Snowflake Is Giving Investors Cold Feet (NYSE:SNOW)

Thesis

Does anyone remember Foreigner’s “Cold as Ice” song? Well, that’s how Snowflake (NYSE:SNOW) is treating us lately! In this article, I’ll examine whether the lack of love is coming from Snowflake or broader systemic issues. A discussion of cloud infrastructure is made along with Snowflake’s position within this rapidly expanding market. I’ll demonstrate how I value SaaS (Software As A Service) companies, making adjustments for their growth rates, business position and profitability. I’ll focus on Snowflake’s Investor Day and how new AI-related products are hurting short-term financial performance but providing clarity for its longer-term success. Lastly, I determine where Snowflake’s shares might bottom in light of the above as well as Macro-factors.

Introduction

Snowflake is a cloud-based data platform that allows organizations to store, analyze, and share data seamlessly across multiple clouds and regions. Snowflake provides some key advantages compared to the “old ways of doing things.” For example, Snowflake provides a central area (“data lake”) where users can store their data which was originated from different sources or warehouses. Users can analyze this data using Snowflake’s tools. Customers don’t need to worry about managing “resources” such as Dell servers, as they can rely on Snowflake’s. Snowflake also provides governance such as sharing customers’ data based on certain parameters such as type of data, time, what types of entities, etc. Lastly, agnostic is a good term to describe Snowflake, as customers are not stuck to particular data warehouses from the likes of AWS (Amazon Web Services).

IPO Heatmap

During the liquidity-filled days of 2020-21, I created a Heatmap that rated Initial Public Offerings (the best rated are shown below). Snowflake was one of the hottest IPOs at the time, doubling on its first day of trading, – it then soared another 90%. I rated Snowflake highly for its elevator pitch, hyper revenue growth and management. Former CEO Frank Slootman had run ServiceNow (NOW) – which is still considered crème a la crème of SaaS. Notice, I rated Snowflake’s Earnings and Cash Flow very low, but investors didn’t care for those metrics in 2020. But times have changed…

Industry Structure

I rate Snowflake “Above-Average” under Michael Porter’s Five Forces framework. The threat of new entrants is relatively low, the bargaining power of buyers is low-to-moderate, and the threat of substitutes is low. Even though Snowflake competes with some of the largest Magnificent 7 competitors (e.g., Amazon, Alphabet, Microsoft) it has a “first mover” advantage and its agnostic approach is quite unique. For example, those companies tend to focus their tools and services towards their native platforms, while Snowflake has none of those conflicts. Snowflake’s ability to ingest both traditional data (i.e., structured data) and unstructured data (e.g., audio, video, images, sensor, clickstream) into a common Data-lake has solidified its position within the traditional data infrastructure and now the company is leading the industry forward to what’s called the Intelligence Cloud.

Industry Size & Growth

While it’s difficult to pinpoint the exact size of Snowflake’s TAM, everyone agrees that it’s large and fast-growing. Research firm IDC estimates Snowflake’s TAM at $60Bn in 2023 (CAGR: 22% through 2027) within a larger cloud application market of $430Bn.

Why is Snowflake acting Cold as Ice?

There are several reasons why Snowflake’s shares are underperforming. These include:

• Lower sentiment after weak earnings reports from Salesforce, Workday, etc.
• Slowing revenue momentum
• Worries over its more-volatile “pay as you go” consumption model
• Lower FCF (Free Cash Flow) and profitability guidance
• Heavy investments in AI (will reduce GPM percentage)
• Declining operating metrics
• Macro worries
• Customer hesitation over spending as Chief Technology Officers focus on their own AI efforts
• The sudden retirement of its top CEO Frank Slootman
• Data breaches

As you can see, most of these can’t be blamed on systemic factors. In fact, investors remain passionate about tech stocks, especially those involved with AI, such as Apple (AAPL), Broadcom (AVGO) and Nvidia (NVDA). Investors are avoiding long-duration companies that are showing GAAP losses, while investing in those that are cash rich and enjoying high 4% plus returns on that cash. For a more-detailed 1Q’25 earnings discussion, I would recommend reading a fellow SA author’s article.

