Snapchat’s IPO – analysis and implications

Sapchat IPO - Cover

Snapchat, launched on July 2011 under the name Picaboo, defines itself as a camera company. However, most of us identify Snap as a multimedia application for image messaging. Before the app became widely known, other social media such as Facebook or Instagram dominated the industry. How did this young company manage to penetrate the market, reaching 158m daily users in such a competitive environment?

Snapchat’s success is based on the innovative idea of 24-hour photo and video sharing. Cofounders Spielger and Murphy were quick to monetize on their invention introducing initially an app available to iOS systems and in 2012 expanding accessibility also to Android users.

After acquiring several companies including Looksery and Bitstrips, Snapchat evolved to include lenses, geofilters, discover features, a chat service and eventually group chats and memories sharing.

Nevertheless, the founders do not envisage Snapchat only within the limits of social media. Although Spielger has tried to maintain maximum secrecy, his intentions of approaching a new market were made clear in 2014. At the time Snapchat acquired Vergence Labs, a company specialized in the development of “smartglasses” for live streaming. Furthermore, the release of Spectacles in November 2016, sunglasses that make Snaps from a human perspective, revealed that the company was pursuing a brand new strategy.

Business Model

Similarly to other social media companies, Snap has one main source of revenue: advertisement. The main tools Snap uses for advertising are Discover, Snap Ads with video attachments, as well as sponsored lenses and geofilters.

In 2015 and 2016, advertising revenue accounted for 98% and 96% of total revenues, respectively. Currently, the cost of advertising through Snapchat amounts to $100 per thousand viewers. Some top brand companies have had to pay bills as high as $750,000 for daily placement to access the exposure that Snapchat provides. This clearly implies that advertising revenues are strongly correlated with the user base. The more users Snapchat is able to attract, the more companies are eager to pay for the advertising space. Over the last year, daily active users have grown by approximately 50m, a 48% increase.

In an attempt to diversify its revenue base, and given the competitive pressure that characterizes the advertising market (in particular from bigger competitors such as Facebook and others), Snap has recently attempted to enter the market for hardware products. It is safe to say that the company did not succeed in its first attempt. Sales from the newly developed “Spectacles” accounted for an insignificant portion of total revenues.

IPO Structure & Analysis

On 2 March 2017, Snap launched an initial public offering on the NYSE for 200m class A non-voting shares. The initial offering price was set at $17 per share, above the recommended $14-$16 price range, because of strong investor demand. Snap managed to cash in $3.4bn from the offering. The proceeds will be used to finance the company’s future expansion plans, among which the agreement with Google for $2bn in cloud storage services in the following 2 years.

Corporate governance will remain practically unaffected by the public offering. In fact, only Class A non-voting shares have been made available to the general public (shareholders who buy them will be entitled to attend the company’s annual shareholder meeting and ask questions). Class B shares, which entitle the holder to one vote per share, are reserved for early investors and executives. Finally, Class C shares provide 10 votes per share and make up 88% of the overall voting capital, and are held solely by the co-founders Evan Spiegel and Bobby Murphy.

On the first trading day, Snap opened at $24.42 per share, 44% more than the initial offering price of $17 per share, and closed at $27.2. Despite early speculations, the Greenshoe option was not triggered to satisfy initial demand.

The equity was raised through class A non-voting shares only. The lock-up period, negotiated between the management and the underwriters, was agreed to be 150 days for three quarters of the shares, and one year for the remaining one quarter.

Snap IPO - Figure 1Is it overpriced?

Investor appetite has been exceptionally high despite Snap’s controversial choice of stock offering and widening net loss figures. Professor Aswath Damodaran valued the company’s equity at an average of $14.9bn, $4.8bn less than the market. Not solely in his opinion, the $19.7bn figure was reached to satisfy demand, and does not represent the company’s true fair value.

Despite never having made any profit, Snap’s revenue growth has been about 590% between 2015 and 2016. A quick look at financial figures shows an approximate $200m increase in R&D expenses as well as Sales and Marketing costs starting in 2015, part of which is attributed to Snap’s new product: the “Spectacles”. However, cost of revenue has decreased from around 210% of revenues in 2015 to only 12% in 2016, which is a good sign. On a different note, analysts claim that Snap’s growth rate in active users, directly tied to revenue growth, is coming to an end due to Facebook’s competitive response. With the introduction of Instagram’s “Stories” one can see an immediate proof of the aforementioned claim.

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