Does The Spectacular Snowflake IPO Have Shades Of The DotCom Bust?

Published On: September 25, 2020Categories: Stocks & Shares3.6 min read

Warren Buffet famously shuns IPOs, which he sees as contrary in nature to his patient, value-hunting approach to investing. His last IPO investment was, until recently, made in 1956. But last week his investment vehicle Berkshire Hathaway, put $735 million into an IPO. The IPO in question was that of Snowflake, the cloud-computing start-up.

So far, the exception to the rule has worked out well. Snowflake’s valuation more than doubled over its first day of free trading on the New York Stock Exchange, earning Berkshire Hathaway a paper profit of around $800 million. Not a bad return for 8 hours.

But what provoked Buffet into compromising on an investment approach that has made him the 4th richest person on the planet? Has the Sage of Omaha been caught up in the excitement of a tech stocks melt up that some analysts are comparing to the dotcom boom, then bust? Has Buffet been seduced by the returns being generated by growth companies?

Snowflake is one of a new cohort of fledgling tech companies to have taken the stock market by storm over recent months. Games development platform Unity Software, enterprise-level software development platform company JFrog and Sumo Logic, the cloud-based machine data analytics and cybersecurity company, all saw double-digit gains last week following their own respective IPOs.

Here in the UK, online retail company The Hut Group saw its share price gain around 25% on its debut on the London Stock Exchange, despite the kind of corporate governance deviations that did for the WeWork IPO last year. Founder Matthew Moulding has a ‘founders share’ that gives him right of veto to any takeover attempt and pre-IPO the company transferred its property assets to his personal ownership. He’ll receive £19 million a year in rent.

But Snowflake’s popping IPO has outdone them all. Briefly during its first day of trading, the start-up was worth more than IBM. The latter may be a relative dinosaur in the context of the technology sector but it generates $70 billion in annual turnover. Snowflake made $250 million over the first six months of 2020.

Snowflake certainly has potential as a company. Cloud computing is one of the fastest growing sectors in the global economy and their cloud computing divisions have become the new engine of growth for huge companies such as Amazon and Microsoft. Cloud computing platforms run pretty much every app we now use on our smartphones and laptops or PCs. The growing army of IoT devices we have in our homes all send the swathes of data they gather to the cloud for processing and analysis.

Companies that use cloud computing services are also wary of avoiding what is termed ‘vendor lock-in’. Many prefer, if possible, to use multiple providers because some offer qualities that better fit certain workloads, because of performance or price, and it also gives big players more negotiating power if they can easily transfer to a competitor.

But apps are not always compatible with different cloud suppliers. If AWS (Amazon Web Services) tools are used in an app, it can be a pain to reconfigure it to work on Microsoft Azure, and vice versa. Snowflake’s tools help companies be more ‘cloud agnostic’, so their apps, or different services within the apps, can run just as well on different cloud computing platforms.

Snowflake does offer something modern companies want, and its sales were up 121% over the most recent quarter. But its current valuation still seems detached from reality. Last year the company lost $348 million, having spent $293 million on marketing. At its current valuation, the company is worth more than 100 times projected revenues for 2020.

So are we heading for a new dotcom crash? Opinions are mixed. Even if valuations are huge, today’s tech companies do tend to have revenues and strong revenue growth, if not profits. Their business models and plans are also far more sophisticated than those of the late 1990s when hundreds of millions were sometimes raised against a website generating insignificant revenues.

But tech valuations cannot be said to meet the kind of fundamentals support Buffet has always favoured. It’s inevitable that some will plunge in value if investors lose even a little faith. Others may well go on to justify the faith investors have put in them.

Mr Buffet will be hoping Snowflake falls into the latter category. It will be interesting to see if the investment in its IPO proves an exception, with him going out on a limb for one particular tech company whose business and market he has been particularly convinced by. Or if the Snowflake IPO investment marks the start of a change in direction from the investment formula that has done so well for him until now.

About the Author: Jonathan Adams

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