Snapchat IPO
Snap Inc., the parent company of Snapchat, began trading on March 2nd after an initial public offering priced 200 million shares at $17 apiece. The IPO raised $3.4 billion, giving the company a valuation of $23.8 billion.
Billionaire Snap co-founders CEO Evan Spiegel, 26, and CTO Bobby Murphy, 28, who met as Stanford undergrads, rang the opening bell of the New York Stock Exchange to commence trading of their ephemeral messaging company under the ticker SNAP.
IPO filings revealed that the company paid ousted co-founder Reggie Brown $157.5 million in 2014 and 2015, stemming from a 2013 lawsuit in which Brown alleged he was unfairly detached from the company. The lawsuit alleged that Brown had “independently conceived of the idea of a mobile device application that would allow a person to transmit a picture to another mobile device user — but the picture would then automatically delete itself.”
After bringing the idea to Spiegel, the two then brought in Murphy for his coding experience, and the three launched the first iteration as Picaboo in the iTunes store the summer of 2011 from Spiegel’s father’s home in Pacific Palisades, California. The lawsuit maintained that Brown was then distanced from the company as his Stanford classmates would move forward with his idea and his other intellectual contributions such as the ghost logo, named Ghostface Chillah after a member of the Wu-Tang Clan. After a 2014 settlement, Spiegel publicly acknowledged Brown’s contributions to Snapchat’s creation.
Strong demand for the highest-profile tech IPO of the year lifted the price of the stock nearly 60% above its IPO price in its first two days of trading, with the stock surging 44% higher on its first day alone. But the stock then declined 21% over its next two days of trading as the market began to re-assess the future profitability of its business model. So, with volatile early trading, here’s why you should love and hate the recently-public stock.
Bear Snap
Snap has never turned a profit. Its IPO prospectus disclosed the rate that spending continues to outpace revenue, and ominously warned that it expects “to incur operating losses in the future, and may never achieve or maintain profitability.” In 2016, Snap’s revenue grew to $404 million from $59 million in 2015, yet its net loss too expanded from $373 million to $515 million. Many investors believe its rich valuation metric of 60 times revenue, compared to Facebook’s 14x, reflects a staggering disconnect with reality. And in addition to sizeable cash burn and the perceived challenge of monetizing impermanent content, Snap also reported a slowdown in its user growth in the fourth quarter of 2016, citing diminished product performance and increased competition as among the triggers.
Snap’s filing warned that the company faces “significant competition that we anticipate will continue to intensify.” Its principal competitor is Facebook, the social media behemoth that Snap famously declined a $3 billion offer from in 2013. Facebook continues to accelerate its efforts to imitate Snap’s ephemeral and private features, the latter which precludes its content from being subjected to the pressures of public ‘like’ counts. Facebook has launched a plethora of copy-cat products, most recently the Stories feature on its Instagram subsidiary, identical to Snapchat’s core Story product, even in name. As Facebook continues to roll out clones across its Messenger and WhatsApp products, Snap will remain under pressure to fend off the mighty Facebook to ensure it does not become another short-lived social fad. But some investors fear that Instagram’s clone product launch last year directly correlated to Snapchat’s Q4 decline in user growth.
The company also faces criticism from institutional investors for its multi-class voting structure which would entrench its co-founders with near authoritarian control. Snap’s ownership structure is such that only pre-IPO investors with private shares have voting rights. Its IPO issuance of Class A shares are non-voting shares, so public investors have no capacity to vote on issues such as pay, board structure or corporate strategy. The Council of Institutional Investors, which fears that Snap could become an unpalatable model for forthcoming tech unicorn IPOs like Airbnb and Uber, is lobbying stock indices to exclude companies that sell non-voting shares. If Snap were excluded from equity benchmarks, it would deflate the artificial buying demand from funds which track indices and thus have to purchase shares.
Final causes for concern include the lingering threat of a cyber breach, having been hacked in December 2013, as well as a pending lawsuit from a former employee, who was lured away from Facebook, and who alleges that Snap has inflated its growth metrics. But the bottom line is that Snap is currently a niche, unprofitable company with slowing user growth and increased competition, which could endanger its ability to ramp up its highly-dependent digital sales revenue and thus see its valuation too self-destruct. Failure to reconcile these challenges will render its IPO as a lucrative exit strategy for its early private investors, but as a poor investment to the public, one which suffers the similar user stagnation and sustained downward trajectory as Twitter.
Bull Snap
Snap has massive upside potential. While the product formerly had the reputation of merely being a sexting app, the company currently has the reputation of being uniquely innovative, and for encompassing enviable features heavily sought by Facebook. Facebook continues to view Snapchat as a significant threat, having unsuccessfully tried to acquire it, and shamelessly copying it ever since. After launching Stories last year, Instagram CEO Kevin Systrom conceded, “we need to have a place where you feel free to post whatever you want without the nagging fear of, did someone like that or not?”
Making sense of these repeated efforts of replication as well as realizing the true potential of Snap requires an investor to discern Snapchat’s true designation. The company does not see itself as a social network, but rather the pioneer of a new medium altogether. Case and point, Snapchat does not have an experiential web presence as is customary for social media. The company stressed in its IPO filing, “Snap is a camera company.” The smartphone camera is its nucleus for empowering images as a form of communication. Its ephemerality breeds a whimsical experience that is more expressive and good-humored. As it continues to centralize communication around the camera, Snapchat has firmly solidified itself as a disruptor to unpleasant social media curation and the mundane experience of SMS. Having forged this new medium, the company can now explore vast additional features, like Lenses, and opportunities, like Spectacles, in ways that don’t integrate as naturally into other companies, most notably Facebook.
While Snap remains an unprofitable company, it’s worth noting that its ad sales focus is still young and undeveloped. The company’s earnings have grown notably, from $3 million in 2014 to $59 million in 2015 and $404 million in 2016. Snap views its greatest revenue opportunity as sustaining this impressive upward trajectory in the expanding global mobile advertising budget, which is slated to expand from $66 billion currently to $196 billion by 2020. The company has a base of over 160 million daily active users who on average use the app 18 times per day, spending 25–30 minutes. This ubiquitous presence with millennials will enable Snap to continue to craft more creative and efficient ways for advertisers to reach the highly coveted generation. And as the company continues to focus on scaling its ad business, Goldman Sachs has estimated that its revenue could reach $2 billion by 2018.
Achieving increased revenue per user will be a product of innovation and a focus on the user experience. Investors should be reassured by the company’s stated goals of creating value through increased user engagement, rather than chasing user growth. When questioned on user growth metrics, Spiegel stated, “we’d rather inspire creation because we know a derivative of that is growth.” An investor can thus frame its slowing rate of user growth as less problematic and its young demographic as its greatest asset, as tech trends tend to permeate up the age spectrum.
Investing in Snap requires faith in the great growth potential of the unknown. Faith in the vision and execution of the owners who have near autonomy. But the risk-return is positive to those who accept the notion that Snapchat is itself a new medium, and to those who acknowledge that Facebook’s perpetual imitations are more than the sincerest form of flattery. If Snap is able to remain innovative in the ways it engages the younger generation, it will achieve the similar revenue growth and sustained upward trajectory as Facebook.
