SNOW - Snowflake: AI Blizzard In The Forecast

2023-10-03 10:48:33 ET

Summary

• After years of waiting, I finally believe Snowflake represents a sustainably attractive value at about $150/share.
• While Snowflake began as a uniquely architected cloud-native data warehouse, the business has materially evolved itself in the last three years.
• There's a certain irony to it: Investors were overjoyed to buy it at $200+/share in 2020, when I found it to be too expensive and when it was weaker overall.
• At this time, it had not meaningfully fielded its data marketplace platform, nor its Snowpark platform, and it had not expanded its free cash flow margins.
• Today, as it operates from its greatest position of strength and most inexpensive valuation in corporate history, with ~$5B in cash, $0 in debt, 20%-plus free cash flow margins, and a very long runway ahead, it has struggled to sustainably catch a rise. I believe this represents an attractive opportunity for investors looking to buy into the secular trend that's the growth of cloud computing.

Introduction

Snowflake (SNOW( is a quality business that has built what some have called the Data Super Cloud.

Today, we will analyze my thesis for Snowflake, which includes the growth of the lines of business that sit atop the Data Super Cloud.

Foundational Pillars Of My Snowflake Thesis

At this point, I have provided two deep dives into Snowflake: One in 2020, in which I realized the stock was vastly too expensive and would require at least five years of stagnation from its 2020 share price levels to become remotely attractive.

And I provided a deep dive in mid 2022, six months after which I made Snowflake a Top Idea at $129/share and began accumulating the stock semi routinely.

From my 2022 deep dive, I shared three pillars for our Snowflake thesis:

Moving From 0 To .5 To 1 (Going 0 to 1)

Presently, Snowflake finds itself at about .25 to .5, as opposed to 0 or 1. It's in an intermediary stage between "idea finding its way into a larger marketplace" and "a robust operating system with significant, long term defensible moats, such as Network Effects." Indeed, were Snowflake to stop here, it would likely not be nearly as exciting an investment as it will be when the company builds out the three vectors I will share with you in just a moment.

Snowflake is unequivocally not resting on its laurels. In fact, Snowflake has delineated quite clearly a path to taking the company from "superior data warehouse in a sea of data warehouses" to The Super Cloud , as some have started calling it.

Snowflake will accomplish this Super Cloud status through three vectors principally:

1. The creation of its Data Marketplace, which will serve as the oil, so to speak, or electricity, into which other companies can plug their businesses.
2. Further expanding its native, proprietary AI/ML predictive capabilities.
3. The creation of businesses and applications built on Snowflake by entrepreneurs. This is known as Powered By Snowflake.

Over the last year or so, Snowflake has made material progress for each of these pillars.

And these pillars are all part of Snowflake's mission to create a "Data Super Cloud." In this vein, I recently remarked,

So, as Peter Offringa shared with me last year, SNOW is building the "super cloud," which is not just a unique configuration of compute and storage atop the various public clouds.

Companies can build applications natively in the Snowflake cloud environment (using Snowpark) and deploy those applications seamlessly to their entire, global enterprises using Snowflake containers (which are a part of Snowpark).

Companies can pipe in various data sources, both from their own data and from "stable edges" created via the Snowflake data marketplace, to these apps seamlessly as well.

It's an entire "data super cloud." I believe SNOW will reaccelerate growth. There's so much growth potential here.

Let's review these pillars individually today, after which we will consider Snowflake's calendar year Q2 2023 through a quantitative lens.

Snowflake's Data Marketplace

AI reaches beyond enterprise boundaries. Models need external data to answer challenging questions. Data sharing makes Snowflake uniquely positioned to enable AI workloads.

As of Q2, 26% of Snowflake customers are data sharing, up from 20% in the same period last year. Approximately 70% of customers with more than $1 million in trailing 12-month product revenue are data sharing with an average of six stable edges.

(Data Marketplace statistics)

Frank Slootman, CEO, Q2 2023 Snowflake Earnings Call

Snowflake's Data Marketplace, or what I've called the Amazon of Data, is arguably one of the most exciting components of the Snowflake thesis and platform broadly.

