Snowflake (SNOW +0.13%) launched the largest software IPO ever in September 2020. The cloud-based data warehousing company went public at $120 per share, started trading at $245, and hit an all-time high of $405 a share last November.
But over the past two months, Snowflake's stock price tumbled nearly 30% as rising interest rates sparked a rotation away from pricier, unprofitable, and speculative growth stocks. Snowflake checked all three boxes.
Should investors consider buying some shares of Snowflake after that big pullback? Let's review the bear and bull cases to decide.
Image source: Getty Images.
What the bears will say about Snowflake
The bears will claim that Snowflake's cloud-based warehousing platform, which pulls data from multiple computing platforms and centralizes the results for third-party services, isn't as disruptive as it sounds.
Amazon's (AMZN 1.88%) Redshift, Microsoft's (MSFT 0.97%) Synapse, and Alphabet's (GOOG +1.00%) (GOOGL +0.97%) Google BigQuery all provide similar services. More importantly, all three tech giants integrate their data warehousing services into their own cloud infrastructure platforms: Amazon Web Services (AWS), Microsoft Azure, and Google Cloud.
Snowflake doesn't operate its own public cloud platform, so its services actually run on AWS, Azure, and Google Cloud. Therefore, Snowflake is actually paying its competitors to keep its own services online, and those competitors could eventually hike Snowflake's cloud hosting rates while undercutting its prices.
That's troubling because Snowflake's revenue growth is gradually decelerating and its net losses continue to widen on a generally accepted accounting principles (GAAP) basis:
|
Period |
FY 2020 |
FY 2021 |
9M 2022 |
|---|---|---|---|
|
Revenue |
$265 million |
$592 million |
$836 million |
|
Growth (YOY) |
174% |
124% |
108% |
|
Net Loss |
($349 million) |
($539 million) |
($548 million) |
Source: Snowflake. YOY = Year over year.
Analysts expect Snowflake's revenue to rise 104% in fiscal 2022, 66% in 2023, and 56% in 2023. But they also expect it to remain unprofitable for the foreseeable future -- which makes it a risky stock to own as rising interest rates potentially increase its borrowing costs.
Meanwhile, rising inflation also reduces the value of a company's future revenue and earnings, which is particularly harmful for a high-growth stock like Snowflake that trades at high-double-digit price-to-sales ratios. Even after its latest drop, Snowflake still trades at 43 times next year's sales.
Snowflake's lack of profits forces it to rely heavily on big stock bonuses to subsidize its salaries. As a result, its number of weighted-average shares surged 82% year over year in the third quarter of 2021. That ongoing dilution could prevent its valuations from cooling off.
What the bulls will say about Snowflake
The bulls will point out that Snowflake's rapid customer growth and high retention rates indicate its platform -- which the company claims is faster, easier to use, and more flexible than older platforms -- still enjoys clear competitive advantages against Amazon, Microsoft, and Google.
Snowflake's numbers support those claims. It ended the third quarter with 5,416 customers, representing 52% growth from the previous year. Within that total, its number of customers that generated more than $1 million in trailing 12-month product revenue jumped 128% to 148. It ended the quarter with a net revenue retention rate of 173%, compared to 169% in the previous quarter and 162% a year ago. It's very unusual for a company to constantly increase its revenue retention rates at these high levels.
As for its net losses, Snowflake still held $3.89 billion in cash, cash equivalents, and short-term investments with no debt on its balance sheet at the end of October. Snowflake can probably absorb losses for a few more years before it needs to consider a secondary stock or convertible debt offering -- so the interest rate concerns might be overblown.
Lastly, Snowflake set very ambitious growth targets during its investor day presentation last June. It expects its annual product revenue to surge from $554 million in fiscal 2021 to $10 billion in fiscal 2029, which equals a whopping compound annual growth rate (CAGR) of 43.6%.
It expects 1,400 customers to be generating over $1 million in annual product revenue by fiscal 2029 -- which would be a near-tenfold increase from its current base of higher-value customers -- and for its average revenue from those customers to grow from $3.4 million to $5.5 million.
It also believes its adjusted product gross margin will expand from 69% in fiscal 2021 to 75% in fiscal 2029. If Snowflake can achieve those ambitious goals, it might just be worth buying at over 40 times next year's sales.
Which argument makes more sense?
Snowflake is a well-run company, but its widening losses and sky-high valuation could ultimately limit its upside potential in this volatile market.
Snowflake's long-term growth targets also seem overly ambitious, and could still be thwarted if Amazon, Microsoft, Google, and other companies aggressively upgrade their cloud-based data warehouse solutions.
Therefore, I think the bearish case against Snowflake still makes more sense than the bullish one. I'd consider buying Snowflake if it gets cut in half during a market crash, but I think it's still too hot to handle right now.
