Why Warren Buffett Bought into an IPO After 64 Years
By: S I Ahmed
Tags: Investing, Money, Finance, Business, Economics

Why Warren Buffett Bought into an IPO After 64 Years

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

The ‘Oracle of Omaha’ is famous for many reasons but acquiring a large chunk of an IPO isn’t one of those. Mr. Buffett has abided by his mentor, Benjamin Graham’s advice in business and in life for the longest possible time until he shifted his stance from “cigar butts”.

Graham believed that any stock should be acquired when it’s trading way below its intrinsic value, thus having the opportunity to obtain a handsome return all with the added cushion of “margin of safety”.

Over the years, Warren has shifted his stance in terms of what he defines as “intrinsic value”. Granted that the stock should trade below that figure and have some sort of cushion to hedge the downside risk, but his sudden shift in preference in terms of choosing companies that were either industry leaders or those that had a ‘durable competitive advantage’ (i.e- moat) outperformed selecting “cigar butts” that were trading cheaply.

His long-term approach to holding stocks acquired at reasonable rates and reaping dividends has taken the ‘failed textile mill’ onto becoming a giant conglomerate that hosts a range of businesses under its umbrella.

But never before has Mr. Buffett acquired an IPO, and even until 2016–2017, he was negative about acquiring technology stocks.

His justification has always been to never buy something you don’t understand, meaning that if you fail to grasp how that business operates or generates its revenues and manages its expenses, then its too complicated and should be avoided at all costs.

But with Berkshire acquiring a large stake in Apple Inc. and a certain percentage in Amazon, millennials are starting to think that the 90-year-old prodigy has finally understood the importance of unlocking value by keeping up with the changing business environment.

Mr. Buffett has acquired $250 million worth of stock of a company called Snowflake. In addition to Marc Benioff of Salesforce, “Berkshire Hathaway and Salesforce each agreed to buy $250 million of stock at the IPO price in a concurrent private placement. Berkshire Hathaway also agreed to buy 4.04 million shares in a secondary transaction”.

According to a report published by CNBC, “the last time Buffett bought into such an IPO was in 1956 when he bought into the Ford Motors IPO”.

But what exactly does the company do?

Snowflake is a cloud platform that enables businesses to process and analyze billions of data points. Their main software is something similar to MS Excel or a Google spreadsheet, except that it processes the data points a million times faster. Instead of thinking in the neighborhood of tens of thousands of data points, imagine a spreadsheet with a billion data points that need to be analyzed quickly without slowing down your computer.

That is their key motto. They provide a centralized data point for hundreds of remote workers, where they can run these data points and help their marketing or business development departments to optimize their business.

Their computer architecture allows them to ‘compute and store to scale’ separately within the storage provided from any cloud provider the customer chooses.

“They utilize ‘massively parallel processing’ (MPP) for processing queries at a faster than usual rate, whereby each node in the cluster stores a portion of the data set locally from where the virtual warehouses can then access the storage layer independently such that it doesn't need to compete for computational power”.

The example given by Snowflake was one that involved “Citi bike”, a bike-sharing company in New York City, whereby the company analyzed the discrepancy for their plummeting rides.

During the second and third weeks of February, rides had declined significantly and when they analyzed the data, they found that seasonal variations such as excessive snow and unexpected closures were the main reason for their bikes sitting idle.

Now, this isn’t the best example, something the average individual could figure out simply by picking up the newspaper or utilizing common sense but there are companies that value the collection and analysis of such data.

The stock was supposed to IPO between $75–85 but just prior to its launch the price was hiked to $110 a share. According to a CNBC report published on September 16th, “the shares surged more than 111% in its market debut on the New York Stock Exchange on Wednesday in the largest ever software IPO. The stock began trading at $245 per share and closed at $253.93. A day earlier, Snowflake priced shares at $120, higher than the $100 to $110 range it estimated on Monday, and a huge bump from the $75 to $85 range it proposed last week”.

With a raging bull market, it’s no surprise that a company would love to offload as many shares as possible at a high rate, but the key question that remains is, “why did an investor like Warren Buffett buy into a ‘money-losing venture’ during it’s IPO phase”?

“Snowflake reported revenue for its January 2020 fiscal year of $264.8 million, up 174% from a year earlier. For the six months ended July 31, the company notched revenue of $249.6 million, up 133%”.

However, the bottom line tells an entirely different story. Net profit/loss has varied depending on what period you are analyzing. The losses have almost doubled from the fiscal year 2019 with net losses of $178 million increasing to $348.5 million in the fiscal year 2020.

More recently for the first six months of fiscal 2021, the net losses were flat at $177.2 million compared to losses of $171.3 million on a period basis.

According to a previous report from Forbes, Snowflake’s former CEO, Bob Muglia, grew the company from 80 customers in 2015 to 1000 customers in early 2018 when he was replaced by Frank Slootman.

“Slootman has since then doubled the company’s customers from 1,547 to 3,117 over the past twelve months amongst which Snowflake now hosts 7 of the Fortune 10 and 146 of the Fortune 500 companies”.

With a positive revenue momentum, a growing customer base, and a raging bull market it will be interesting to see if Berkshire Hathaway decides to hold on to the shares after the lock-in period or simply sell out and take their profits off the table.

The company currently doesn’t even have a P/E ratio due to negative earnings but then again neither did Amazon when it started out.

For one traditional metrics used to value manufacturing companies aren’t applicable to valuing banks or tech companies.

Despite the S-1 outlines placed by IDC for Analytics Data Management, Integration Platforms, Business Intelligence, and Analytics Tools at $56 billion, acquiring a company with limited public data might not be a good thing to start off.

If you happened to be one of those lucky private placement individuals like Buffett, you can still be profitable when you get a chance to offload your shares. However, the last tech IPO of this magnitude was Uber, and we all know how that went.

In general buying into an IPO at the very beginning still might do you more harm than good. With no P/E and inconsistent P/S, P/B, and detailed cash flow metrics predicting a company’s future growth potential is a tough ask.

Did Buffett actually contemplate his mentor’s words which he famously quoted for IPOs?

I don’t know.

But I still believe in Graham when he said that, “in the short run, the market is like a voting machine — tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine — assessing the substance of a company.”