When cloud-based data warehousing company Snowflake Inc. (SNOW, Financial) went public in September 2020, many investors were surprised to see that Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) was among its early buyers.
Berkshire purchased $250 million worth of Snowflake shares at the initial public offering price, quickly adding another 4.04 million shares at the debut price of $120.
Given the size of the position, it is likely one of Buffett’s portfolio managers is responsible for this investment. Todd Combs and Ted Weschler are also more familiar with the technology sector.
Since its IPO, Snowflake’s share price has not done too well. After enjoying a decent run through the end of 2021, the stock is down 46% year to date, trading around $134.82 per share as of this writing.
On the other hand, revenue has been increasing at a breakneck pace, and the company turned free cash flow positive in its third quarter of fiscal 2022, which ended in October 2021. Could Snowflake now be in value territory?
Growth
In its first quarter of fiscal 2023, which ended in April, Snowflake recorded product revenue of $394.4 million, an increase of 84% year over year. Total revenue was $422.4 million, representing 85% year-over-year growth.
On the bottom line, the company still has not managed to achieve profitability, with the first-quarter loss per share coming in at 53 cents, though this was an improvement compared to the loss per share of 70 cents in the prior-year quarter.
The company record another quarter of positive free cash flow, though. Free cash flow per share was 55 cents. This marks the third quarter in a row of positive free cash flow.
The net revenue retention rate was stellar at 174%. Snowflake had 206 customers with trailing 12-month revenue greater than $1 million as of the quarter’s end. This means Snowflake’s customer base is growing and spending more.
Valuation
Now that Snowflake has a few quarters of positive free cash flow, we can utilize the free cash flow-based discounted cash flow model to value the stock.
Based on the trailing 12-month free cash flow per share and assuming a discount rate of 9%, the reverse discounted cash flow model shows us that Snowflake would need to grow its free cash flow at a rate of 43.15% per year for the next five years in order to be worth its current share price.
Considering its trajectory of free cash flow growth so far, this should be possible to achieve, though past results are never a guarantee of future success. Growth rates also tend to slow down over time. Wall Street is estimating overall free cash flow to approximately double in fiscal 2023 and 2024 before slowing to around 75% growth for the four years after that.
These optimistic estimates are a result of the combination of Snowflake’s rapid growth over the past couple of years and the expectation that its unique cloud-native offering will revolutionize the data warehousing industry.
Insiders
After a three-month lockup where they could not sell their shares, Snowflake’s insiders predictably began cashing in.
This is not necessarily a bad reflection on Snowflake in particular, so much as it is a function of Wall Street. Insiders know they can turn a quick and easy profit by selling into the hype soon after the IPO. Stocks that have a smooth upward path from their IPO are extremely rare; normally there will be a correction after the hype dies down and before business really gets into full swing.
The important thing to look at is just how many shares insiders have sold compared to how many they still own. From the below chart, we can see that the volume of insider selling peaked in March, August and December of 2021, with the most recent insider sells occurring in March 2022.
In total, insiders have sold approximately 7.05 million shares since Snowflake’s IPO, or 2.21% of shares outstanding. This leaves the company with an insider ownership level of just 0.01%, which is quite worrying. It seems insiders do not have much faith in their own company’s share price, given that they dumped nearly all of their shares over the past couple of years.
For comparison, a close competitor of Snowflake, Teradata Corp. (TDC, Financial), has an insider ownership level of 4.3%. Even though insiders have been selling recently, they still have a decent amount of skin in the game.
Competition
For Snowflake, everything really hinges on whether its product offerings are attractive enough to draw in new customers left and right. In order to do that, it needs to be in a clear position of strength compared to the competition.
Snowflake has carved a unique niche for itself by offering data warehousing that is cloud native. All of Snowflake’s components run on public cloud infrastructure by Alphabet’s (GOOG, Financial) (GOOGL, Financial) Google Cloud, Microsoft’s (MSFT, Financial) Azure and Amazon’s (AMZN, Financial) AWS.
This means it can be integrated into a user’s existing cloud infrastructure. Users can load data into the cloud without converting or transforming it into a fixed schema, allowing structured and semi-structured data to be combined for analysis.
Snowflake also requires almost no administration. Customers can typically set up and manage Snowflake without the help of the IT team. Processes like auto-scaling, software updates and increasing clusters and virtual warehouses are automated.
One advantage of Snowflake is that it offers unlimited compute sizes and storage, though some customers complain this can result in them spending more than they intended to. Teradata provides fixed capacity, and when you exceed that capacity, you have to restructure systems with additional hardware and upgrades.
Snowflake also competes with Amazon’s Redshift and Alphabet’s BigQuery. Two consistent ways that Snowflake differentiates itself are via instant scaling and more automated maintenance, though it does lose out on the more natural integration of cybersecurity solutions that some of the big tech giants offer.
Outlook
Snowflake has meaningfully differentiated itself from its peers, which is crucial in order to compete, especially when the competition includes giants like Alphabet, Amazon and Microsoft.
One thing to pay attention to is how the growth rates going forward compare to the past. Some analysts have pointed to the deceleration of Snowflake’s growth as an indication that the stock is overvalued, since slowing growth would make investors less enthusiastic about the stock.
Product revenue growth was 110% in the first quarter of 2022, for example, compared to the 83% recorded in the same quarter of 2023. The company projects product revenue growth of 71% to 73% for the second quarter of fiscal 2023 and 65% to 67% for full fiscal 2023.
Snowflake has also warned that its net revenue retention rate should decline. Chief Financial Officer Mike Scarpelli predicts this metric will stay above 130% for “a very long time,” but that would still be a pullback from the current level.
According to Allied Market Research, the global data warehousing market was valued at $21.18 billion in 2019 and is estimated to reach a value of $51.18 billion by 2028 for a compound annual growth rate of 10.7%. Given Snowflake’s current revenue level, it still has plenty of room to grow faster than the market average by taking market share from competitors.
Overall, the business prospects of Snowflake as a company look good, though a successful company does not always translate to shareholder gains. The stock is still undeniably pricey even after being cut in half from its IPO price. If it grows as expected, then it looks like a bargain now, but if it disappoints, then losing that hype could be devastating.