While still nascent, it has grown substantially over just the last three years.

A Visualization Of Data Being Shared In The Snowflake Data Marketplace

To provide a more granular understanding of this chart, Snowflake shares its total marketplace listings and total "stable edges," i.e., instances in which two companies share data with each other, each quarter. I provided a comparison of Q2 2022 and Q2 2023 below.

Q2 2022 Marketplace Listings and Stable Edges

Q2 2023 Marketplace Listings and Stable Edges

As we can see, the adoption of the product has continued to grow and it shows no signs of stopping at these levels.

Frank Slootman, Snowflake's CEO, shed light on the value of Snowflake's data marketplace as a component of the entire Snowflake Super Cloud in an exchange with an analyst on Snowflake's recent earnings call:

Brad Zelnick: Frank, stable edges continue to tick up, which is great to see, and I know it's an important metric for the company and its strategic vision. Anything else perhaps qualitative that you can share in terms of how data sharing is progressing?

Frank Slootman: On the topic of data sharing, we instrument that whole side of the business very, very carefully and we drive it on a quarterly basis. But sometimes data edges are very enterprise specific. In other words, they just have things, the use cases, that just pertain to their business and these are bilateral relationships between Snowflake accounts and different institutions.

But where it gets really interesting, where you get real network effect kicking in, is when you have industries or sub-industries where data sharing just makes sense. And obviously, in financial institutions, because financial institutions inherently have been pumping data around in massive, massive volumes for - literally for generations. This is an absolute no-brainer. And we do the vast majority, historically data edges have been in the financial services sectors become almost a standard. This is how we move data from A to B to C. Asset management particularly has a really big need for that.

But the other area, and again, this is an industry, in supply chain management. I mean, in the supply chain, there are multiple entities to the degree that they all have Snowflake accounts, it's very easy to get visibility and supply chain across entities and being able to flag supply chain events much earlier and get visibility to that. So once you're in a supply chain, the need to be on Snowflake and share data with your supply chain partners is going to become very, very compelling. And we announced at Summit and even earlier our relationship with Blue Yonder, for example, which is really the largest software company in the world in supply chain management, that they are re-platforming on Snowflake. So, we think that's another sort industry/sub-industry where every manufacturer, every retailer is going to become an opportunity for us. So it's a little bit of color on how these things develop from our perspective.

Frank Slootman, CEO, Q2 2023 Snowflake Earnings Call

As I've noted, the Snowflake Data Marketplace is a component of the entire Snowflake Super Cloud.

The unique data warehouse architecture, with highly configurable and elastic compute and storage, provides the optimized, trusted, and sanctioned data foundation.

Atop this foundation, Snowflake further locks its customers into its ecosystem via its Data Marketplace, the importance of which was detailed above, and via its Snowpark applications platform, which includes Snowflake's Containers Services, which allows enterprises to run large portions of their enterprise natively atop the aforementioned data foundation, seamlessly and globally.

With Data Marketplace and Snowpark in mind, atop Snowflake's data warehousing platform, we can see how the entire ecosystem has been strategically architected to create the Data Super Cloud.

Let's now turn to a review Snowpark.

Snowpark

Snowpark is Snowflake's native application development platform. It's a strategic pillar of the aforementioned Super Cloud strategy that allows enterprises to conduct data operations at global scale more seamlessly than ever.

Enterprises can build applications natively in the Snowflake cloud environment (using Snowpark) and deploy those applications seamlessly to their entire, global enterprise using Snowflake Container Services (which are a part of Snowpark).

Enterprises also can employ third party apps, such as Amplitude, that have been natively built on Snowflake for a likewise seamless experience.

Companies can pipe in various data sources, both from their own data and from "stable edges" created via the Snowflake data marketplace, to these apps seamlessly as well.

