My SNOW decision

I’ve received a couple requests offline asking if I would join Saul and Bear in sharing my decision on Snowflake. It turns out I exited as well but did it before earnings. Here’s the current draft for my August writeup. I could see a final edit or two but think the gist is set.

SNOW – Scheduled to report August 25, Snowflake was just wandering along minding its own business until all heck broke loose on August 20. The stock plummeted that day from roughly $280 to under $250 after a Cleveland Research report indicated a contracting slowdown due to longer sales cycles and increased competition (https://www.crn.com/why-snowflake-s-stock-is-falling). Analyst Piper Sandler responded the selloff was “overdone,” and the stock bounced right back into the $280 range over the next few days (https://www.streetinsider.com/Analyst+Comments/Snowflake+(SN…).

As all this was playing out, I had immediate flashbacks to a similar scenario with ZScaler in August 2019. At that time, an outfit named OTR Global issued a report warning of the potential for subpar 4Q19 sales based on its channel checks (https://www.otrglobal.com/sites/default/files/public/samples…). At the time ZS’s stock was doing great, so I shrugged off the report and even added a few shares before earnings. Well, it turns out OTR was right, ZS announced a revamp of its sales process, and the stock was punished accordingly. Afterwards, I made a mental note to myself that if nothing else I would be more wary next time reports like these were issued.

Granted, I might simply be subjecting myself to confirmation bias (https://en.wikipedia.org/wiki/Confirmation_bias), but compounding the issue was my own concern about what I felt was a larger than normal seasonal decline in SNOW’s customer adds during Q1. As I wrote at the time:

“The one possible glitch I see is customer growth. The highlight was a record 27 new customers spending >$1M a year, bringing the total to 104 (+117% YoY). However, growth in total customers and Fortune 500 companies both finished at record lows. While there’s seasonality to this count, the 393 customers added in Q1 was just 67% growth versus 73% last quarter and 128% a year ago. It was also the first time ever sequential customer growth dropped below double digits at 9.5%. And fluke or not, adding only one Fortune 500 customer after 17 (year ago comp), 10, 13, and 19 the prior four quarters is disappointing no matter how I look at it. Being honest, management’s explanation of a “very, very long sales cycle” and staff wanting to close as many Q4 deals as possible to beat year-end commissions didn’t do much to put me at ease. I mean, those same long sales cycles and Christmas bonuses were in play last year too, amirite?

My reason for being so wary here is the relationship between SNOW’s customer growth and future revenue. Management has consistently stated it takes 6 to 9 months for new customers to fully reach contracted usage rates [update: management is now stating 9-12 months as per the Q2 call]. That lag means we will likely see a flood of new revenue during Q2 and into Q3 from the record number of customers just added in Q4. I feel Q2 guidance reflects that, so no problem there. My concern is just how large a role the lowish Q1 figures might have played in the soft FY raise. These Q1 customers will be the main cohort for new revenue in Q3 and Q4. Was the Q1 customer add maybe lower than expected? And will this group contribute enough during the second half to let Snowflake maintain the revenue growth we’ve come to expect (and likely need to maintain its current valuation)? That’s still TBD in my opinion.

If I’m going to own a stock priced for perfection, I can’t gloss over the potential pitfalls. I consider customer growth something to watch here. Virtually every software company pursues a “land & expand” revenue strategy combining new business with upsells into its existing base. The strategy works best when both halves contribute steadily to that mix. Between last year’s Q4 and Q1, SNOW saw a 28% seasonal drop in new customers (458 to 328) with 17 Fortune 500 adds. This year’s drop was a larger 33% (585 to 393) with just one Fortune 500 add. If nothing else, Snowflake seems to be entering this year with less wiggle room for underperformance in the “land” part of the equation during the second half. That could hypothetically put pressure on upsells to make up the difference. Frankly, I’d rather not test that thesis and will be paying close attention to these numbers in Q2.”

Given all this info, I saw three likely scenarios for SNOW’s report:

  1. Hold Serve. Snowflake posts the expected impressive Q2 results with the customer adds and guides large enough to suggest things generally remain on track. In this case, the stock would probably hover short term within a few percent of wherever it closed into earnings.

