Monday, 27 March 2023

Here’s How Snowflake Is Sustaining Revenue Growth by Tripling Its Market Opportunity

by Earn Media

Data company Snowflake (NYSE: SNOW) went public in September 2020. At the time, management said it had a market opportunity of $81 billion. But nowadays, just 2.5 years later, management says its market opportunity is $248 billion.

The story of how Snowflake’s market opportunity tripled in under three years is worthy of investors’ attention. It shows how the company can sustain mind-blowing revenue growth and why this is a great business.

Snowflake is creating its own demand

Snowflake is trying to solve the “data-silo” problem. In traditional infrastructure, parts of enterprise data are isolated from the rest of the business, prohibiting broad insights and collaboration. Therefore, Snowflake came to market with its Cloud Data Platform, providing a way to onboard and store enterprise data all in one place.

Snowflake has a usage-based business model. When businesses try to gain insight from their data, Snowflake generates revenue from the usage. This is what management believed was an $81 billion opportunity in 2020.

However, Snowflake’s management shifted its focus to address a new problem. As it turns out, the company’s customers didn’t really know how to best use their data sets. Therefore, while growth was outstanding, it wasn’t living up to its full potential. Customers would logically use the platform more if they fully knew what they could do.

Therefore, Snowflake’s business model evolved to become an applications platform. The company now provides application programming interfaces (APIs) so that developers can build and deploy apps that do more with the data already stored on Snowflake’s platform.

The genius of this evolution is that Snowflake started a new business that creates demand for its core business — the company facilitates the creation of applications that create new use cases for data, which drives usage. And as usage goes up, so does Snowflake’s revenue, since the model is usage-based.

For CFO Mike Scarpelli, it’s more than just genius. At the Morgan Stanley Technology Media and Technology conference, he said, “It’s actually a beautiful model.” [emphasis added]

How visionary leadership can sustain top-line growth

To be clear, Snowflake’s progress as an applications platform is recent. In March 2022, the company acquired Streamlit to make it easier for developers to build apps. Then in June, it launched its Native Application Framework so apps could be built, monetized, and deployed. And in November, it began supporting Python — a coding language popular with developers.

Because Snowflake’s pivot is recent, it’s not yet showing up in financial results.

If investors are only looking at Snowflake’s recent financial results, there’s reason for alarm. The company’s revenue growth has been outstanding. But its growth rate has steadily plummeted, as the chart below shows.

<div>Here's How Snowflake Is Sustaining Revenue Growth by Tripling Its Market Opportunity</div>

SNOW Revenue (Quarterly YoY Growth) data by YCharts.

Snowflake expects to generate $10 billion in annual product revenue six years from now. This works out to be about a 32% compound annual growth rate (CAGR) from the end of its fiscal 2023, which ended in January.

For perspective, Snowflake grew its product revenue by 70% in fiscal 2023. But for fiscal 2024, management is guiding for just 40% year-over-year growth. This means the company’s growth rate is declining at an alarming rate if it’s going to sustain revenue growth of over 32% for the next six years.

The company’s pivot to becoming an applications platform may be the key to sustaining Snowflake’s long-term revenue growth above the guided threshold. In the conference call to discuss financial results for the fourth quarter of the company’s fiscal 2023, CEO Frank Slootman said that 20% of customers have now tinkered with Python since it became available. Eventually, the experimentation happening in applications should lead to higher usage of Snowflake’s platform.

Slootman believes increased usage as the result of apps will happen in the second half of the company’s fiscal 2024 (the fiscal year started in February). Therefore, perhaps Snowflake’s slowing revenue growth rate isn’t as concerning as it seems. Management appears to be visionary, developing a way to become more relevant to its customers over time, which could reaccelerate growth.

I believe that Snowflake stock will struggle to outperform the stock market average, even if it hits its revenue goal of $10 billion because its valuation is so high already. That’s why it remains a stock I wouldn’t invest in today.

However, I’m not avoiding Snowflake stock because I believe it to be a bad business. To the contrary, this article showed how strong of a business Snowflake is and why management believes its model is “beautiful.” Indeed, the company exhibits many favorable traits and is one I’d love to invest in if the price was right.

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Snowflake. The Motley Fool has a disclosure policy.

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