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Shares of Snowflake Inc. (NYSE:SNOW) have seen a real pullback like the rest of the technology complex. The good news is that shares have snapped back quite a bit from recent lows already.
It was late August of last year when I concluded that it was time to take some profits after the company had seen a solid quarter, with triple-digit sales growth and real operating leverage displayed.
Former Take
The promise of Snowflake was and remains that it has a huge addressable market, as it aims to reimagine data management for cloud solutions through seamless access, sharing, thereby unlocking the real value of this data in collaboration.
The proposition comes from the fact that Snowflake can disrupt and solve the issue of data silo forming, in what it calls “WAAS” which stands for warehouse-as-a-service. Unlike a SAAS model, Snowflake’s revenues are tied to actual consumption instead of subscription (at least partially), giving it a greater piece of the pie when customers succeed.
Founded in 2012, the company has been a major success and went public at $120 in 2020, some 50% above the preliminary offering range, with prominent investors stepping in at those levels. The momentum fueled a rally to $300 on the first day of trading, and even as shares fell to $225 on the first day of trading, the company supported a $60 billion enterprise value.
This was a huge valuation for a business with $265 million in sales in 2019 at a time when operating losses came in at $358 million. That was a bit too simplistic, as the company posted sales at a run rate of a billion a year at the time of the IPO, if we look at the quarterly results ahead of the offering and add back revenue performance obligations.
As Snowflake saw huge momentum during the remainder of 2020, I initiated a small position around $200 in May 2021. Pegging the annualized run rate of revenues + increase in bookings at $1.3 billion a year, the resulting $55 billion valuation looked a lot friendlier, although this was still a nosebleed valuation in a different market mantra a year ago. A solid second quarter, made that shares rallied to $300 again in August, as I took profits on that position, only to see shares continuing to rise and hit the $400 mark again in November.
What Happened?
The peak in November more or less coincided with the release of solid third quarter results in which revenues rose 110% to $334 million. In March, Snowflake posted its results for the fiscal year 2022, pretty much coinciding with the calendar year 2021. Revenues rose 101% to $384 million, for a run rate in excess of $1.5 billion. Moreover, remaining performance obligation doubled for the year to $2.6 billion as well, as that the increase in obligations adds about $1.3 billion in annual revenues, for a realistic booking rate of $2.8 billion.
With 309 million shares outstanding, Snowflake’s valuation fell to $62 billion at $200 per share in March of last year, or about $58 billion if we factor in a net cash position of nearly $4 billion. This reduces the realistic sales multiple to around 20 times sales, but that is still too simplistic as full year operating losses of $715 million remain very steep, even if cut to a $600 million run rate in the fourth quarter already. This all changed as shares fell to $110 in June, reducing the operating asset valuation to around $30 billion, at just over 10 times realistic sales.
First quarter results, as released in May, revealed an 85% increase in sales to $422 million as momentum is still by all means solid, just no longer translating into triple-digit growth, all while operating losses rose to $189 million. While the company tries to let you look at the adjusted operating losses, the reconciliation items are mostly stock based compensation expenses, a very real expense to investors by all means. The law of large numbers is catching up with the company, as a low seventy percentage increase in sales is seen in the second quarter.
With revenues trending at $1.7 billion a year, and remaining performance obligation up $1.2 billion on the year, the current run rate comes in around $2.9 billion. A diluted share count of 315 million shares now trade at $150 again, for a $44 billion enterprise valuation, or about 15 times realistic revenue multiple. That is still quite steep as growth is slowing down a bit, but moreover, as operating leverage is no longer displayed upon, with operating losses currently trending around $750 million a year, creating real dilution and continued burn to the company, or at least to shareholders as they will see their shareholdings dilute.
What Now?
Based on the current valuation, expectations are nosebleed-high, as the company still aims to generate $10 billion in sales in 2029, as the company hiked the non-GAAP margin guidance from 10% to 20% of sales. That does not tell me a lot, as the company currently incurs stock-based compensation expenses which are equal to 40% of sales.
If the company manages to achieve this, the company trades at about 4.5 times forward sales, five years ahead in time, assuming no further dilution. Even as the company has hiked the adjusted margin target to 20% of sales, I am still wondering if the company is able to post realistic earnings at that point in time.
Given all these moving targets, this is not the time to become bearish after shares have fallen substantially from the highs, down about 60%. While that is more encouraging, I feel that lower growth, but mostly lack of operating leverage, makes me cautious to get involved here.
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