SNOW - What To Know About The Partnership Between Snowflake Nvidia And Microsoft

2023-06-28 09:24:43 ET

Summary

• Snowflake Inc. stock's lofty valuation premium remains resilient, defying concerns over its recession-prone business model and a disappointing FY2024 guidance implying product revenue deceleration amid an uncertain IT spending climate.
• The company has announced new and expanded partnerships with Nvidia Corporation and Microsoft Azure earlier this week to bolster its exposure to incremental AI-driven demand.
• The latest development is expected to neutralize some of the near-term fundamental downside risks facing the stock, and as such, we are retreating to the sidelines.

Snowflake Inc. (SNOW) stock's recent rally appears to still have legs. Admittedly, we were previously wrong about its lofty valuation premium's exposure to both fundamental and valuation risks amid the uncertain market climate. In the latest development, Snowflake's tie-up with AI juggernauts such as Nvidia Corporation (NVDA) and Microsoft (MSFT) Azure stands to provide the data company with direct exposure to burgeoning AI opportunities, complementing the incremental demand that stems from the massive data needs of related workloads, and reinforcing the company's exposure to secular growth trends ahead.

However, we remain incrementally cautious, as the latest development expands Snowflake's already lofty market valuation premium further, especially as the underlying business' fundamentals lack profitable margins and its revenue model remains susceptible to weakness amid looming recession concerns. But considering Snowflake's increasing direct participation in recent AI momentum, which is likely to overshadow the potential impact of near-term market uncertainties on the durability of its steep stock gains (cue Nvidia's market-defying rally this year despite its exposure to the persistent slump in its core consumer end markets), we are retreating to a hold rating.

Snowflake's Partnerships with Nvidia and Azure

Earlier this week, Snowflake made back-to-back announcements pertaining to deepening its reach into incremental cloud-based data demand stemming from the latest AI frenzy. In addition to recognizing the incremental demand for data stemming from industry's urgency in developing and deployment generative AI technologies, Snowflake has announced keystone partnerships with Nvidia and Microsoft to reinforce its direct exposure to related opportunities.

Specifically, Snowflake's partnership with Microsoft will provide its customers access to " Azure OpenAI Service ," which is a compilation of advanced AI models created by OpenAI, as well as other AI and machine learning applications available through the public cloud-computing vendor. By integrating Snowflake's data cloud with Azure's prowess in AI capabilities, the data company effectively bolsters its appeal to customers looking to develop and deploy new products based on the emerging technology to stay operationally and economically efficient and competitive.

And Snowflake's follow-up on the development with its subsequent tie-up with Nvidia will also help directly address increasing customers' needs to access large language models ("LLMs") without having to move or store their data in the model, enabling a "secure and trusted" process critical to the enterprise environment. Specifically, Snowflake will be integrating NVIDIA NeMo - a cloud-based hub of LLMs that developers can access and customize with ease and efficiency - into its data cloud, which will effectively help customers reduce development costs and time to deployment by removing the need to build and train models from scratch, and/or incur egress fees from having to transfer large amounts of data. Nvidia CEO Jensen Huang explains the partnership as a mean that would "move the compute to the data," instead of the other way around as observed in the past, in order to optimize performance and cost efficiency requirements.

Complementing Data with Compute in the AI Era

As discussed in our previous coverage , the advent of generative AI and LLMs is poised to drive incremental demand for data, which would represent an adjacent tailwind for Snowflake's data cloud solutions.

Generative AI is powered by data. That's how models trained and become progressively more interesting and relevant. Models have been primarily trained with Internet and public data and we believe enterprises will benefit from customizing this technology with their own data. As Snowflake manages a vast and growing universe of public and proprietary data, the data cloud's role in advancing this trend becomes pronounced.

Source: Snowflake F1Q24 Earnings Call Transcript .

While we had initially anticipated for Snowflake's downward-revised fiscal 2024 guidance to overshadow its exposure to generative AI opportunities, the company's latest tie-up with Nvidia and Azure could likely arrest some of those concerns. Specifically, these partnerships will help materialize Snowflake's belief that "enterprises will benefit from customizing [AI] technology with their own data" by integrating the related services directly to its data cloud, and drive incremental demand for its data warehousing offerings.

