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Investment Thesis
Snowflake (NYSE:SNOW) and Twilio (NYSE:TWLO) represent two very different platforms. Snowflake operates the Data Cloud. Its multi-cloud offering aims to integrate the enterprise world into a single interconnected cloud-native ecosystem. Its technological architecture allows its customers to consolidate and analyze data within "a single source of truth."
Twilio is the leading Communications Platform-as-a-Service (CPaaS) platform. Twilio is a highly customizable real-time customer engagement platform. Twilio's customers rely on the company's platform to integrate "world-class engagement into their customer experience."
Investors should not consider both companies as your typical Software-as-a-Service (SaaS) platforms. They mainly derive their revenues from usage. Therefore they drive higher revenue from higher use. As a result, their revenue retention (NRR)/expansion (NER) rates are strongly indicative of their customers' consumption behavior. Hence, investors are strongly encouraged to pay attention to their revenue retention metrics. Without subscriptions revenue to depend on, both companies need to drive consumption increasingly.
In this article, we will share with our readers which company is our preferred pick for our portfolio.
SNOW Stock Vs. TWLO Stock YTD Performance
SNOW stock Vs. TWLO stock YYD performance (as of 4 Oct 21).
TWLO stock had a fantastic start as it raced to a 40% YTD gain by February. Meanwhile, SNOW stock's early momentum quickly faded into a -30% YTD loss by May. However, SNOW stock has dramatically recovered since then. Although its YTD return of 4.36% still trails QQQ's YTD return of 12.5%. However, TWLO stock's 40% YTD early gain has since been completely wiped out. It is also trailing QQQ and SNOW with a -2.1% YTD return.
Snowflake's Gangbusters Growth Momentum
Snowflake quarterly revenue. Data source: S&P Capital IQ
Quarterly (operating expenses margin, SG&A margin, R&D margin). Data source: S&P Capital IQ
Snowflake continues to deliver gangbuster revenue growth in FQ2'22. Its revenue grew by 104% YoY. It was also broadly in line with the FQ1'21 YoY revenue growth rate of 110%. These are phenomenal growth rates that even high-growth SaaS companies can be proud of. It certainly validates the consumption-based business model of Snowflake's platform. Snowflake often reminds investors that it takes time for its customers to ramp their consumption. Sometimes, it might even take up to 12 months or more. But, once they got up to speed and running, they couldn't help but ask for more bandwidth. Snowflake's platform is so sticky it has been posting industry-leading NRR. 
Snowflake NRR. Data source: Company filings
Readers should be able to glean the incredible NRR posted by Snowflake quickly. The company continues to post phenomenal NRR north of 160% consistently. New customers are unlikely to be essential revenue contributors in the short run. However, it doesn't deter Snowflake. Snowflake is so confident in its platform that it wouldn't make sense to use a subscription-based model. They are in for the long game. They know that once the customer got up to speed, they wouldn't stop. Snowflake emphasized:
Two years ago we sold a contract to a large retailer in Europe. We did a $5 million deal. It took them nine months to really do their migration, nine plus months. In the fourth quarter of that deal, they consumed close to one million in that year where they did five. They still renewed, and so they had nine. This past year, they were consuming close to $8 million. It would not surprise me if they're close to $20 million next year with that specific customer use case. And by the way, that was a -- almost a two-year sales cycle to get into that account. That's why I'm just telling these are long -- it takes a long time before you get to -- and this is revenue I'm talking about. (from Piper Sandler 2021 Virtual Global Technology Conference)
Quarterly (operating expenses margin, SG&A margin, R&D margin). Data source: S&P Capital IQ
Despite SNOW's breathtaking revenue growth rates, readers can observe that the company is still unprofitable. Its operating expenses (OpEx) margin came in at -134.5% in FQ2'22. However, the company has been gaining operating leverage. Ever since it launched its IPO in September 2020, the company has improved its operational efficiencies.
Snowflake stock-based compensation (SBC) margin. Data source: S&P Capital IQ
The critical aspect of its improving efficiencies is its declining SBC margin trend. Of course, it's normal to observe a skewed SBC margin at its IPO launch. Therefore, readers shouldn't be apprehensive over SNOW's 74.6% SBC margin in the quarter ending October 2020. Notably, that margin has been coming down as Snowflake scales. In addition, by using SBC, the company has also significantly improved its cash flow margins.
