Snap Inc. (NYSE: SNAP) – market cap as of 10/03/2017: $25.54bn
Company Overview
Snapchat, launched on July 2011 under the name Picaboo, defines itself as a camera company. However, most of us identify Snap as a multimedia application for image messaging. Before the app became widely known, other social media such as Facebook or Instagram dominated the industry. How did this young company manage to penetrate the market, reaching 158m daily users in such a competitive environment?
Snapchat’s success is based on the innovative idea of 24-hour photo and video sharing. Cofounders Spiegel and Murphy were quick to monetize on their invention introducing initially an app available to iOS systems and in 2012 expanding accessibility also to Android users.
After acquiring several companies including Looksery and Bitstrips, Snapchat evolved to include lenses, geofilters, discover features, a chat service and eventually group chats and memories sharing.
Nevertheless, the founders do not envisage Snapchat only within the limits of social media. Although Spielger has tried to maintain maximum secrecy, his intentions of approaching a new market were made clear in 2014. At the time Snapchat acquired Vergence Labs, a company specialized in the development of “smartglasses” for live streaming. Furthermore, the release of Spectacles in November 2016, sunglasses that make Snaps from a human perspective, revealed that the company was pursuing a brand new strategy.
Business Model
Similarly to other social media companies, Snap has one main source of revenue: advertisement. The main tools Snap uses for advertising are Discover, Snap Ads with video attachments, as well as sponsored lenses and geofilters.
In 2015 and 2016, advertising revenue accounted for 98% and 96% of total revenues, respectively. Currently, the cost of advertising through Snapchat amounts to $100 per thousand viewers. Some top brand companies have had to pay bills as high as $750,000 for daily placement to access the exposure that Snapchat provides. This clearly implies that advertising revenues are strongly correlated with the user base. The more users Snapchat is able to attract, the more companies are eager to pay for the advertising space. Over the last year, daily active users have grown by approximately 50m, a 48% increase.
In an attempt to diversify its revenue base, and given the competitive pressure that characterizes the advertising market (in particular from bigger competitors such as Facebook and others), Snap has recently attempted to enter the market for hardware products. It is safe to say that the company did not succeed in its first attempt. Sales from the newly developed “Spectacles” accounted for an insignificant portion of total revenues.
IPO Structure & Analysis
On 2 March 2017, Snap launched an initial public offering on the NYSE for 200m class A non-voting shares. The initial offering price was set at $17 per share, above the recommended $14-$16 price range, because of strong investor demand. Snap managed to cash in $3.4bn from the offering. The proceeds will be used to finance the company’s future expansion plans, among which the agreement with Google for $2bn in cloud storage services in the following 2 years.
Corporate governance will remain practically unaffected by the public offering. In fact, only Class A non-voting shares have been made available to the general public (shareholders who buy them will be entitled to attend the company’s annual shareholder meeting and ask questions). Class B shares, which entitle the holder to one vote per share, are reserved for early investors and executives. Finally, Class C shares provide 10 votes per share and make up 88% of the overall voting capital, and are held solely by the co-founders Evan Spiegel and Bobby Murphy.
On the first trading day, Snap opened at $24.42 per share, 44% more than the initial offering price of $17 per share, and closed at $27.2. Despite early speculations, the Greenshoe option was not triggered to satisfy initial demand.
The equity was raised through class A non-voting shares only. The lock-up period, negotiated between the management and the underwriters, was agreed to be 150 days for three quarters of the shares, and one year for the remaining one quarter.
Is it overpriced?
Investor appetite has been exceptionally high despite Snap’s controversial choice of stock offering and widening net loss figures. Professor Aswath Damodaran valued the company’s equity at an average of $14.9bn, $4.8bn less than the market. Not solely in his opinion, the $19.7bn figure was reached to satisfy demand, and does not represent the company’s true fair value.
