Demand for Snowflake (SNOW) shares was high when it went public on the New York Stock Exchange on 09/16/2020, but that does not mean that a prospective long-term investor should get caught up in the hype. Indeed, looking ahead, this stock may see its share price melt significantly.

This may seem like a counterintuitive take in light of how Snowflake’s market capitalization more than doubled on the first day of trading. The IPO price was set at $120 per share with a market capitalization of $33 billion, opened at $245 per share with a market capitalization in excess of $70 billion. At the close of the market on 09/18/2020, the stock had pulled back to $240 per share with a market capitalization of $66.4 billion; the considerable enthusiasm for Snowflake is evident.

Warren Buffett

Warren Buffett’s Berkshire Hathaway made a sizable investment in Snowflake – which accrued a sizable profit. Image provided by CNBC.

Furthermore, such enthusiasm seemed to extend to the Oracle of Omaha too – Warren Buffett’s Berkshire Hathaway (BRK.A) (BRK.B) and Salesforce (CRM) agreed on 09/08/2020 to each acquire $250 million worth of stock at the IPO. Berkshire also acquired another four million shares from an existing shareholder on the same day.

This investment has paid off for Buffett, who has long been reputed to be wary of IPO’s and tech stocks – Buffett made $800 million on the opening day (given the amount invested, it is likely that Buffett’s lieutenants – Todd Combs and Ted Weschler – pulled the trigger rather than Buffett himself).

So, what is it about Snowflake that generates such confidence? In broad terms, the database management system market in which Snowflake operates is poised to grow to a market size of $63 billion by 2022, and database systems have evolved from in-house data centers to computing clouds – a consequence of data volumes expanding significantly and the need for a cheap storage facility to warehouse said data. And Snowflake is one of the pioneers of this evolution.

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Snowflake has a number of traits that make it competitive in the sector. First, customers are able to add capacity as and when they need it and are only charged for use rather than incurring a fixed price for a software license. Second, its data marketplace has a feature that permits customers to market and monetize their data to Snowflake’s 3,000+ customers.

Third, Snowflake’s multi-cloud service operates across all three big public clouds offered by Alphabet (GOOG) (GOOGL), Amazon (AMZN), and Microsoft (MSFT), so customers are not restricted to any one of these. Fourth, and finally, Snowflake not only sells software but also manages the servers, which puts it ahead of competitors such as Databricks.

While Snowflake has yet to become profitable as a result of these competitive factors, it does seem to be increasing its revenues as indicated by the annual revenues it has reported thus far, with a 173% year-on-year increase in revenue.

Year Revenue ($) Net Income ($)
2019 96.7 million -178.0 million
2020 264.7 million -348.5 million

Figures collated from the income statement available on Seeking Alpha.

The net income figures suggest difficulty with its path to profitability, but the quarterly figures for the current financial year suggest that Snowflake has this problem in hand and that its revenues continue to grow.

2021 Quarter Revenue ($) Net Income ($)
Q1 108.8 million -93.6 million
Q2 133.1 million -77.6 million
Total 241.9 million -171.2 million

Figures collated from the income statement available on Seeking Alpha.

In spite of these positive factors, however, the road ahead may prove rocky for Snowflake. The competitive factors that Snowflake bring to the table may not be enough to provide it with an advantage against its rivals, as start-ups such as Altinity can offer cheaper open-source alternatives (e.g. Altinity’s ClickHouse). More troubling is the fact that the larger and better-established firms – Alphabet, Amazon, Microsoft – have their own competing products, which are improving all the time (BigQuery, Redshift, and Azure SQL respectively).

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As noted above, Snowflake’s service operates across all three cloud services, but as the companies behind those cloud services strengthen their own products, the scope for Snowflake may become more limited – and there have already been attempts by Amazon and Microsoft to encourage users to opt for their services over Snowflake’s. AWS RA3 can separate compute from storage, and Microsoft has upgraded its own data analytics product. These attempts will increase going forward.

Furthermore, Snowflake will need to contend with rivals that offer more specialized services. To take one example, MongoDB (MDB) can store data culled from websites in JSON-like document databases, rather than simply extract the data. Snowflake’s more general offering is thus likely to be overlooked in favor of a host of specialized service providers going forward.

In addition, the fragmented nature of the cloud computing sector means that no one company dominates the sector, which may seem to give Snowflake scope. However, the larger and better-financed firms outlined above are more likely to gain market share through mergers and acquisitions, eventually squeezing other competitors like Snowflake out. As of July 2020, Amazon holds 31% of the market share, while Microsoft has 20% with Azure and Alphabet holds 6% with Google Cloud.

This makes the notion of investing in Snowflake at this time unwise. The valuation is extraordinarily steep, as noted by fellow Seeking Alpha authors Gary Alexander and Lukas Wolgram. Its price-to-sales ratio of 121.11 is well in excess of the sector average of 13.69 and the S&P 500 (SPY) average of 2.50. In light of the competitive environment that Snowflake faces, which will only grow tougher going forward, the likelihood that it will ever become profitable enough to justify this valuation is highly unlikely.

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In summary, the scope for Snowflake to become the next Oracle (ORCL) in the database management sector is offset by the range of competitive threats that it faces – particularly from the likes of Alphabet, Amazon, and Microsoft. Combined with the fact that Snowflake’s various competitive factors do not do enough to establish a significant advantage over any other supplier for the long term, and it is hard to justify getting on board here at its current valuation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.