Snowflake quarterly (EBITDA & Levered FCF) margins. Data source: S&P Capital IQ
By astutely using SBC, Snowflake has significantly improved its levered free cash flow (FCF) profile. It's vital as the company needs some time to ramp its customers' consumption habits. In addition, we have explained that enterprise customers take time to migrate their systems over. Even though Snowflake offers "self-tuning" capabilities, customers still need the time to explore the incredible capability of Snowflake's platform. Therefore, by using SBC, Snowflake could avoid burning cash "uncontrollably." At the same time, it could also incentivize its employees to push for growth. It aligns their employees' motivation with the company's long-term stock performance. It's not as bad as it seems, as long as Snowflake can improve its earnings per share (EPS) more quickly than SBC's implied dilution.
Snowflake est. EPS mean consensus. Data source: S&P Capital IQ
On this aspect, Snowflake Inc. is expected to improve its EPS rapidly over the next few years. Therefore, we don't think we need to be unduly concerned over SNOW's SBC related items. We believe it helps the company to expand quickly without burning cash. Moreover, the company is in a very healthy financial position. It reported a cash hoard of $4.14B in FQ2'22. It also reported total debt of just $194.9M. Hence, the company has tremendous flexibility to make necessary changes to its SBC policies.
Twilio Continues its Rapid Growth, But Lacks Leverage
CPaaS est. revenues worldwide. Data source: Juniper Research
CPaaS market share worldwide. Data source: Synergy Research Group
Twilio operates within a market that is estimated to experience rapid growth. The CPaaS market is estimated to grow at a CAGR of 29.5% by 2025. Importantly, TWLO Inc. is the undisputed market leader with a 38% share. The #2 Vonage (VG) holds just 11.8% of the market. Despite that, we think there are still plenty of opportunities for both companies to capture.
Twilio LTM (revenue & EBIT). Data source: S&P Capital IQ
Vonage LTM (revenue and EBIT). Data source: S&P Capital IQ
Interestingly, despite leading the market, both VG and Twilio have found operating profits highly elusive. Twilio grew its revenue by an incredible CAGR of 66% over the last three years. Despite that, the company doesn't seem to be getting anywhere near operating profitability.
Twilio LTM EBIT margin. Data source: S&P Capital IQ
Readers can easily observe it by taking a closer look at its last-twelve-months (LTM) EBIT margins trend. In contrast to Snowflake, the company's operating efficiencies seem to be getting worse over the past year. TWLO grew its revenue by a remarkable 62% year-over-year (YoY). Despite its market leadership position and massive growth, Twilio hasn't gained momentum on its operating leverage. If we consider VG's profitability, it seems that the company has also been operating with razor-thin margins. Its LTM EBIT margin is merely 2.6%. Hence, the CPaaS market could be much more "commoditized" than we think it is. Even though TWLO is already the undisputed leader, it remains to be seen whether they can even turn profitable.
Public cloud services end-user spending worldwide. Data source: Gartner
In contrast, Snowflake is still an emerging player in a vast cloud computing market. End-user spending is expected to be worth a massive $397B by 2022. It's expected to be 40x the size of the CPaaS market by 2022. Snowflake is operating in a market with enormous opportunities to displace the incumbents. It has set its sights to compete aggressively against the hyperscalers Azure (MSFT), GCP (GOOGL) (GOOG), and AWS (AMZN). So far, Snowflake has been gaining incredible traction.
Which is the Better Cloud Computing Pick?
Snowflake stock currently trades at an EV/Fwd Revenue of 72.2x. In contrast, Twilio stock trades for 18.9x. However, we shouldn't compare them directly as it fails to account for their respective growth rates.
SNOW stock Vs. TWLO stock EV/Fwd Rev trend. Data source: S&P Capital IQ
Readers can quickly glean the incredible growth momentum for Snowflake Stock. If SNOW can continue to execute well, valuing it at a 14x by CY25 seems to be unreasonably low. Therefore, SNOW might not seem that expensive even at the current valuation. Despite that, it is clear that SNOW trades at a premium. For investors with high conviction about SNOW's business model, SNOW might seem to be the better stock.
Therefore, between TWLO and SNOW, we think Snowflake stock represents the better cloud computing pick for investors.
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