  2. Disappoint. Snowflake posts its usual strong numbers for Q2, but customer adds are again a little soft and/or the FY guide doesn’t move enough to satisfy the market. In this case, the stock would probably sell off quite considerably given how much outperformance has already been priced in.

  3. Surprise. Snowflake posts a blowout quarter with customer numbers and a guide suggesting a great business is primed for even additional takeoff. While we root for this scenario for all our holdings, I ranked this the least likely outcome based on the info at hand.

Entering this earnings season, I ranked the potential outcomes for companies like DDOG and UPST surprise, hold serve, disappoint. That’s why I felt content carrying outsized positions into their reports. Luckily, I was rewarded. In Snowflake’s case, I couldn’t shake the feeling holding serve was the best I could realistically hope for. And being honest with myself, I thought disappointment more likely than surprise. Therefore, I exited our entire position during the run back into the $280’s (I’d put my average exit around $278). The market was clearly shrugging off the Cleveland Research report, and something about that made me uneasy. Since SNOW was already one of our smallest positions, I decided I was more comfortable turning it into cash at what I felt a reasonable price and adjusting accordingly once I had better information. If I missed out on a few dollars to the upside, so be it.

I’d say Snowflake did hold serve, at least as I was viewing it. The $255M (+103% YoY) in product revenue and $272M (+104% YoY) in total meant SNOW maintained its triple-digit growth. Operating expenses were a record-low 78% of revenue. The company posted all-time highs for both total (69.7%) and product gross margin (73.6%), though management noted some one-time positive effects for product gross margin this quarter. The increased execution led to a record-low -8% operating margin, meaning loss margins have narrowed from -44% to -30% to -24% to now -8% over the last four quarters. That’s a pretty good run. Adjusted free cash flow was positive for the third quarter in a row and is anticipated to remain positive going forward. Topping it all off, net revenue retention ticked up to 169% implying current customers will continue spending strongly. I would certainly say that qualifies as “the expected impressive Q2 results” in the headline numbers.

Turning to customer adds, I’d label the results better than Q1 but far from overwhelming. Snowflake gained 458 this quarter for 4,990 total, accelerating slightly to 10.1% QoQ. While that trails last year’s 14.6% due to larger numbers, it does beat 2Q21’s 397 net new clients. It was nice to see Fortune 500 customers rebound to 18 this quarter after just one in Q1. However, it’s worth noting SNOW adjusted from the 2020 Fortune 500 list to the 2021 version between quarters, meaning all past numbers were restated (making Q1’s adds now look like four even though we know it was one at the time). Either way, it does appear to be a Fortune 500 upswing. Management emphasized it has been targeting larger customers and has 462 Global 2000 clients as well, so a solid base with room to grow. Finally, a dozen more customers spent at least $1M with Snowflake in the last year brining that count to 116. Count me as neutral in this area.

The top line performance let management raise the full year guide another $35M to $1.070B, which would be 93% growth on the year. Again, a decent raise but fully expected given the relative strength of the stock. Overall, I’d give SNOW the benefit of the doubt on “customer adds and guides large enough to suggest things generally remain on track.”

However, a new area of discussion popped up with Remaining Performance Obligation (RPO). Management has consistently cited this metric along with product revenue as key measures of the overall business. While RPO was a stout $1.5B and up 122% YoY, it also marked the lowest sequential increase ever (MF’s terrible formatting wins once again):


RPO							% YoY							% QoQ					
	Q1	Q2	Q3	Q4	YR			Q1	Q2	Q3	Q4	YR			Q1	Q2	Q3	Q4	YR
2018	 	 	 	 	 		2018	 	 	 	 	 		2017	 	 	 	 	 
2019	 	 	$82.80	$128.00	 		2019	 	 	 	 	 		2018	 	 	 	54.6%	 
2020	$137.90	$221.10	$273.00	$426.30	 		2020	 	 	229.7%	233.0%	 		2019	7.7%	60.3%	23.5%	56.2%	 
2021	$467.80	$688.20	$927.90	$1,333.00	 		2021	239.2%	211.3%	239.9%	212.7%	 		2020	9.7%	47.1%	34.8%	43.7%	 
2022	$1,432.00	$1,529.00	 	 	 		2022	206.1%	122.2%	-100.0%	-100.0%	 		2021	7.4%	6.8%	 	 	 

