from earning just $100 million in revenue to over $1.4 billion. His expertise in developing Software as a Service (SaaS) is likely to help Snowflake achieve growth targets, which would then be a driving force of the market value of the company.
Second, the business model of the company requires little to no working capital in the long run, which is a characteristic Buffett has commended on numerous instances in the past. This will help Snowflake earn a high return on equity in the future, which guarantees acceptable returns for early investors in the company.
Third, Snowflake has the opportunity to build an economic moat around its products and services as the company is pioneering the drive to enable data sharing services among users of different data management software. This novel feature has already grabbed the attention of many industry experts and Snowflake has an open-ended opportunity to build this feature into the crown jewel of the company that differentiates it from its rivals. Competitors are already playing catch-up from this front, and the ability of Snowflake to develop a moat depends on how soon customers can be onboarded before its peers introduce the same functionality.
Takeaway
Investors do not associate Warren Buffett (Trades, Portfolio) with loss-making, relatively new companies. In a surprise move, however, the guru has decided to plow more than half a billion dollars into one of the hottest IPOs this year, Snowflake.
Berkshire Hathaway's success in its previous IPO investment in StoneCo, a fintech company, is likely to have set a good precedent for this new deal, and the exponential growth projected for the cloud industry significantly improves the chances for Snowflake to become profitable in just a few years. Risk-seeking investors who follow gurus to identify growth investment opportunities are likely to find Snowflake a company worth looking at.
Disclosure: I do not own any stocks mentioned in this article, but I may open a long position once the stock starts trading on September 16.
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