For years, we focused on the programmability of our platform via Snowpark. We are seeing momentum. In Q2, we added more than 400 Snowpark customers and our consumption grew approximately 70% quarter-over-quarter. 63% of our Global 2000 customers are using Snowpark on a weekly basis.

Frank Slootman, CEO, Q2 2023 Snowflake Earnings Call

One very noteworthy example of this has been Amplitude's recent launch of a version of its product natively built in Snowflake.

• Amplitude Announces Snowflake-native Amplitude, a Snowflake Native App with New Snowpark Container Services

To highlight the value of this, for instance, Capital One (which has gone all in on Snowflake) could employ Amplitude to enhance its users' experience within its finance app. Product managers and data scientists, in Capital One offices around the world, could easily employ Amplitude to enhance customer experiences in the Capital One app in different regions, with very little intervention from IT professionals, as Snowflake Container Services would make deployment of Amplitude in these various regions seamless.

Capital One could run its entire Product-Led-Growth strategy globally, powered by Amplitude, directly from the Snowflake Super Cloud.

And with Capital One running more and more of its business within Snowflake, Snowflake would in turn generate more and more sales from Capital One, driving net retention rate and overall sales higher.

Tyler Radke: Great. And then to follow up, just in terms of the Snowpark revenue. Any update on kind of where you're expecting that to track as you exit this year? And then these related services, whether it's the Native App Store or Container Services, would that all fall under Snowpark theoretically when that goes GA next year? Thank you.

Mike Scarpelli: In terms of Snowpark, as we said, whereas Frank talked about seeing 70% growth in Snowpark consumption, still relatively small, but meaningful. We have a number of customers that are in the process of doing their migrations, a few quite large ones. I do think next year, it will be more meaningful to revenue. But on $2.6 billion in revenue, it's a couple of percent of our revenue this year.

Frank Slootman: Once that container services become primetime and that is part of Snowpark, obviously, that means any workload becomes a fair game to be deployed on Snowflake. This is obviously running close to the data, inside our governance perimeter, it's essentially virtualization for the cloud. So, we think there is enormous upside for us once those services become generally available across all our cloud platforms.

Q2 2023 Snowflake Earnings Call

Mr. Slootman further described the seamless nature of the Snowflake Super Cloud, with Snowpark in mind, in the following manner.

Frank Slootman: Container Services was the absolute hit, star performer at our Snowflake Summit conference. I mean, customers were just mesmerized by the possibilities that a platform capability has because we essentially eliminated any limitation on deployment on Snowflake. And why do you care? I mean the thing is, first of all, you wanted to deploy close to the data for all the reasons that we talk about. This enabled us, you get a fully trusted sanction platform where you can deploy applications without any further questions.

And one of the challenges that you have in cloud computing is, who's managing this, right? I mean what is the safe space to deploy into and whose is really guaranteeing the high trust enterprise-grade capabilities of the platform? So, we are bringing that. So, we're going to see a lot of services, a lot of them could be on-premise legacy engines that are going to be containerized and re-service as a cloud service, right? So, a lot of things that were old will be new again. So, it's virtualization for the cloud and having secure, safe, high-performance, very, very efficient spaces to run services and applications.

And so, the sky is the limit on this capability, and we and our customers and our partners could not be more excited about the potentials and the possibilities here. But specific to AI, this matters a whole lot because the containers, our vehicle, our vessel, if you will, to deploy large language models, there are no limits on which models and how many models and for what segments of the business we can deploy. And we can shift gears very, very quickly. And we have incredible flexibility in terms of deploying these capabilities, because you're going to see a lot of change and a lot of movements. We've already seen an enormous amount. That's going to continue. So, we're very, very well-positioned architecturally platform-wise to enable the AI revolution with Container Services.

Q2 2023 Snowflake Earnings Call

And Snowpark continues to gain traction:

We've also reached an inflection point on the applications front. At Summit, we launched so-called Native Apps in Public Preview. And we have over 25 native application providers today. Snowflake is a save, certified, and sanctioned place to deploy applications. Grassroots support is building. We now have more than 145,000 monthly active developers on Streamlit. This represents an increase of 160% year-on-year. Our start-up program allocates resources to developers planning to build on Snowflake. Approximately 20% of new customers landed in Q2 landed on Snowflake through our start-up program.

