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Snowflake Initiation Report

Snowflake (SNOW) has a solid business and is likely to be a beneficiary of actual dollar spending on AI. The core business is helping customers maximize the value of their data by using Snowflake Data Cloud. They have an impressive customer list and have shown great growth rates, growing revenue from $554M to an est. $2.6B in 3 years. However, the growth rate has slowed dramatically.

 The FY 2024 guidance (year ending Jan 31, 2024) looks okay on surface, but dig a bit deeper and things are not looking good.

Q1 revenue => $590M

Q2 revenue => $640.2M (8% QoQ)

Q3 revenue forecast => $675M (5% QoQ)

Q4 implied revenue => $694.7M (3% QoQ)

The company's forecast shows that the 34% YoY growth projected for this year is all front half weighted, and the back half looks unimpressive.

The stock looks cheap, with RSI bouncing off oversold territory, but is it really? The company has an approx. $50B market cap, which puts the price-to-sales ratio at 19.23x. The company has been consistently making GAAP losses, so there is no E to speak of.

The net income figures are distorted by stock-based compensation, which ran pretty high because the stock ran pretty high during the company's growth spurt. So let's assume that normalizes and the company achieves 30% GAAP net income margin going forward.

Using that 30% assumption and extrapolating the company's revenue growth needed to achieve its FY 29 target gets you this. Somewhere between FY 26-27, the stock will be reasonably priced for a $50 billion market cap.

However, notice something here. From $2.6B today to $10B in 5 years requires a revenue growth rate of 31%. The implied quarter-on-quarter growth rate is already slowing to low single digits, which makes the company's "target" more of a dream than a realistic valuation input.

31% annual growth implies 7% quarter on quarter growth. The company's growth rate is already falling way short of that, which leads me to question whether the business has already matured.

Big Tech is already involved in the cloud business and competition for data services can only go up from here. Is there a "secret sauce" to Snowflake's business that will keep them ahead of the pack? I'm not a tech expert so I don't know. But looking at the fundamentals of the business, in combination with a basic valuation framework, tells me the stock is overvalued and has a lot more room to fall before I'd consider it a GARP (growth at a reasonable price) opportunity. A stock can fall 60% from all-time highs and still not be cheap.

That said, the chart looks very interesting from a technical perspective and SNOW won the buzzword bingo by announcing a partnership with NVDA "to create customized generative AI applications using their [clients] own proprietary data, all securely within the Snowflake Data Cloud".

Valuation concerns or otherwise, the interest level on this stock is going to be high until the AI buzz fades off. Just don't overstay your welcome when the music stops.

One final thought on valuation:

"At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?"

-Scott McNealy, CEO of Sun Microsystems

Good Trading!

Kashyap Sriram

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