The Snowflake (NYSE:SNOW) IPO may not be the biggest IPO of the year, but it is probably the most anticipated. Analyst after analyst has raved about this cloud company’s potential, as it appears to be going public at the perfect time in a critical and highly growing market.
Such praise will inevitably attract those who want to zig when others are zagging, and it is true that there are certain aspects of Snowflake’s IPOs which should provoke some concerns. But the hype is very much deserved, and investors should be willing to take the risk of a more outsized valuation for this company.
The Power of Cloud
Amazon (NASDAQ:AMZN) and Google (NASDAQ:GOOGL) may be the companies most closely associated with the cloud, but Snowflake plans to revolutionize cloud data storage. The company was founded in 2012 by two individuals who had worked for Oracle (NYSE:ORCL) and wanted to create a cloud data warehouse which did not have to worry about a history of maintaining legacy data software.
Because it is a data warehouse, Snowflake could be compared to Cloudera (NYSE:CLDR), a big data company that was supposed to see major success with the open-source Hadoop framework but has largely disappointed. And any cloud company faces the concerns of how it will stand up to tech titans like Amazon and Google.
But Snowflake has managed to differentiate itself in multiple ways. Unlike other cloud companies that charge per user, Snowflake only charges for the data storage and resources that are used which creates a more flexible pricing scheme. Its technology lets it separate compute from storage, which improves performance. And for all the concerns about its ability to compete with Amazon, Snowflake’s cloud platform is well-integrated with not just Amazon Web Services but with Microsoft (NASDAQ:MSFT) and Google’s cloud platforms as well. On top of offering an excellent product, Snowflake has a strong leadership team. This will be CEO Frank Slootman’s third IPO, with his previous two IPOs both being successes. According to CNBC, the company jumped in value from $4 billion when he took over in April 2019 to $12.4 billion as of this past August.
Finally, there is the fact that Snowflake is a cloud company when cloud is all many businesses want to talk about. The coronavirus pandemic and the transition to remote work has spurred companies to move to the cloud that otherwise would have stuck with traditional data systems.
The picture is not entirely rosy for the cloud market, as a slowing economy can mean either less investment in the cloud or the loss of businesses that were forced to close down due to the pandemic. But Snowflake deals with data warehousing, and the companies which remain will increasingly look towards data in order to grab a competitive advantage. The data warehousing market was already predicted to see significant growth up to 2025 as it surpassed legacy business intelligence tools, and the coronavirus will only further augment this trend.
Tech IPOs normally emphasize growth more than anything else, and Snowflake under Slootman has epitomized that strategy. According to its S-1, Snowflake reported a revenue of $241 million for the six months ending July 31, 2020. This is a 132% growth rate compared to the same timeframe in 2019. And while Snowflake is not profitable, its net losses decreased slightly from $177 to $171 in the aforementioned time period, which is even better given its revenue growth. If we use the Rule of 40 of combining profit margin with growth rate, Snowflake has a value of 62, an excellent figure.
The other key financial number is that Snowflake has a net revenue retention rating of 158% in the three months ending July 31, 2020. It should be noted that this figure represents a fairly steady decline beginning in July 2019, though this is to be somewhat expected as the company grows. But 158% remains a high number, and it shows that Snowflake can continue to retain customers and get more value even in the face of competition from larger companies.
The Right Valuation
The major problem with the Snowflake hype is that it will be difficult for investors to get shares at a reasonable price. While Snowflake has not announced its pricing, the company is widely expected to announce a valuation of around $20 billion. This valuation will likely explode in the days and weeks after the IPO, and it is important to make sure that investors are not needlessly caught up in the hype window after debut.
Snowflake faces some concerns about whether it can continue to stand up to larger companies and its profitability numbers could perhaps improve. But the company is in a growing field, has strong leadership, and offers a strong product which has attracted users. Combine that with its good financial profile, and this is an IPO which investors should pay attention to.