Analyst/Investor Day:

Snowflake is a difficult company to “wrap your hands-around” and understand. On the recent Investor Day, the company introduced a potpourri of new applications. Perhaps it’s a good thing that Frank Slootman’s retired as the new CEO, Sridhar Ramaswamy has a background in LLM-based technologies and AI. He’s leading Snowflake’s effort to leverage the company’s data capabilities for AI. During Investor Day, Snowflake introduced a slew of new products that won’t bring in much revenue until at least 2025 (page 22 of presentation). One product, for example, Iceberg Tables will allow customers to store their data cheaply using open file formats and allow for easy sharing. Another, called Cortex, is an AI platform that will combine machine-learning, real-time (and predictive) analytics that will allow organizations to immediately know near-term customer behaviors. Remember, Snowflake is a platform like Palo Alto (in cybersecurity) and they’re playing the long-game of “land & expand.”

How should we value Snowflake?

While Snowflake’s shares are having short-term indigestion, I believe at a certain point they will have a good return potential. My preferred valuation standard for all companies is Enterprise Value to Forward Revenues (EV/Revenues) as it can be used for any company in any industry and accounts for balance sheet net debt (i.e, Cash minus Debt). In fact, EV/Revenues is the preferred valuation method for the SaaS industry.

If we examine EV/Revenues for the second-most expensive cohort of Enterprise Value (so EV between $30-50BN) we can see that Snowflake (light-blue line) is valued near the median EV/Revenue. So shares do not look overpriced in this chart:

However, I would argue that Snowflake’s shares remain overvalued based on:

• A regression-line of EV/Revenues vs Revenue Growth (see below)
• Loss of momentum in key operating metrics (e.g., Net Retention Ratio, Rule of 40)
• Investors’ perception that Snowflake may no longer be a “best-in-class” SaaS company
• Downward revisions to next FY’s earnings estimates

Today, Snowflake’s EV/Revenues is about 11.5x as compared to 8x where it would fall on the regression line. At first glance, this 44% premium seems unjustified; however, most “best-in-class” SaaS companies trade at a similar or even higher premiums. The problem is that since its IPO, there has been a steep decline in Revenue growth, Net Retention and Rule of 40 (Revenue growth plus FCF margin).

Further, despite the company’s 10-fold revenue increase since its IPO, profits have failed to scale. Gross Profit Margin is just 68% (FY’24) compared to 75% for most SaaS companies. There’s also the “earnings quality” issue, as stock-based compensation is a huge 43% of FY’24 revenue. Further, 95% of analysts’ earnings revisions have been to the downside (see below). The D+ Grade reflects higher downward revisions relative to the Tech industry.

Again, there’s nothing wrong with Snowflake’s best-in-class metrics – the issue is that they’ve been eroding. For example, Snowflake’s 128% Net Retention Rate was among the 1% highest in a survey I conducted of over three dozen SaaS companies. The problem is that it’s come down from 175% just two years earlier. There has also been downward pressure on Snowflake’s Rule of 40 as revenue growth has slowed, yet profitability has failed to rise markedly. Snowflake’s FY’25 Rule of 40 is forecast at 50% (page 28 of Snowflake’s slides) which is down from 80% just two years earlier. Again, we’re talking about decelerating best-in-class metrics – not the absolute numbers per se.

Conclusion

As mentioned above, Snowflake’s 40% plus valuation premium to other SaaS companies leaves it vulnerable to a share price decline just to match the regression line. If macro factors weaken (e.g., slowing economy, rates remain high) that regression line could compress further. A midpoint decline of 20% is more reasonable, which would place the shares around $100 and below the company’s $120 IPO price in September 2020. Nonetheless, as a long-term investor, I appreciate how the company is investing now so that it could lead into the future.

As a sidenote, Warren Buffett’s Berkshire Hathaway owns Snowflake, so why shouldn’t you?