The Q1 decline makes some sense looking at past seasonality. However, it’s hard to call Q2 anything other than a significant slowdown compared to past years. The CFO addressed this issue by stating RPO has some lumpiness to it and should be considered in context with revenue:

We are still maturing the sales organization to sell multi-year contracts, and the timing of the largest multi-year deals will be lumpy. As a reminder, in Q2 last year, we sold our largest multi-year contract ever, a three-year $100 million deal. While the multi-year component of new booking sets up a difficult comparison, we saw a net — we saw new annualized contract value accelerate compared to the year ago period. This is why RPO and revenue must be evaluated together in a consumption-based business model. Of the $1.5 billion in RPO, we expect approximately 56% to be recognized as revenue in the next 12 months, representing approximately an $87 million increase quarter-over-quarter. We remain focused on penetrating the largest enterprises globally, as we believe these organizations provide the largest opportunity for account expansion.

Analyst Jamin Ball provided more detail here, though it’s fair to point out the source he used to help explain the dynamic modeled a much higher $1.8B RPO for this quarter:
https://twitter.com/jaminball/status/1430706365643706370

While RPO was less than ideal, Snowflake did have some other factors in its favor. International continues to grow faster than the overall rate, SNOW’s data sharing marketplace is expanding rapidly, and the company released a host of new tools making it even easier for customers to customize use cases on its platform. There’s an inevitability surrounding the increased use of data, and Snowflake is clearly well-positioned to take advantage of that trend.

Yet as impressive as the above sounds, it’s indicative of the crazy-high expectations for Snowflake that there’s even a doubt about a quarter like this. Kudos to management for continuing to execute. As the numbers hit the wire, the stock did indeed fall into “hover a few percent” mode. Immediately after hours the stock went from its ~$284 close to $295+ (+4%) to under $275 (-3%) and back to $300+ (+6%) before opening the next day at $299 (+5%). So, even the market initially seemed a little unsure exactly what to do. [With the stock now sitting at ~$297 in the middle of a couple up days for the indices post-earnings], the market seems to have placed SNOW somewhere toward the positive end of holding serve as well.

Ultimately though, it’s not this quarter but future quarters that count. And while locking in on one specific metric might seem extreme, RPO does represent 50% of the measures specifically identified by management in gauging the health of the business. With a customer onboarding lag of 9 to 12 months, RPO is the best measure we have of how well the spring is loading for future quarters. While I’ve since seen plenty of great breakdowns and explanations for interpreting RPO since these numbers came out, none seem to conclude this quarter’s result was actually a good one for SNOW. That matters, particularly for the highest-valued stock in our portfolio.

Stepping back, I found myself doing too many mental gymnastics trying to piece together SNOW’s revenue/customers/RPO dynamic in a way that made sense. All I know is this exercise wasn’t required in prior quarters…and maybe that’s answer enough. Since it was already a small position, I decided to keep the cash and spend my energy elsewhere while waiting for our remaining companies to report. Even though I had several opportunities to buy back in within a few percent of our exit price, I find I’m more comfortable sitting this one out for now.

166 Likes

Please excuse me for piggy-backing on your detailed explanation…

My Fool profile says my investing expertise is “keeping it simple”, so here it is:

I have a gigantic allocation in UPST. It seems they have a strong competitive advantage, as shown by their growth, gain of customers and even seeing one bank drop FICO. They also have multiple large TAMs, high margins and they’re already branching into another couple markets (autos, mortgages).

UPST’s market cap is ~$17B and they are rapidly closing on $1B annual revenue. Cheap. I can easily see it hitting 10X in a few years… and they’ll have a ~$170B-$200B market cap. Possible. Perhaps likely.

