Snapchat IPO: Snap-up? or Hold-back?

Snap Inc., Snapchat's parent company, has recently made a regulatory filing for an IPO listing on the NYSE scheduled for March with ticker code: (NYSE:SNAP). Snapchat (“Snap”) is looking to raise $3bn in funding for the company in its SEC filing with a $20-25 billion valuation. 

In terms of its business activity, as at end of 2016, Snap has 158 million daily, active users creating circa 2.5 billion daily “snaps” on its platform.

Growth Potential:

Timing-wise, Snap has been cherry picked now as ripe for flotation due to it reporting a phenomenal sales growth rate with revenues increasing 600% in 2016 to $404.5 million from less than $59 million in 2015.

This is an explosive growth rate when compared to its comparative peer, Facebook, which grew sales by 54% in 2016, but this does not take into account that Facebook sheer size dwarfs Snap’s revenues by reporting $27.6 billion last year.

Snap’s structure and set-up when put under scrutiny raises concerns:

Corporate Governance structure: Snap’s 26-year-old CEO Evan Spiegel will have near absolute control through proposed asymmetrical voting rights which is expected to alienate potential investors.

Snap is exposed and heavily reliant on its platform functioning by working off other providers systems including Google Drive, etc. This creates an additional risk factor in its supply chain that could affect its ability to function properly without disruption, etc as opposed to Facebook managing its platforms supply chain in-house.

Valuation Issues:

Snap has an eye-watering, proposed price valuation of 62 times of its sales (P/S ratio, "PSR"). As an industry peer, Facebook (NASDAQ:FB), which owns Snaps direct competitor Instagram, has a current PSR of just 14.1x (vs PSR 23.7x at IPO in 2012).

Other Sector Benchmark's are even lower on current PSR valuations, namely: Yelp (NYSE:YELP) at 3.9x (vs PSR 17x at IPO in 2012), Google (parent co: Alphabet NASDAQ:GOOGL) at 6.6x (vs PSR 8.5x at IPO in 2004) and Twitter (NYSE:TWTR): at 4.6x (vs PSR 22x at IPO in 2013).

From an alternative perspective, if we compare Snap's valuation as a "Camera company", would make GoPro (NASDAQ:GPRO), an appropriate measure to Snap, and trades on a PSR of just 1.1x (vs PSR 5x at IPO in 2014).

High Valuation Justification?

Snap’s valuation can only justify such a high price tag based on its future growth scope. Its revenue has increased rapidly, but the growth in the number of people using its app has slowed considerably. Also the demographic of its users are largely made up of the under 35 age range who have less brand loyalty, are more fashion conscious, and therefore more receptive to migration and switching to other brands.

Since Snap’s launch in 2011 it has been loss-making, reporting a net loss of $515 million, 38% higher than its loss in 2015. Until Snap can establish a profit it will be haemorrhaging through its capital.

Snap has also projected in its IPO filing that its expenses are increasing at a rate that could outpace revenue growth for the foreseeable future.

Snap currently generates revenue through:

1. Advertisements placed on Snapchat's platform (this is its main, most stable revenue stream)
2. Hardware revenues from its Snapchat Specs (this is early stage, representing a relatively small portion of the sales mix and represents a high-risk , future revenue stream); and
3. Fee growth potential from Snap's new payment feature: Snapcash (possible area for growth but too early to assess its viability just yet).

Recommendation:

Snap’s valuation has built in a huge expectation of sustained, high growth, which does not appear reasonable or fair by conventional standards as well as considering the risk of competing against, its direct competitor, Facebook’s Instagram which has deeper capital reserves and infrastructure to compete and outmaneuver Snap with its cross functional expertise and innovation as well as being able to quickly replicate Snaps existing ideas.

The current market take-up of the IPO also indicates to a lower valuation expectation from Snap’s original filing, at a now reduced $19.5–22.2 billion range.

Snap is currently based on speculative hope on its potential possibilities. In a year from now the investor would be in a better position to see how management performs and how costs impact on its future profitability.

I would recommend holding off getting involved in Snap’s IPO and review its position after 1 year of being listed on the secondary markets to be able to gauge:

1. The effective leadership and credibility of the yet untested, Snap CEO who will wield near complete control in voting rights and the strategic decision-making for Snap; and
2. Also to assess how prudently the current fund raise will be used in future acquisitions to shape and reinforce the potential growth scope for Snap
3. How many times Snap may have to comeback to market to raise further funds and the perceptual valuation changes over time and factoring in competition in this space, to make Snap a commercially viable proposition.