Specifically, Snowflake's integration of NVIDIA NeMo into its data cloud will allow customers to directly access and train AI models using their own data sets "without risking losing control of it."

The ability to customize LLMs without moving data enables proprietary information to remain fully secured and governed within the Snowflake platform.

Source: nvidianews.nvidia.com .

This is expected to be a differentiating factor for Snowflake's data warehousing services by addressing both optimization and security demands from its end markets. Close to 40% of the private sector have cited cybersecurity improvements as a top priority, complementing the expanding demand environment for cloud-based data solutions. By linking up with Nvidia to have the NVIDIA NeMo platform integrated into Snowflake's data cloud, the cloud-based data warehousing company essentially helps customers realize incremental value from their increasingly massive data troves by addressing two key emerging trends in the enterprise IT spending environment - namely, cloud spend optimization, and security. Specifically, by "[moving] the compute to the data," the integration of NVIDIA NeMo into Snowflake's data cloud enables customers to partake in the development and deployment of generative AI technologies "where their governed data already resides," thus driving significant cost reductions without compromising on latency and security.

On the other hand, partnering with Azure will further complement Snowflake's aspirations in expanding its direct exposure to AI-related opportunities. Azure is already a key go-to-market partner for Snowflake, and the latest expansion of their relationship is expected to bolster the latter's ability in directly addressing customers' growing AI needs and capitalizing on related growth opportunities. Recall that Azure is currently the second largest public cloud computing vendor, and is becoming the "top primary public cloud vendor" amongst large enterprises ($5+ billion annual revenue) with close to 60% market share, ousting rival Amazon's (AMZN) AWS as the adoption of multi-cloud strategies gains momentum. Microsoft is also currently one of the biggest market share gainers in all things AI, thanks to its prescient investment in OpenAI - the creator of the ChatGPT application that has brought mass market awareness to generative AI capabilities.

Similar to its tie-up with Nvidia, Snowflake will be integrating Azure's "generative AI and LLM services," including Azure OpenAI and other AI/ML applications and frameworks, into its data cloud to "[enhance] the productivity of developers." This would, again, address growing optimization demands from Snowflake's enterprise end market users, as the convenience of directly linking data warehousing needs to customers' efforts in developing and deploying new AI technologies could drive incremental efficiencies. The partnership will be additive to Snowflake's existing benefits from partnering with Azure, as the second largest public cloud computing vendor becomes one of the biggest share gainers in the market for generative AI.

Snowflake's recent efforts in improving its data cloud offering's direct contribution to budding interest in generative AI is expected to resonate favourably with increasing customer demand for tools to make sense of their massive data troves. To date, only 4% of companies claim to have a "highly sophisticated approach to leveraging data." This leaves a sizable addressable market in which Snowflake could penetrate, especially given recent AI momentum and the company's bolstered direct reach into the related opportunities via partnerships with Nvidia and Microsoft.

Final Thoughts

As discussed in our post-1Q24 deep dive into Snowflake's fundamental and valuation prospects, the stock's valuation at current levels implies a perpetual growth rate of more than 8% on its projected future cash flows. And the stock's latest rally is taking that implied perpetual growth figure towards 9%, on par with eyewatering levels observed at Nvidia.

A similarly lofty valuation premium is present when considering the multiple attributed to Snowflake relative to its large cap software and broader tech peers with similar growth profiles.

i. Sales Growth vs. P/S Multiple - Software

ii. Sales Growth vs. P/S Multiple - DevOps / Data Software

iii. Sales Growth vs. P/S Multiple - Technology

Although we were previously cautious of macro-driven deterioration in Snowflake's near-term growth outlook given its recession-prone consumption-based revenue model and the recently downward-revised FY 2024 guidance, the company's bolstered direct exposure to AI momentum realized through its recent partnerships with Nvidia and Microsoft serves as a potential risk neutralizing factor and will likely restore some balance to its risk profile. As such, we are retracting our sell rating for Snowflake stock and staying on the sidelines, considering the underlying business' exposure to incremental AI-driven growth opportunities - both indirectly through increased cloud-based data warehousing needs, as well as directly through its recent incorporation of enhanced compute capabilities to better assist the development and deployment of AI technologies - essentially alleviates some of the challenge in finding incremental catalysts within the immediate-term to justify its lofty valuation premium.

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