SNOW, on the other hand, also has a lot of similar superstar metrics, but they are already a ~$90B company with a bit over $1B revenue. I ask myself, can I see SNOW being a $1 TRILLION company in a few years?

Me: “Uh…not likely.”

That’s my internal discussion, shared with you. Simplistic? Simple, but I’d say not too simplistic.

Disclosure: Never bought SNOW, recently made our final UPST addition. Allocation? I’ll keep that to myself because I think it would upset too many people… :slight_smile: But let me say that CRWD is a distant #2 with 15%. Other holdings in my Fool profile.

Rob
Rule Breaker Home Fool & STMP/MTH Maintenance Coverage Fool
He is no fool who gives what he cannot keep to gain what he cannot lose.

85 Likes

Hi TMFRob,

No position or opinion on SNOW, and still looking to increase my UPST position, so just a quick question:

Wouldn’t UPST market cap be 20b+ with Diluted Weighted-Average Share Count of approximately 94.9 million shares? (I guess you are using the Basic Weighted-Average Share Count of 78 million).

Not that it matters that much in the grand, long term scheme of things.

best,
Purplemist

1 Like

Thanks StockNovice

Actually whilst your post was accounting for your exit pre earnings, it has actually reconfirmed my intention to hold, (although I only have a 4% holding so possibly a lower exposure than Saul, Bear and yourself).

The business financials are performing superbly as you highlighted from Revenues to Gross Margins, to Cash Flow.

The customer adds are making sense both with the reclassification of numbers, the focus on Global 2000 and higher value customers progress. Their entire monetisation of the business model is about the expand rather than land at this stage. Their 169% expansion metric demonstrates that.

On RPOs looking at the prior year comparisons on a QoQ basis, Q2 faced an elevated Q2 comparison last year (47%) which was already comparing with a massive Q2 in 2019 (60%). This absolutely helped explain this concern. In any case I’m not sure that RPO is as important in a usage based business model than a subscription based one.

Furthermore the company has been totally transparent that the revenue expansion from recent customer wins hasn’t kicked in yet and they have yet to launch SnowPark.

All in all I see strong progress and much more potential here and enough to hold.

On the market cap front Rob - actually, although I also hold Upstart (4%), I have on balance a stronger belief in Snowflake being able to reach $900bn than Upstart to reach $200bn.

Ant

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Wouldn’t UPST market cap be 20b+ with Diluted Weighted-Average Share Count of approximately 94.9 million shares? (I guess you are using the Basic Weighted-Average Share Count of 78 million). – Purplemist

For my post, I just pulled numbers from Yahoo.

For purposes of this discussion, the difference doesn’t really matter.

My background is engineering and I have an MBA. You’d think I’d be interested in precision. For some things, precision is important…

…for making investment decisions, if you need precision… it’s probably not the right investment.

Will I be disappointed if I get 8X instead of 10X on UPST? A bit (but if so, it’s probably because I moved on to a better opportunity). Will I be surprised if I get 20X? Not really.

I look for massive success and am willing to settle for great. If necessary. Aim high, but be careful to not take silly risks. That’s a part of my investing viewpoint.

Rob
Rule Breaker Home Fool & STMP/MTH Maintenance Coverage Fool
He is no fool who gives what he cannot keep to gain what he cannot lose.

16 Likes

On the market cap front Rob - actually, although I also hold Upstart (4%), I have on balance a stronger belief in Snowflake being able to reach $900bn than Upstart to reach $200bn. – Ant

And may your SNOW expecatation come to life! Perhaps in the meantime, I’ll see the light with SNOW. :slight_smile: I’m adaptable and I’m willing to change my mind.

Rob
Rule Breaker Home Fool & STMP/MTH Maintenance Coverage Fool
He is no fool who gives what he cannot keep to gain what he cannot lose.

2 Likes

Hi Ant, I felt the same regarding Stocknovice’s post. Valuations aside great report. I do have a question for investor relations about Snowflakes sales motion and how it could be effecting RPO.

Something Mark Scarpeli said in the Q2CC got me :thinking: about the decline in RPO.

