Snowflake joins Wall Street’s Tech IPO Bonanza
After the stock market crash during mid-March, a mixture of government stimulus, low interest rates, and a flurry of euphoric retail investors caused a rally that drove tech-heavy NASDAQ index to a record high. Tech companies took advantage of the resulting disconnect between the stock market and the US economy, with over 15 venture-backed unicorns going public this year, setting 2020 to become the best year for US IPO’s since the dot-com bubble.
Snowflake, cloud-based data storage and analytics provider, became the latest addition to list of unicorns offering their stock to the public markets. Snowflake made history by becoming the largest software IPO ever, raising nearly $3.4 billion at a $33.2 billion valuation in September.
Having drawn investments from Salesforce and Warren Buffet’s Berkshire Hathaway, a company typically averse to both tech and IPO’s, Snowflake’s stock more than doubled from its $120 IPO price, closing at $253.93 on the first day of trading. This raises the question, is Snowflake another one of the unprofitable tech companies driven by hype? Or is the sky-high valuation assigned to its stock fundamentally justified?
COVID-19 has made clear the need for digital transformation and has catalyzed the importance of cloud software companies such as Snowflake. Despite competing with goliaths in the database software space including Oracle and Microsoft, the sheer size of the company’s potential market clearly excites investors, with Snowflake trading at a multiple of 227 times revenue. To put things into perspective, this is over 2.5 times the multiple of Zoom and more than 4 times that of other fast-growing software firms such as Shopify.
Like most venture backed tech companies, Snowflake boasts high growth. In its IPO prospectus, the company disclosed that its revenue rose 174% to $264.7 million in fiscal 2020 and 121% annually during its July quarter to $133.1 million. Furthermore, itsremaining performance obligation (RPO), a figure that covers all of the future revenue a company has under contract, stood at $688.2 million at the end of July - up 211% annually. Lastly, its net revenue retention rate stood at an impressive 158%, in spite of COVID related headwinds. This certainly played a role in fueling investor enthusiasm, as higher growth justifies a higher value, all else being equal.
While the company faces steep competition in this space from public cloud providers such as Amazon’s Redshift and Microsoft’s Azure Synapse, strengths including high performance and scalability, ease of use, and an efficient, project-based pricing model have given Snowflake a competitive edge in an increasingly saturated market.
Finally, the surge of Robinhood traders afraid of missing out on potential gains played a significant role in Snowflake’s epic 124% first-day pop. Individuals near the IPOs mentioned that retail investors drove the boosts, representing single-digit percentages of the drifts. However, majority of such retail investors tend to buy into a stock due to ‘herd behaviour,’ as has been recently seen through their purchases of call options on big tech companies.
Despite the positives to its story, which is imperative for any unicorn IPO, Snowflake is still unprofitable, generating an operating loss of $349 million over the past four quarters. In addition, whereas many cloud software firms sport gross margins north of 80%, Snowflake’s margins are 62%, thanks to its substantial cloud infrastructure expenses.
Some investors are also comparing the current IPO market to the 1999 dot-com bubble. The average one-day gain for U.S. IPOs so far this year is 23.7%, compared to 12.8% in 2019 and 13.4% in 2018. This represents the highest average since the dot-com bubble, leading to concerns that the exuberance could lead to frothy valuations that are not sustainable in the long run. However, A significant difference from the companies that went public in 1999-2000 is that many of those young internet companies generated very little revenue. In comparison, this year, almost all the tech companies going public have significant sales. They are much older, have proven that they have a product that sells, and while many of them are still turning a loss, they have demonstrated they are not just vaporware. The fact that Berkshire Hathaway bought into a tech IPO may be a tempting reason to follow suit. However, it is worth noting that this investment was likely not made by the Oracle of Omaha himself, but rather by his lieutenants Ted Weschler and Todd Combs, who bought 250 million shares at the $120 IPO price, not the $245 opening price retail investors were exposed to.
With a rollercoaster of a stock market this year, the US elections looming upon us, and potential for a second wave of the virus, volatility remains at record highs. Will companies such as Snowflake, which have capitalized on the current rally be able to survive the headwinds that await? Or will a series of volatility-inducing events in the global capital markets raise the standards for assigning sky-high valuations? While it is uncertain how things will unfold for unicorns such as Snowflake, what is certain for now is future volatility. For these reasons, prospective Snowflake investors might want to wait for a better entry point, even if one happens to be very bullish about the company’s long-term opportunity and the competitive strengths of its platform.