Despite never having made any profit, Snap’s revenue growth has been about 590% between 2015 and 2016. A quick look at financial figures shows an approximate $200m increase in R&D expenses as well as Sales and Marketing costs starting in 2015, part of which is attributed to Snap’s new product: the “Spectacles”. However, cost of revenue has decreased from around 210% of revenues in 2015 to only 12% in 2016, which is a good sign. On a different note, analysts claim that Snap’s growth rate in active users, directly tied to revenue growth, is coming to an end due to Facebook’s competitive response. With the introduction of Instagram’s “Stories” one can see an immediate proof of the aforementioned claim.
As Snap is a tech-unicorn, it is consistently being compared to Facebook and Twitter with investors hoping that its performance will resemble that of the former rather than the latter. At the moment, unfortunately, Snap looks more like Twitter than Facebook.
Rationale
The IPO could be seen as a signaling event – the two co-founders are trying to show the goodness of their projects, by disclosing part of their strategy. In a sense, investing in Snapchat’s shares is a bet on Evan Spiegel and Bobby Murphy. On the other hand, it is certainly a way to monetize part of the investment before uncertainty reaches its maximum and competition becomes truly problematic. Less than half a year ago Instagram, of the Facebook family, introduced “Stories”, a tool resembling Snapchat in many (if not almost all) of its aspects. Zuckerberg is now integrating Stories in almost every app he owns, making clear the objective to obtain and keep absolute monopoly of the social media landscape.
After all, however, Snapchat’s public offering is all about raising capital. Financial and non-financial resources are in fact much needed now that the company is at its turning point, still relying on its flagship product (the “camera app”, i.e. Snapchat) but certainly attempting to come up with a breakthrough in the hardware segment, and currently working on augmented reality products.
New funds are needed especially because Snap’s main competitors in the digital advertising market have mountains of cash on hand ($78.5 billion for Alphabet and $23.3 billion for Facebook, 2016). If Snap wishes to keep up with competition, it needs at least half of their financial resources and innovation potential.
As noted above, only non-voting Class A shares have been issued, with no impact on the governance of the company. The rationale for this choice reflects Spiegel’s “secrecy and control” approach. Issuing non-voting shares avoids proxy fights and tender offers, but offers few incentives to investors, especially given the fact that this is a growth stock with no prospects of dividends in the short to medium term. At the same time, however, Snapchat will be able to attract personnel through stock-based compensation without diluting the founders’ voting power.
Implications
Snapchat’s IPO carries big implications for the market: it is the biggest IPO in the U.S. since 2014 and represents one of the few unicorns (or, better, decacorns) deciding to go public these days. This move could boost the activity in the Equity Capital Markets and encourage other promising tech companies to work for their own listings.
From the company’s point of view, a public quotation implies the end of Spiegel’s secrecy policy on Snapchat’s future steps: it is hard to maintain the traditional lack of disclosure with an extensive roadshow and several meetings with new investors, not to mention the necessity to deal with regulatory authorities.
“Keeping secrets gives you space to change your mind, until you’re really sure that you’re right,” said Spiegel in 2015 in a note to its employees. Now that he does not have the space to change his mind anymore, it appears clear that Snapchat must present something better than the Spectacles (disappointing in terms of revenues until today) in order to narrow the gap with its main competitors and to ensure the survival of the company in an industry ruled by Facebook’s pervasiveness.
Investor Response and Market Reaction
The non-voting shares offered by Snap have generally received a negative acclaim within the financial community, and the governance structure has been compared to a “banana-republic”. A recurring concern is the possible inclusion of Snap in the S&P 500 and the possibility that many tracker funds will end up with the stock whether they like it or not. David Blitzer at S&P Dow Jones indices said that the decision is not imminent and that the IPO should be seasoned for 6 to 12 months before Snap’s eligibility is assessed. This should bring a sigh of relief among fund managers.
After the initial high of $29.08 per share, as of March 10 the stock has fallen to $22.07 per share, 10% below the opening price of $24.42. If Snap continues to trade in the current range, the operation could considered “successful”, however we cannot predict what is going to happen in the future. Something to keep in mind is that, after the lock-up period, it is highly likely for the stock price to see a further drop.
Lead Underwriters
Lead underwriters for the deal were Goldman Sachs and Morgan Stanley. JPMorgan, Deutsche Bank, Barclays, Credit Suisse, and Allen & Company are among the other banks working on the share sale.
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