Snowflake (NYSE:SNOW) is now widely acknowledged as one of the most successful IPOs of the year, in a year that has seen quite a few high profile IPOs scuppered one way or another.
The company created plenty of excitement among US investors, thanks to its strategic positioning in the data warehousing sector, which is one we continue to follow here at The Armchair Trader.
The Snowflake IPO was originally priced at $80, then re-priced at $120, and has remained steady in the $217-282 price range ever since it listed. Like some other stocks, it is looking extremely pricey, but it is trading in a sector where traditional forms of valuation for equities are being scrapped as stocks push higher.
We like data warehousing as an industry, but…
We do, however, like data warehousing as an industry. We believe it is a market that is going to grow in its size and sophistication. Snowflake offers companies a more secure way of exchanging and accessing data that is changing the ways companies work. Some analysts think Snowflake is now enjoying important first mover advantage in this field, and could be building an important critical mass of users.
Hyperboles for Snowflake’s valuations include “nosebleed” and “sky-high”: analysts and fund managers are wary of the stock. While it has a market cap flirting with $80bn it has sales of $405m for the last 12 months. While sales are trending up, the company still has to make a profit. At The Armchair Trader we like to see a profit. Snowflake’s sales and marketing expenses are huge compared to its total sales.
Snowflake is bringing in business during the pandemic, and it is making money, but so are many other companies.
Snowflake’s key risk
One key risk Snowflake faces, and it is a big one, is its reliance on other companies’ clouds to provide its services. Firms like Amazon, Google and Microsoft also have data warehousing solutions which they would like to make money from. While we have seen some analysts refer to the ‘public’ cloud, we think this is a little misleading, as the cloud is not owned by the tax payer. Most of it is divided up between these behemoths.
Snowflake relies heavily on infrastructure like Amazon Web Services (AWS), and we can conceive of a scenario where companies like Amazon decide it is time to trim Snowflake’s sails a little. The tools available to do this are many, including pricing and the development of new Amazon services for direct customers.
Another key factor behind the surge in the Snowflake share price this autumn is the lack of free float, with only 10% or so going out to public investors through the IPO. A lack of supply can stimulate artificially high prices in a listed asset like this. A lot of employees and early stage investors are sitting on shares that they cannot sell until March next year, but if the price stays this high, they have every incentive to start selling them in the spring.
We also note that hedge fund Third Point seems to have been in and out of Snowflake shares, having listed it in its September update and exited from the position by the end of October, thereby locking in gains from the IPO. There are other investors, like Salesforce, who seem to be in for the long run, so holders of Snowflake are still in good company.
To answer our own question, by conventional terms, Snowflake looks radically overvalued, and does not fit our criteria for a buy. We most certainly don’t like its reliance on other people’s infrastructure for its success. We are in an interesting economic environment, however, that has seen a number of tech stocks move yet further into fantasy level valuations, so just because Snowflake does not get our seal of approval, does not mean it can’t go higher.