Now that the dust has settled on the whirlwind IPO of Snap Inc., and most of the institutional traders have been in and out, let’s take a look at the company that investors are now buying into.
Snap, parent company of popular social media company Snapchat, bills themselves as a camera company, whose main product is a video and image sharing mobile app with over 158 million daily active users on average. Like all social media platforms, they generate revenue from advertisers who put engaging video advertisements in between the media created by the users.
Where are the earnings?
Snap ran its first ad (implying the first cent of revenue) in late 2014. It has ramped up pretty quickly from there, increasing from US$58.7m in 2015 to $404m* in 2016, which could suggest that their revenue journey is only just beginning.
It all sounds pretty impressive so far. Until you see that costs in 2015 amounted to $440m, and $925m in 2016. I’ll save you some maths and tell you that this means (after interest and tax are added) the net losses for the years were $372.9m and $514.6m respectively. Snapchat is a data hungry app and the storage requirements for the billions of Snaps sent every day is immense. In fact, it is all stored on Google Cloud, the services for which Snap has committed to paying $2 billion over the next 5 years.
Will Snap ever be profitable?
This is a trend that has been continuing since their inception in 2011, from which time they have racked up an astonishing $1.2billion of accumulated losses. Worse still, Snap can’t actually see when or if this trend will cease. In fact, in their prospectus they issued a warning saying:
“We have incurred operating losses in the past, expect to incur operating losses in the future, and may never achieve or maintain profitability.”
I can guarantee that most external shareholders of Snap have not read this line.
Most prospectuses I read make big claims of how much their profits will grow in the future, and in the case they are still loss-making at time of IPO, they forecast when they think they’ll hit break even. I suppose, at least Snap aren’t trying to sugar coat it.
Ok, but you might say that many companies list while they are still making a net loss in order to raise capital and grow faster. This is true and is not uncommon. But Snap actually had almost $1 billion in cash at the end of 2016 (presumably from prior private investors) so I don’t think that lack of cash was preventing them from executing their expansion strategy.
Every prospectus lists risk factors, and it is always good practice to pay close attention to these. The most pressing risks are generally listed first and Snap is no different. Number one on Snap’s list is the threat of competition whereby users begin using competing products in place of Snapchat. I didn’t need to read too much further in this list because I have already begun to see this happen.
In my personal blog I am surrounded by influencers who push out content all the time to increase their brand awareness. For many, Snapchat is an integral part of their daily life and daily content creation. However, Instagram rolled out a feature called “Stories” last year, which is almost identical to Snapchat’s flagship (read: only) product – that being instant image and video sharing that is deleted after 24 hours. (Facebook have also dabbled but with no success thus far).
I have seen a number of large influencers jump ship to Instagram because that is just one less social media platform to manage. I assume that small social groups of friends will likely stay on, as the filters and geolocation filters are genuinely fun, engaging, and unique to Snapchat, but if influencers with large audiences begin to leave the platform, the attractiveness to advertisers will also begin to decrease. Anecdotally I have seen the number of Stories shared on Instagram increase and those on Snapchat decrease so based on my own experience I would expect to see a higher churn rate and slowing user growth in the next SEC filing than last period.
The success of a social media platform is firmly rooted in its ability to build a network effect. Facebook have created a network effect better than any company has in the history of companies. It could be argued that Snapchat has built a small network effect, however I’d argue that this is diminished by the fact that most people with a Snapchat account will also have an Instagram account and the barriers to change are very low.
All this talk about the business and we haven’t even discussed valuation yet. Snap listed on the NYSE at $17 per share and rose to $24.48 on the first day of trading. Today it is trading at around $20, a market capitalisation of around $23 billion.
Given that Snap is still loss making, it is impossible to value on many traditional methodologies like a discounted cash flow or price to earnings. But as an indication, a market cap like that gives a price to sales ratio of around 60 times. That is astronomical for any stock. In comparison, Facebook trades on a sales multiple of 14 times, and Twitter a measly 4 times.
Regular readers would know that Farnam follows a Buffett-style value and growth investing methodology and it’s just really hard to find any value in what Snap are offering to investors. There might be growth, but even that seems risky.
Robert Kiyosaki put it perfectly when referring to the $3billion of new capital raised under the IPO, over which new stockholders will have no voting rights due to the structure of the stock issued. He said it was the “ultimate con that worked like a charm.
I think the most concerning thing about Snapchat is the combination of the widening loss gap and the churn that we (at least anecdotally) are beginning to see. The competition should be concerning to all investors and if this trend continues, I can’t see Snap ever being profitable, which will require more and more capital to be pumped into the business over time, and could destroy value for investors.
An alternative to this might be that if revenue growth slows, the market will begin to value the company at lower multiples until eventually another player (most likely Facebook) buys the company. It is worth noting that Facebook offered to acquire Snapchat for $3billion in 2013, which Evan Spiegel, Snap’s CEO, declined at the time. This may have been Spiegel’s end goal the whole time, but he saw many more dollar signs just a few years down the road.
All this leads me to one conclusion about Snap Inc.: Evan Spiegel and Robert Murphy, co-founders of Snapchat, have identified that they might have bitten off more than they can chew. Sure, they have built a product that has successfully grown its user base through a fun and engaging product, but they entered a highly competitive market without a proven revenue model. And an IPO was the best and most lucrative means to reducing their own exposure and filling their pockets.
I think it goes without saying that we do not own Snap in the International Opportunities Portfolio.
*Note: all figures in this article are in USD.
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