SNOW - Understanding Snowflake: An In-Depth Exploration Of The Data Giant

2023-06-23 14:26:30 ET

Summary

• Snowflake is a cloud-based data warehousing company that simplifies storage, searching, and sharing of data for businesses, with a usage-based pricing model.
• The company has a diverse clientele and a strong net retention rate, but faces challenges from robust competition and less predictable revenues due to its usage-based model.
• Despite some decline in fundamentals, Snowflake has the potential to expand significantly in the big data analysis market, with a current market cap of $60B and an estimated addressable market of $248B.

After absorbing a plethora of videos, reading countless articles, and studying the tech sphere in general, I've discovered a noticeable void in understanding what many of the industry's big players actually do. We all comprehend the business of Amazon ( AMZN )—it's straightforward. And Apple ( AAPL )? Even simpler. But understanding the companies we don't engage with daily proves to be a more formidable task.

I intend to demystify and provide an introductory overview of some of the renowned names in tech. We'll delve into their core functions using some relatable analogies, identify their primary clientele, and paint a potential picture of the future from both optimistic and pessimistic viewpoints. Today, we set our sights on Snowflake ( SNOW ).

What is Snowflake?

Snowflake Inc., established in 2012, is a company specializing in cloud-based data warehousing. Its platform unifies all your data and supports all kinds of data workloads, creating a singular space for the development of modern data applications.

What Snowflake offers to corporate users is a platform to store and analyze data employing cloud-based hardware and software. It delivers a cloud-based solution for the storage of vast volumes of data, coupled with swift data analysis capabilities, bypassing the need for dedicated IT resources typically required for such operations. This fusion of services has rendered Snowflake a crucial component in the infrastructure of numerous companies that hinge on large-scale data analysis.

Now, this might sound like technobabble if you aren't immersed in the tech world, so let's distill it using a more familiar analogy. We're all acquainted with what a library is, so let's use that as our metaphor.

Imagine you're the custodian of an expansive collection of books, encompassing various genres - thrillers, cookbooks, travelogues, scientific journals, and more. Over time, this collection burgeons to such an extent that your house can no longer accommodate all the books. Moreover, locating a specific book becomes a daunting task that could potentially take hours or even days due to the sheer volume and disorganization of your collection.

Now, envision Snowflake as a tremendously large and meticulously organized library. Instead of attempting to squeeze all your books into your home, Snowflake, or the library, offers a storage solution. But Snowflake doesn't merely store your books. It categorizes and indexes them, ensuring you can locate the precise book you need in seconds.

Say you're part of a book club, and every member wants to peruse the same book simultaneously. In a traditional library, you'd need as many copies of the book as there are members. However, with Snowflake's multi-cluster, shared architecture, multiple members can "read" one "book" at the same time, without any interference or delay.

On the financial side, rather than paying for a storage unit or a building to house your books, or purchasing the necessary shelving, ladders, and lighting to organize and read your books, you only compensate Snowflake for the space your books occupy and the time you spend reading or sharing them. It optimizes your expenditure by enabling you to use only what you need, when you need it.

In summary, Snowflake serves as an enormous, cloud-based, supremely efficient "library" for your data, simplifying storage, searching, and sharing of your data in a way that's quicker, easier, and more cost-effective than traditional methods.

How Snowflake Makes Money

Snowflake's pricing structure diverges somewhat from other Software-as-a-Service (SaaS) solutions. Instead of a flat monthly subscription fee for tool access, Snowflake employs a usage-based model.

The more data you store, the more you pay. The more frequently you access that data, the more you pay. Looking to trim expenses? Reduce the data volume or adopt more judicious data access practices.

One key feature of Snowflake's revenue model is its flexibility, accommodating businesses of various sizes. For smaller enterprises or those just beginning to explore cloud data warehousing, Snowflake's pay-as-you-go model can prove more cost-effective, as it allows these businesses to pay exclusively for the resources they consume. As these businesses expand and their data storage and computational demands escalate, they can effortlessly scale their usage of Snowflake's platform, thereby contributing to Snowflake's revenue growth.

Snowflake also implements a customer success strategy, a plan designed to boost customers' usage over time by consistently demonstrating value and providing unwavering support. As the usage by customers rises, so does Snowflake's revenue from those customers, making customer success an integral component of their revenue model.

However, it's crucial to highlight that while the usage-based model offers a flexible solution potentially beneficial for businesses, it can result in less predictable revenues for Snowflake. This is because, unlike subscription models with fixed costs, revenues can oscillate based on customers' varying usage patterns.

As we witnessed in Q1 , if customers are optimizing spending, it can negatively impact Snowflake.

The Customer Base

Like many software entities we've grown to appreciate, Snowflake boasts a diverse clientele. As depicted above, their customers hail from various industries and backgrounds. Prominent names like Adobe ( ADBE ), Okta ( OKTA ), and Electronic Arts ( EA ) all avail themselves of Snowflake's offerings in some capacity.