Of the $1.5 billion in RPO, we expect approximately 56% to be recognized as revenue in the next 12 months, representing approximately $87 million increase quarter-over-quarter.

This means when looking at the raw dollar amounts of RPO presented here:
F2020 138 221 273 426
F2021 468 688 928 1333
F2022 1432 1529

and when looking at RPO increase each quarter here:
F2020 10 83 52 153
F2021 42 220 240 405
F2022 99 97

We see in Q2 of last year the huge bump explained by Jamin Ball, when he said that for this period sales reps were incentivized to sell multi-year deals. I read his tweets and I’m assuming he meant that these last two quarters sales reps were no longer incentivized similarly.

And we must keep in mind roughly half of the prior year total has been used by Snowflakes customers. And when we look at the RPO Increases QoQ, are we keeping in mind that going forward at least $87M will already be accounted for?

Snowflake took pains in there first Conference Call to explain how they are not a Saas. And I struggled with that, at least a little. I’m struggling now to understand how all the above is true and add to that what was described during the Q2CC as an effortless Sales process, Slootman used the word ‘enabled’ as opposed to selling customers on the ‘transformative benefits Snowflake offers’, how do I reconcile this information?

When looking at RPO, I assumed Multi-year deals were negotiated to get those more than 470 G2000 companies to become Snowflake Customers, for the sake of lending legitimacy to a new and singular business proposition, at least as much as profits. Is it possible Snowflake no longer sees the need to offer multi-year deals and that is why Sales Reps are, as Jamin Ball eluded, no longer incentivized to make many more multi-year deals? And that’s why we’re seeing the crazy decline in RPO numbers.

Nothing else makes sense. I’ll be following up on this with Investor relation for sure.:thinking:

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Ant: Actually whilst your post was accounting for your exit pre earnings, it has actually reconfirmed my intention to hold, (although I only have a 4% holding so possibly a lower exposure than Saul, Bear and yourself).

WillO2028: Hi Ant, I felt the same regarding Stocknovice’s post. Valuations aside great report.

For any new readers, this is exactly why this forum works. My post was not intended to change any minds, and I’d venture to guess neither was Ant’s or Will’s. It was only meant to lay out the info as clearly as possible and give one possible interpretation. Ant and Will did the same. I thought SNOW had an impressive quarter as well. I simply decided the future was too cloudy for me to feel comfortable. I’m glad they felt I presented the info fairly enough to reach a different conclusion.

The large majority of companies discussed here are likely to beat the market. After all, it’s pretty tough to even make the cut. As Saul has said repeatedly, you don’t have to own them all. You only need to own those that for whatever reason resonate with you. In my opinion, the exchange of ideas with no strings attached might be the #1 reason why the returns here have been so good.

59 Likes

I have another way of looking at it. Snowflake had a quarter that would be a great quarter for any other company, but perhaps was a tiny touch below what was expected for Snow, when everyone was expecting more than what was “expected”. But that was the catch that perhaps made many people exit. The justification for the huge valuation was the great performance, always coming in way better than “expected”, and what made people uncomfortable is the feeling that if Snow just keeps having solid but no longer “marvelous” quarters, the market may no longer be willing to pay the huge premium.

I hope that that was clear enough to understand.

Saul

51 Likes

Stocknovice,
Thank you for that excellent write up. I previously posted on Bear’s thread that I had been having some discomfort with my position in SNOW for quite a while for not very specific reasons. But, reading your post reminded me of the one thing that had been gnawing at me.

I tend to be one of the folks that follow this board who does not pay much attention to valuation. But I feel that it can’t be ignored completely. The reason I feel that way is because it’s such an important part of the investment decision for so many other investors. If valuation becomes too stretched there’s no room for the stock price to grow. In that I count on capital gains for my portfolio to grow it just doesn’t make sense to hold positions that are “priced to perfection”.

You will be hard pressed to read an article about SNOW without mention of it’s very high P/S ratio. I don’t know if it’s priced to perfection or not. What I do know is that most analysts consider it “expensive”.

In a nutshell, that was what made me feel uncomfortable. Your write up here reminded me of it.

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