Last Thursday, March 2, shares of Snapchat parent Snap Inc. (SNAP) went public at $17, well above the $14-$16 initial public offering range. The shares hit a high of $29.44 on Friday morning before closing the week out at $27.09. That quick gain of just under 60 percent was great for investors that were involved with the IPO, but it wasn’t quite the same for investors that entered into SNAP shares after the shares started trading on Thursday morning.
With SNAP shares now trading in the secondary market and the buildup of the IPO now behind us, the question to us is are SNAP shares really worth the current $34.7 billion in market capitalization? At that market valuation, the shares are trading at about 37 times EMarketer’s estimate for Snap’s 2017 advertising sales. As spelled to out in the S-1 filing, Snap’s Snapchat is free and the company generates revenue “primarily through advertising,” the same was true of Facebook (FB) and Twitter (TWTR).
Actually, that’s not THE question, but rather one of the key questions as we contemplate if there is enough upside to be had in SNAP shares from current levels to warrant a Buy rating? Odds are the IPO underwriters, which include Morgan Stanley (MS), Goldman Sachs (GS), JPMorgan Chase (JPM), and Deutsche Bank (DB), that made a reported $85 million in fees from the transaction, will have some favorable research comments on SNAP shares in the coming weeks.
While SNAP shares fit within the confines of our Connected Society investing theme and are likely to benefit from the shift in advertising dollars to digital and social media platforms like Facebook and Alphabet’s (GOOGL) Google and YouTube, our charge is to question using our thematic 20/20 foresight to see if enough upside in the shares exists to warrant placing them on the Tematica Select List?
Boiling this down, it all comes down to growth
The question when looking at Snap is, “Can it grow its revenue fast enough and deliver positive earnings per share so we can see at least 20 percent upside in the shares?”
Well, right off the bat the company’s user base of 158 million active daily users was relatively flat in the December quarter and grew just 7 percent between 2Q 2016 and 3Q 2016. Assuming the company is able to continue to grow its user base, something that has eluded Twitter for the most part, it will still need to capture a disproportionate amount of the mobile advertising market to hit Goldman Sach’s forest that calls for Snap to increase its revenue fivefold by 2018.
Snap recorded $404.5 million in revenue last year, up from $58.7 million in 2015, so a fivefold increase would put 2018 revenue at more than $2 billion. IDC projects that mobile advertising spend will grow nearly 3x from $66 billion in 2016 to $196 billion in 2020, while non-mobile advertising spend will decrease by approximately $15 billion during the same time period.
While a fivefold increase in revenue catches our investing ears, we have to question Snap’s ability to garner such an outsized piece of the mobile advertising market when going head to head with Facebook and its several platforms, Google, Twitter and others. The argument that a rising tide will lift all boats will only go so far when all of those boats are vying for the same position in the monetization river.
There are other reasons to be skeptical, including users migrating to newer social media platforms or ones that have been updated like Facebook’s Instagram that launched Stories to better compete with Snapchat. Snap called this out as a competitive concern in its S-1 filing — “For example, Instagram, a subsidiary of Facebook, recently introduced a “stories” feature that largely mimics our Stories feature and may be directly competitive.” With good reason, because as Instagram Stories reached 150 million daily users in the back half of 2016, Snapchat’s growth in average daily user count slowed substantially. Part of that could be due to Snap’s reliance on the teen demographic, which even the company has noted is not “brand loyal.” We’re not sure anyone has figured out how to model teen fickleness in multi-year revenue forecasts.
Making things a tad more complicated is the recent push back on digital advertising by Proctor & Gamble’s (PG) Chief Marketer Marc Pritchard, who publicly expressed his misgivings with today’s digital media practices and, “called on the media buying and selling industry to become transparent in the face of ‘crappy advertising accompanied by even crappier viewing experiences.'” As Pritchard made those and other comments, a survey from the World Federation of Advertisers showed that large brands are reviewing contracts related to almost $3 billion of advertising spend on programmatic advertising, which automates digital ad placement. The question to be answered is whether ads are actually seen and this has led to a call for companies like Snap to follow Facebook, YouTube and have Snapchat’s ad metrics audited by the Media Rating Council.