According to their Q1 earnings report in May, the company counts 373 customers who contribute more than $1M annually, a robust 80% growth compared to the 207 customers from the previous year. The total customer count stands at 8,167, marking a 29% increase over the last year. In terms of large-scale customers, Snowflake lays claim to 590 entities from the Forbes Global 2000 list.

What's the Current Outlook?

Net retention rate is a pivotal performance metric for subscription-based businesses. It measures the percentage change in recurring revenue from existing customers over a given timeframe, considering upgrades, downgrades, and churn. It's an essential factor that software investors should weigh when contemplating a potential investment.

As seen in the above chart, Snowflake boasts an exceptional net retention rate, albeit a diminishing one.

This reduction played a significant role in the narrative that led to Snowflake's stock decline following their Q1 earnings report on May 25th.

The company's business model also came under scrutiny. Investors and market watchers began to question Snowflake's billing choice. While usage-based billing can be effective if users aren't closely monitoring their spending, it becomes a prime target for cost-cutting when they do.

Users who previously queried data indiscriminately, with no regard for caching or saving needed data for later, might now exercise more discretion. Similarly, those storing daily backups of data without considering the cost might now recognize that eliminating excessive copies could save thousands of dollars per month. These patterns pose a challenge for Snowflake.

Valued at roughly $60B and with only $2.26B in trailing twelve-month ((TTM)) revenues, it's easy to understand why some investors may steer clear of Snowflake. Should the fundamentals continue to slide, it could spell trouble for shareholders.

Lastly, another point of concern is Snowflake's robust competition. While Snowflake has its unique selling propositions and often outperforms rivals in head-to-head comparisons, price-sensitive customers or those uninterested in additional features may not regard these advantages highly.

Companies offering similar functionality include:

• Amazon Redshift - Its integration into the AWS ecosystem could appeal to those already using AWS.
• Google BigQuery - It's seamlessly integrated with Google Cloud's suite of services.
• Azure Synapse Analytics - It's fully incorporated into the Azure ecosystem.
• Teradata - It offers both on-premises and cloud-based solutions.
• Databricks - While not a traditional data warehouse, it simplifies big data processing.

Reasons to Remain Bullish

Despite a decline in some fundamentals, Snowflake highlighted several positive aspects in its Q1 filing.

Firstly, Snowflake's estimates indicate that the addressable market hovers around $248B. If Snowflake continues to be perceived as the market leader, offering superior tools in this space, it could seize a substantial portion of this market. With gross margins of 75.2% (and climbing), Snowflake has the potential to expand significantly.

Considering the current market cap of $60B, we can reverse-engineer this figure to infer what investors are expecting. Assuming a "fair" PE ratio of 20x, Snowflake would need to generate $3B in net income. With a "fair" 15% net margin, Snowflake would need to grow tenfold to approximately $20B in annual revenues. Is this feasible? Absolutely in my view.

To reach $20B in revenues, Snowflake would need to capture around 8.1% of the big data analysis market, a realistic objective given its current market position. If Snowflake can maintain its dominance by offering superior tools to its customers, the company might end up securing 20-25% of this market, thereby providing investors with over 100% return on what appears to be a lofty valuation today.

While some might downplay Q1 results and highlight slowing growth in various metrics, it's undeniable that Snowflake is still expanding at a remarkable rate.

Revenue growth from FY22 to FY23 was a solid 69%. Year-over-year, quarterly growth leading into Q1 surged by 48%. The law of large numbers suggests that Snowflake can't sustain over 50% growth annually indefinitely, and we're beginning to observe this reality. Yet, 48% growth is still impressive; however, given the $60B valuation, Snowflake will likely need to maintain this pace for an extended period.

We briefly touched on gross margins earlier. Snowflake has been broadening these alongside its rapid revenue growth. In the fiscal year 2022, the company reported a 74% gross margin. That figure expanded to 77% in Q1 of 2024.

Guidance and Outlook - The Year Ahead

I alluded earlier to a deceleration in revenue growth, and Snowflake's guidance suggests this trend may continue. Overall, the company anticipates FY24 revenue of $2.6B, reflecting a year-over-year growth rate of 34%.

Given the current momentum in the tech sector, it's plausible that Snowflake could exceed this conservative forecast. As companies begin to ease back on their cost-cutting measures, it should play well into Snowflake's business model.

However, if the economy stalls and spending is drastically curtailed, it may pose a challenge for Snowflake to significantly surpass this guidance.

Snowflake's performance in the coming year will largely hinge on the broader economy. At present, it appears that investors could afford to wait for a more attractive entry point. Certainly, we might have missed a recent opportunity, but there's always a chance another one may present itself soon for those aiming for long-term investments.

For now, I'll be observing from the sidelines.

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