Intense competition, No shareholder control and Sky-high valuation - Will Snapchat IPO succeed ?

Snap Inc., the parent company of Snapchat, on Thursday, filed for an Initial Public Offering (IPO) to raise an estimated $3 billion.

Snap's S-1 filing for potentially the largest tech IPO since Facebook in 2012 brings long sought-after information on the previously secretive company’s financials.

Uniquely, this is the first time a company has attempted to make an initial public offering of non-voting stock on a U.S stock exchange. The stock in the offering are all Class A common stock, and have no voting rights. Evan Spiegel, the CEO, and Bobby Murphy, the CTO hold the majority of the Class C common stock, which entitles holders to ten votes-per-share, and means each of the co-Founders hold 44% of the voting rights.

Evan Spiegel, the co-founder and CEO, was granted Restricted Stock Units (RSU’s) equaling 3 percent of the company’s outstanding shares, which will vest on the day of the IPO, meaning he would hold 24.7% of the total outstanding shares, worth an estimated $6.25 billion, based on the target IPO valuation of $25 billion. Bobby Murphy’s control of 21.7% of Snap Inc.’s shares would be worth approximately $5.5 billion.

The top investors are also expecting big gains through this IPO. Benchmark Capital, the biggest external investors, own a 12.7% stake in the company at an estimated $3 billion. Lightspeed Ventures own approximately 8.3 percent, worth $1.9 billion.

The values above are under the assumption that the $3 billion IPO goes as planned, valuing the company at $25 billion, less than 6 years since its inception. This valuation is 62x the most recent full year revenue figure, which is extremely high compared to comparable company valuations.

The chart below shows the quarter-on-quarter evolution of Snap Inc.’s revenue in 2015-16.

Snapchat has shown a phenomenal rise in revenue, quarter-on-quarter since the start of 2015. Revenue in the final quarter of 2016 was at 42x the revenue in the first quarter of 2015. The rapid gains in revenue, however, were accompanied by a $514.6 million net loss in 2016, 38% more than the $372.9 million loss in 2015. In particular, Cost of Sales increase from $440.4 to $924.9 million. This includes hosting costs, and also amounts paid to partners who create content against which Snap advertising is sold, and we think is a key line item to watch.

The chart below tracks the active daily users of Snapchat over the past 3 years.

Though active daily users increased 47% from 107 million in Q4 2015 to 158 million in Q4 2016, the rate of growth in daily users declined in the second half of 2016. Q3-Q4 2016 had the lowest quarter-on-quarter increase in users during the last three years, at 3.3%.

The graph below looks at the quarter-on-quarter growth rates in active users for Snapchat over the last 3 years.

A potential reason for this slowdown may come from the competition Snapchat faces from Instagram Stories, an application launched in August 2016, which already has a reported 150 million users, and offers many of the same features. This shows the severity of the competition Snapchat faces, as it looks to take the next step in its evolution.

Snapchat is aiming to establish itself as a marketing platform, competing for social media advertising dollars with Facebook, Twitter, LinkedIn, Pinterest and others. Facebook’s user base of over 1 billion is a figure we think Snap is unlikely to reach in the foreseeable future; the data-intensive app is less likely to break into markets where data is expensive, and usage among older generations remains low. Snapchat’s users, however, use the app for 25-30 minutes on average per-day, and this level of engagement, coupled with ad-friendly medium of photos and videos is what Snap believes will appeal to investors and advertisers, as it competes in an online advertising market dominated by Facebook and Google.

Snapchat’s popularity among millennials makes it a very attractive proposition for advertisers. There are plans to diversify the product too; Spectacles by Snap bring a new way to record and share stories on snapchat, and provides an avenue to increase both user acquisition and engagement. Such innovation and focus on increasing user engagement will be imperative in investments in Snapchat yielding positive returns in the long-run.

In summary, we think Snap’s target IPO valuation is high relative to historical performance. However, the company has such a unique value proposition in market that we see significant long-term upside.

For a detailed profile of Snap Inc’s financial, operating and human capital metrics, please click here.

For a detailed comparison of Snap, Facebook, Twitter and LinkedIn please click here.

Sources & Notes:

Snap Inc. S-1 Filings

Twitter, Facebook S-1 Filings

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