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Will Snap Pass the IPO Test?

Posted on Friday, Mar 10th 2017


After years of flipping between will it or won’t it, messaging service Snap (NYSE: SNAP), finally went public. The market has been looking forward to the IPO. But Snap will have to do more than just publish user metrics now. To justify its valuation, Snap will have to show its ability to drive revenue growth and profitability.

Snap’s Financials

Founded as a Stanford class project by Evan Spiegel, Reggie Brown, and Bobby Murphy, Snap has diversified its business from being an ephemeral messaging service to an advertising platform and, of late, a hardware company. Snap began to monetize its business in October 2014. It was only in the IPO filing that it finally revealed how far it has come.

For the year ended December 2016, Snap recorded revenues of $404.5 million compared with a rather modest $58.7 million earned a year ago. Snap does not break out details about the revenue segments. Global average revenue per user has increased from $0.31 a year ago to $1.05 for the quarter ended December 2016. Snap continues to suffer losses and it incurred a net loss of $514.6 million for the year 2016 compared to a net loss of $372.9 million in 2015. It ended 2016 with 158 million daily active users generating an average of 2.5 billion snaps every day.

Till earlier this week, Snap was venture funded with $2.65 billion in funding from investors including Alibaba, General Atlantic, GSV Capital, Fidelity Investments, Glade Brook Capital Partners, York Capital Management, August Capital, Yahoo!, GIC, Kleiner Perkins Caufield & Byers, Coatue Management, Tencent, SV Angel, Benchmark, General Catalyst Partners, Institutional Venture Partners (IVP), Lightspeed Venture Partners, and Lone Pine Capital. Its last round of funding was held in May last year when it raised $1.8 billion at a valuation of $20 billion. Valuation increased from $16 billion in March 2015.

Earlier this month, Snap went public by selling 200 million shares at $17 each, pegging the company valuation at a fairly high $24 billion. Post the listing, the stock soared to $29.44, taking its market capitalization to an even higher $34.7 billion. But since then, the stock has been floundering. Currently it is trading at $22.71 with a market capitalization of $28.7 billion, still above its list price. Still very high, though.

Snap’s Concerns

Snap has its work cut out if it wants to continue to justify its valuation. With investors watching over, it will have to continue to deliver strong growth on both operational and financial metrics. It may have developed a product that has a big following, but its core demographics may be worth caution. At the end of last year, 36% of Snap’s US Daily Active Users were between the ages of 18 and 24. Its next largest age group is 25-34 at 27%, followed by 13-17 at 22%. The focused demographics offer Snap a big advertising opportunity. But they come with their own woes. Snap itself believes that its core user base of 18-34 year olds is less brand loyal and more likely to follow trends, thus negatively affecting Snap’s user retention, growth, and engagement. Snap has also seen user engagement fall with age. Users 25 and older visited Snap approximately 12 times for an average 20 minutes daily compared with younger visitors who visited the chat engine over 20 times for an average of 30 minutes everyday. It is also seeing a deceleration in Daily Active Users where growth has slowed down from 7% in the June ended quarter to little or no growth in the more recent quarters.

Undeterred, Snap continues to build its advertising arsenal. Earlier this year, it launched ad platform 2.0 along with a new lineup of ad tech partners that could buy ads through its automated self serve ad tool. Its ad tech moves appear impressive as it has expanded its partnership from 4C, Adaptly, Brand Netowrks and TubeMogul to include names like Kenshoo, Kinetic Social, AdParlor, HyFn, Adglow and Videology. Snap will also allow Omnicom’s Resolution Media to become the first media holding company to license an API partner’s software.

Snap is also using Oracle Data Cloud’s syndicated audience segments for targeting its users. Oracle tracks online and offline purchases across nearly 100 categories and organizes them into broad segments. It then matches the users in those segments to their Snap accounts based on the email accounts and unique advertising-only identifiers that Snap has on them. The data is still encrypted and anonymous to block both Snap and Oracle from seeing the individual users, while still allowing Snap’s advertisers to deliver targeted ads. Snap allows users to opt out of this Audience Match feature. But the ad-targeting options do help Snap in offering more targeted advertisements.

The most worrying aspect though is its inability to rake in profits. Snap mentioned in its prospectus that it “may never achieve or maintain profitability.” It is not the only company to make a statement like this. Twitter and Etsy had made similar comments in their prospectus. At any rate, I quite agree with Brian Wieser, an analyst with Pivotal Research Group, that Snap is significantly overvalued. The research group estimates that the share should be valued at $10 each – less than half of its current valuation.

Or less?

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