One other wrinkle in the Snap investing story is the company has yet to turn a profit.
In 2016, while Snap’s revenue was just over $400 million, it managed to generate a loss off $514.6 million and per the S-1 it will need to spend a significant amount to attract new users and fend off competition. In reading that, the concern is user growth could be far slower — and expensive — than analysts are forecasting, which would impact advertising revenue growth like we’ve seen at Twitter. The thing is, new user growth for Snapchat already slowed in the back half of 2016 as newer messaging apps like Charge, Confide and Whisper have come to market.
When Snap finally does turn a profit, we could see the outsized P/E ratio lead value and growth at a reasonable price (GARP) investors to balk at buying the shares, which means Snap will be relying on growth investors. It amazes us how some investors love companies even though they are not generating positive net income, but balk at P/E ratio that is too high the minute they start to generate positive albeit rather small earnings per share. We get around that problem by using a multi-pronged valuation approach to determine upside and downside price targets.
Is Snap the Next GoPro?
While all those numbers and forecasts are important to one’s investment decision making process (we make that point clear in Cocktail Investing: Distilling Everyday Noise into Clear Investment Signals for Better Returns), we have a more primal issue with Snap. Back in late 2015, we shared our view that GoPro (GPRO) was really a feature, not a product. As we said at the time, we saw Yelp (YELP), Angie’s List (ANGI), Groupon (GRPN) and others as features that over time will be incorporated into other products — like Facebook’s Professional Services, those at Amazon (AMZN) or others from Alphabet’s Google, much the way point-and-shoot cameras were overtaken by camera-enabled smartphones and personal information management functions were first incorporated into mobile phones and later smartphones, obviating the need for the original Palm Pilot and other pocket organizers.
When GoPro shares debuted in June 2014, they were a strong performer over the following months until they peaked near $87, but 15 months after going public GPRO shares fell through the IPO price and have remained underwater ever since.
What happened?
We recall hearing plans for a video network of user channels at GoPro as well as the management team touting the company as an “end to end storytelling solution,” but over the last few quarters, we’ve heard far more about new product issues, layoffs, facility closures and falling unit sales. In 2016, GoPro saw camera unit sell-through fall 12 percent year-over-year to 5.3 million units from approximately 6 million units in 2015.
In our view, what happened can be summed up rather easily — GoPro was and is a feature, not a standalone product. It just took the stock market some time to figure it out once the IPO blitz and glory subsided. While we could be wrong, we have a strong suspicion that Snap is more likely to resemble GoPro than Facebook, which is monetizing multiple platforms as it extends its presence with new solutions deeper into the lives of its users and has changed the way people communicate.
As investors, we at Tematica would much rather own innovators of new products and solutions that are addressing pain points or benefitting from disruptive forces and changing economics, demographics, and psychographics in the marketplace than companies that offer features that will soon be co-opted by other companies and their products. Following that focus on 20/20 foresight, we avoided GoPro shares that fell from $19.50 in December 2015 to the recent share price of $8.84.
And then there’s this . . .
There is another consideration which is not specific to Snap, but is rather an issue that all newly public companies must contend with — the lock-up expiration. For those unfamiliar with it, the lock-up period is a contractual restriction that prevents insiders who are holding a company’s stock, before it goes public, from selling the stock for a period usually between 90 to 180 days after the company goes public. Per Snap’s S-1, its lock-up expiration is 150 days, which puts it in 3Q 2017. Given the potential that insider selling could hit the shares, and be potentially disruptive to the share price, we tend to wait until the lock-up expiration comes and goes before putting the shares under the full Tematica telescope. This isn’t specific to Snap shares, but rather it’s one of our rules of thumb.
We have a strong suspicion that Snap is more likely to resemble GoPro than Facebook, but we’ll keep an open mind during the SNAP shares lock-up period, after all, companies are living entities that can move forward and backward depending on the market environment and leadership team. Let’s remember too that it took Facebook some time to figure out mobile.
Finally, we aren’t so thrilled that none of the 200 million shares floated came with voting rights, leaving the two founders Evan Spiegel and Robert Murphy with total control of the company. We prefer seeing more direct shareholder accountability… but hey, that’s us.
