Buffett’s IPO Bet: Time To Buy or Sell?

On the face of it, cloud-based data warehousing firm Snowflake had an excellent first quarter of fiscal 2024. Total revenues spiked 48% to $623.6 million, while adjusted free cash flow of $287 million grew even faster at 58% year-on-year.

Moreover, the company experienced strong momentum in its business relationships, with the number of customers with product revenue exceeding $1 million rising sequentially from 330 in the last reporting period to 373 today.

But most importantly, SNOW maintained its net revenue retention rate at a staggering 151%, suggesting that those using its services were happy with the benefits they received.

Nevertheless, despite these positive indications, there are enough warnings looming on the horizon to provoke anxiety among investors.

In reality, although Snowflake’s client count is on the correct trajectory, the pace of its expansion is actually decelerating. For instance, from the initial quarters of FY22 to FY23, the corporation witnessed a 40% surge in its total customer numbers to 6,322. However, if you compare FY23 to FY24, that expansion decreased to 29%.

Just as worrying, the firm’s “world-class” NRRR seems to be grinding to a halt. Yes, the metric mentioned earlier is good – but that’s been falling for the past four quarters, from 174% at the start of fiscal 2023 to its current level.

With such a paradoxical narrative, you might wonder whether Snowflake is still the investment prospect it once was.

Therefore, to answer that question, let’s dig deeper into SNOW’s operational setup – and see if the company remains a buy at its present price.

How Does Snowflake Make Money?

Snowflake’s revenue model primarily relies on a consumption-based approach, where customers are invoiced according to their usage.

Unlike traditional subscription methods, only a tiny portion of Snowflake’s revenue comes from ongoing charges. Instead, Snowflake offers two main types of billing: pre-committed capacity and on-demand use.

Indeed, customers enter into contracts to commit to a specific capacity to secure better unit pricing. At the moment, these contracts have a weighted average remaining life of 1.8 years, with customers often making upfront payments.

Conversely, the pay-as-you-go scheme is distinguished by its lack of a binding prepaid agreement. Consequently, users are not eligible for reductions, and their charges are based on a retrospective calculation of the services they have used.

In addition to these arrangements, Snowflake employs a traditional billing model for certain aspects of its business, such as its Professional Services and other offerings.

Architecture and Technology

Snowflake’s cloud-native technology delivers exceptional performance and scalability through its meticulously crafted architecture. Comprising three layers – compute, storage, and cloud services – this integrated system operates independently and seamlessly, with 40 regional deployments across major public clouds.

As such, the proprietary platform offers a robust storage architecture for structured, semi-structured, and unstructured data, enhancing access and analytics capabilities. Storage service is predicated on consumed capacity, with lower costs for higher pre-committed volumes.

In the compute domain, Snowflake’s architecture enables efficient access to shared data sets with minimal latency. This separation of storage and compute layers maintains data integrity while allowing manipulation. Compute capacity is billed using credits per hour, and customers choose based on their particular needs.

Virtual warehouse compute also allows user-managed credit for queries, data loading, and manipulation. Serverless compute, managed by Snowflake, incurs credits due to workload requirements. Cloud Services compute integrates Snowflake components for user requests, login, and query display.

Snowflake’s platform likewise facilitates secure and efficient data sharing, aligning with its goal of eliminating data silos and simplifying data management. Transfer services are invoiced on data size, the origin/destination regions, and the hosting public cloud provider.

Pros and Cons Of Snowflake’s Approach

One of the critical drawbacks of Snowflake’s pricing model is the inherent business risks associated with revenue generation.

For instance, unlike subscription-based procedures – where customers can only opt in or out of services upon renewal – the consumption-based model allows customers to scale their usage up or down at any time. This unpredictability in customer usage patterns can lead to a choppy revenue recognition trajectory for Snowflake, even if most customers have contracted pre-commitment capacity.

That being stated, the success of this approach depends on the presumption that the accumulated income will be significantly increased over a period, depending on the efficiency and feasibility of the proposed product.

Nevertheless, the flexibility provided by Snowflake brings significant advantages to consumers since they can adjust their usage in accordance with their individual requirements.

While most customers are bound by fixed contracts, the prepaid credit associated with the billing framework is only used once the service is consumed. Any unused credit at the end of the contract can be easily rolled over with a new top-up, similar to prepaid or pay-as-you-go plans in the mobile industry.

Is Snowflake A Buy?

It goes without saying that SNOW’s astronomical forward price-to-earnings (PE) ratio of 316x gives investors an easy reason to avoid this stock.

However, this ought not to pose a problem in the software-as-a-service niche, where cumbersome valuations are commonplace. In fact, Cloudflare and Shopify, two peers of Snowflake in the IT sector, are in the same 3-figure ballpark, with anticipated price-to-earnings ratios of 207x and 194x, respectively.

As a business with one of the finest net revenue retention rates in the field – and one that continues to acquire customers at a rapid pace – Snowflake is bound to emerge as a certain victor.

The company affirms that clients can anticipate a 612% return on investment within the next three years – a fact that suggests shareholders will likely experience comparable gains themselves.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.