Frank Slootman, CEO, Q2 2023 Snowflake Earnings Call

Financial Analysis: Returning to Growth

Over the last six months, I've routinely noted that Snowflake grew at 0% in the month of April 2023.

The 0% growth for the platform I have detailed for you today is pretty wild to put it lightly. But, as we all know, this came on the heels of the fastest interest rate hiking cycle in US history, which was followed by the second, third, and fourth largest bank failures in American history.

On Snowflake's Q2 2023 earnings call, Mr. Slootman characterized early 2023 in the following manner:

There's really a change in how customers engage. A couple of quarters ago, like I said earlier, people were doing unnatural acts to force themselves into spending envelope and they were doing it almost regardless of consequence, that's fixation on that reset, we obviously felt that.

Frank Slootman, CEO, Q2 2023 Snowflake Earnings Call

And, of course, we've seen this across the board in the realm of software and digital ads, which has created the cratering growth rates for the software industry as a whole.

Recently, however, Snowflake has seen signs of stabilization.

In May, we saw a return to growth with strength continuing into June and July. From a booking standpoint, we saw promising signs of stabilization with new bookings outperforming our expectations. However, we believe, productivity has room for further improvement.

Mike Scarpelli, CFO, Q2 2023 Snowflake Earnings Call

Now let's turn to guidance. Our forecast assumes that our largest customers will continue to be a growth headwind. We are seeing encouraging signs of stabilization, but not recovery. Our forecast calls for these customers to more closely align their consumption with their annual contract value.

Mike Scarpelli, CFO, Q2 2023 Snowflake Earnings Call

In Q2, we saw these statements borne out in Snowflake's financial metrics.

Snowflake Grew Net New Sales Sequentially

Growth Of Total and Large Customers Accelerated In Q2

This is incredibly heartening to see, and the additional customers will serve to drive the network effects in the Data Marketplace needed to create a more robust Super Cloud, the creation of which should push Snowflake into the multi-hundred billion dollar realm from an enterprise value perspective over the long run.

The creation of the data Super Cloud also should serve to sustain Snowflake's other-worldly net retention rate for years to come.

Lastly, Snowflake continues to grow $1M customers rapidly, and I believe this will ramp into the thousands in fairly short order in the coming years, driving Snowflake to its guided $10B in sales by 2028 (calendar year) target.

With all of these ideas in mind, the Snowflake platform, in so many senses, is just getting started. To this end, I believe the current macro environment may actually be masking the true growth the company should be experiencing at present.

Tough Times In Software

I've lately been highlighting the idea that software is currently experiencing a recession of sorts, with growth rates collapsing in recent quarters.

For Snowflake, it has been no different, despite signs of stabilization in its most recent quarter.

We can see evidence of this in the company's decision to pull its long-term growth guidance from its long-term operating model slide.

Snowflake's Long-Term Operating Model As Of Q2 2023

Over the last couple years, we've seen this same withdrawal of guidance from companies like Splunk ( SPLK ), Twilio ( TWLO ) and Okta ( OKTA ), all three of which are world-class software businesses.

Snowflake's Previous Long-Term Operating

From what I can remember, these four companies are the only software companies to release 3-5-10 year growth guidance, and all three have since withdrawn that guidance.

I would hazard the guess that, had more software companies published such guidance, they too would have withdrawn it by now in light of the current software growth environment.

Concluding Thoughts: The Data Super Cloud

Each time I work through Snowflake, I walk away more excited and energized about the company and its prospects than ever.

The Data Super Cloud is forming, and, while it may not be the next Facebook ( META ), I believe it could certainly be a much better version of ServiceNow ( NOW ) or Salesforce ( CRM ) from a long run, sustainable growth perspective.

Thank you for reading, and have a great day.

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