In Sept 2020, long-term Warren Buffett watchers were surprised to learn that Berkshire Hathaway purchased shares of a ‘Cloud Company’ called Snowflake during its IPO debut. This action was atypical of Buffett – who famously eschews Technology Stocks as they are outside his ‘circle of competence’. Buffett also had a stated aversion to buying companies during IPOs – the last IPO he participated was when Ford went public in 1956!
But what really made value investors’ eyes pop out was the valuation – a Price-To-Sales multiple of 156!
So why did Berskhire and Warren break so many of their rules to invest in the Snowflake IPO?
Background
Snowflake was founded in July 2012 by Benoit Dageville, Thierry Cruanes, and Marcin Zukowski, all quitting their cushy jobs in Oracle. They had worked in the Data Warehousing space long enough to realise that a new approach could shake up the marketplace. The idea was simple – re-imagine Data Warehouses in the Cloud as opposed to On Premise and separate compute from storage.
The timing couldn’t have been more propitious. Amazon Web Services (AWS) had just thrown a coming-of-age party – re:Invent, the first major annual conference for AWS partners and ecosystem. Reed Hastings, CEO of Netflix, boldly announced plans to migrate 100% of Netflix’s infrastructure to AWS.
The signs were clear. The rapidly accelerating trend of moving to the Cloud had now acquired an irrevocable momentum.
What does Snowflake do?
Simply put, Snowflake provides Cloud Data Warehousing solutions to clients. In Snowflake’s own words:
“we deliver the Data Cloud, a network where Snowflake customers, partners, data providers, and data consumers can break down data silos and derive value from rapidly growing data sets in secure, governed, and compliant ways.”
Essentially, Snowflake offers the following services:
- Data Storage – Snowflake looks to store a company’s data in its cloud data warehouse, including structured and unstructured data. To do this, it relies on Cloud Storage offered by Hyperscalers such as Amazon, Microsoft, Google etc.
- Reporting & Analytics – Companies can generate reports and analytics based on the data stored.
Peak Valuations – There is a Reason
At its IPO, Snowflake had a Price to Sales multiple of 156! And it still doesn’t make a profit.
For context, Google had a Price to Sales (P/S) multiple of 8.5 when it went Public in 2004 (PE of 80.5). Facebook did one better and IPO’d at a P/S multiple of 23.7 in 2012 (PE of 91.2).
A major reason was the overall market sentiment prevailing in Sept 2020 when Snowflake debuted in NYSE. This was the time of Robinhood, Cryptocurrency and NFTs. In short – an unusual period of speculative frenzy.
“People always ask me what is going on in the markets. It is simple. Greatest speculative bubble of all time in all things. By two orders of magnitude,”
Michael Burry
Apart from irrational exuberance, there are other good reasons why investors were willing to pay for such sky-high valuations:
- New Customers – New customer growth regularly clocks around 50% every year
- Existing Customers – Net Revenue Retention Rate (NRR) of 158% means that every year, an existing customer spends more on Snowflake than the previous year
- Revenue Growth – Both factors above were contributing to a Revenue growth of 150% plus every year and a more sedate 70% of late
Let’s look at each of these points.
New Customers Added
Snowflake’s Annual Report for 2022 gives the following information (as of 31 Jan 2022) on customers and the rapid pace of new customers being added:
- Total customers: 5,944 total customers, increasing from 4,139 customers in the previous year; approximately 44% growth yoy
- Biggest companies in the world:
- 48% of Fortune 500 (241 companies) – approx. 26% of Revenues
- 24% of Forbes Global 2000 list (488 companies) – approx. 40% of Revenues
Net Revenue Retention Rate (NRR) of 150% plus
Snowflake’s Net Revenue Retention Rate (NRR) of 178% for FY22 means that for every dollar a customer spent the previous year with the company, they are spending 78% more the current year.
Typically, consumers have an NRR in line with inflation – plus or minus 3 to 9%.
Snowflake’s NRR of 178% is incredible by any measure. This is to a large extent facilitated by the ease of migration to Snowflake and the Pay-As-You-Use or Netflix model for pricing. This allows customers to move some workloads to Snowflake and test things. Snowflake calls this ‘On-Demand Arrangements’ where it charges clients for additional usage in arrears.
With wider Snowflake adoption within an organization, the usage steadily increases resulting in an NRR of 150% plus.
Conclusion
In hindsight, Snowflake was overvalued at its IPO. However, there were very good reasons why savvy investors were willing to pay a steep price. Companies that grow revenue at 70% with a decade of growth ahead don’t come too often.
How much of it is priced in the ticker? That’s a subject for another article.