Authored By Louis Stevens
I recently shared my view of the Snowflake setup on X, and I also recently shared a unique view of its business in a Brief.
Here's that unique view of Snowflake leveraging a comparison to Adyen.
In today's Brief, I wanted to essentially store the aforementioned Snowflake setup for future reference.
Generally speaking, I maintain that Snowflake is one of the most compelling software companies on earth, which is an idea that has been curiously forgotten in the midst of its recent share price declines.
Notably, at $235/share, I was vocal about Snowflake's valuation being far too lofty, communicating that it would invariably experience valuation compression through either share price stagnation or stock price declines.
We've gotten the latter, which, frankly, is a good thing for those who believe in the business and who want to generate the proper returns that correspond with the company's risk profile (despite Snowflake being an incredible, dominant business, akin to Crowdstrike or Palantir, it should, like Crowdstrike or Palantir, still offer 20%+ annualized returns because it is a risky growth equity. If we can get 10% from the SPY and 12-15% from the QQQ, betting on an individual growth equity should yield 20% or higher returns. That should be our hurdle rate in this space, which is an idea that was totally vacated from 2019 to today, with a few moments of clarity in late 2022 and large portions of 2023).
So, without further ado, let's briefly review this Snowflake setup that I recently shared with you.
Snowflake Bullish Setup
We will start with the main points of the prevailing bear thesis that has been contributing to Snowflake's share price declines; then, we will look at what could neutralize that thesis and get SNOW's share price cruising upward.
The bear thesis that has been winning the info wars causing the stock price to slide:
1) Snowflake's transition to Iceberg tables has objectively created a revenue headwind, and its CEO transition has also created uncertainty, and these factors have equated to a lower valuation (higher possible forward returns, all else being equal).
2) Snowflake's "breach," which was not its fault (no liability here), has added to negative sentiment.
3) Concerns over Snowflake's multi-product execution have also added to negative sentiment that's created further share price declines. I'll say, in this vein, that Snowflake did likely remove its former CEO Frank Slootman and install its latest product/founder-type CEO due to lagging in its AI product roadmap.
We know all of this, but here's how the narrative could shift bullish:
1) Eventually, the headwind created by the transition to Iceberg tables will get lapped, and the increase in workloads created by Iceberg tables will become a tailwind. Snowflake's new CEO is actually a great, competent product guy who's pretty endearing once you listen to him. The market will start to appreciate his leadership and ability to push Snowflake towards its product roadmap vision.
2) The market realizes the Snowflake breach was nothing. AT&T (T), its poster child, has said that it will experience no material financial impact. Moreover, Snowflake was not responsible for T's contractors not employing the proper SecOps (security operations) when accessing the Snowflake platform, which is what led to the breach in the first place.
3) Snowflake's product roadmap execution has demonstrated recently that it's adding to revenue growth, e.g., Snowpark has been growing triple digits, and customers are adopting it. New products will contribute to growth rate re-acceleration, alongside the removal of the Iceberg tables' headwinds, and these factors should result in improving sentiment in 2025, calendar year. In addition to Snowflake recently making Meta's latest AI models available on its platform (I'm excited about Meta's AI ambitions), we could see a flurry of other AI-related product announcements, which should serve to improve sentiment around the company.
4) And, of course, stock prices always follow free cash flow per share over time, and SNOW's free cash flow per share has continued its upward ascent despite all of the negative sentiment and its declining share price.
Snowflake Free Cash Flow Per Share Vs Price
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For me, personally, at this point, Snowflake is simply a question of valuation. I don't believe any of the bear narratives are a death knell for the company nor the investment thesis. Snowflake is still a dominant, vertically integrated data platform that serves enterprises, and especially the largest enterprises on earth, extremely well, as evidenced by its exceptional sales growth and net retention rate metrics over the last few years.
Because I target 20%+ annualized returns via the best businesses on earth, I must be very attention to valuation in our current investing era, in which slow growth companies like Costco and Waste Management trade at 50x earnings (which would have been aggressive even for a fast growing company in bygone market eras) and fast growing companies can trade at 75x to 100x+ earnings, as Crowdstrike recently demonstrated (and I was correspondingly bearish on the business due to this valuation.
And that's really my only concern as of today, though you can see the assumptions I made below and decide for yourselves, of course.
Valuation
And here are the results:
I did not include further dilution because the company's cash production is very high at this point, so it should be able to offset dilution over time via this cash.
Moreover, I used a 22.5% annualized growth rate. This is a growth rate that only the 99th percentile of companies can achieve over 10 years on an average annualized basis. It is aggressive, but I do believe Snowflake to be a 99th percentile business, so it's acceptable, in this vein, to assume such an incredible growth rate.
In fact, I actually think Snowflake could accelerate growth in the years ahead, as Palantir has done recently, once Iceberg tables transition gets lapped and once more AI products roll out.
Let's now turn to total projected returns:
I used an ~3% fcf yield, or a 35x exit multiple, and I think this is fair in light of the nature of the business through the lens of the four points of equity value.
As we can see, we're getting about 20% annualized returns from these levels, and I think that's probably a very good estimate of what investors will net buying Snowflake here.
I've been really nitpicking the valuation at these levels; hence, LAS has not issued a buy rating on it, but broadly speaking, I think it's as good a buy as it's ever been...
Certainly, I'd say it's the best its ever been through the lens of risk/return.
Disclosures:
L.A. Stevens has not rated Snowflake.
