Snapchat Unfiltered: Fundamental Company Analysis

The proliferation of social media platforms is a trend characterized by an ever-changing development landscape. Many tech and social media companies come and go in the blink of an eye. One such company that continues to amass a significant user base is Snap Inc. This article looks at the digital monetization of advertising revenue streams and the upside potential this offers for the company. Last week’s initial public offering is referenced, including commentary on the accuracy and sustainability of it’s current valuation. Furthermore, the potentially hazardous corporate governance implications of it’s voteless shares should garner further attention in advance of a formal review by the Investment Advisory Committee this week. Ultimately it is suggested that investors should exercise a degree of caution when considering a company that certainly displays significant upside potential.

Good start on Wall Street-A Throwback to the 90’s

In a market starved of sizeable tech IPOs and under-performing hedge funds and mutual funds in recent years, a heavy oversubscription for shares in Snap Inc. came at no surprise. When the bell rang to signal the start of trading last Thursday, the floor of the New York Stock Exchange emanated a similar overcrowded buzz to that seen at it’s peak in the 1990’s. The prospectus listed a price of $14 to $16. It was initially priced on Wednesday at $17. On Thursday, the stock opened at $24, a staggering 42% above it’s pre-IPO valuation. This generated significant momentum for the stock to reach a high of $28.84 on Friday, a gain of almost 70%. With an opening market capitalization of $34 billion, the stock was already in the top third of the S&P. In comparison to Facebook and Google, who both traded below their IPO price, the stock had a very positive start.

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Snap Inc’s Innovative Touch

The initial interest is largely driven by the monetization potential of virtual advertising streams. The company’s primary application, Snapchat, represents a new form of engagement for the younger demographic, that is becomingly increasingly difficult to reach from a marketer’s perspective. Continually developing facial recognition filters give advertising companies the potential to display branding on user faces, without compromising engagement and usability. Similarly, geo-filters allow for location specific advertising platforms to provide a limitless and memorable mode of artistic entertainment for vacationers and locals. Many investors see this as an example of

spectacles
Snapchats new wearable tech, ‘Spectacles’

the entrepreneurial nature of the company and are excited about the upside potential associated with this new advertising medium. The introduction of the ‘Discover’ mode as well as Spectacles, leads the way in a new wave of augmented reality and wearable tech. After turning down a $4billion dollar acquisition offer from Facebook, Snap Inc co-founder Evan Spiegel’s visionary leadership provides plenty of impetus for investor optimism.

Reality Check

Despite being the biggest tech IPO on the US market in 3 years, prudent investors and research companies are displaying an ever-growing degree of caution. While revenue was $404.5 million last year, up from $58.7 million the year before, so too were losses. Operational losses of $515million in 2016 increased from $373 million in 2015. Even though the firm incurred significant legal costs early on and revenue is expected to climb to over $1 billion, it is difficult to justify the stocks current market valuation. The company has generated significant losses and has seen a drop in the growth of its user base following increasing competition. In particular, the introduction of Instagram’s ‘Stories’ feature immediately preceded a noticeable reduction in the growth of Snapchat’s user base. This was listed as a competitive concern in Snap’s prospectus. One of the most alarming metrics is the fact that at it’s current valuation, Snap shares are trading at 37 times the estimate for 2017 advertising sales. The market is pricing the company on the basis that there is a full realization of future advertising revenue potential. This could perhaps be a Twitter 2.0, which has seen a drastic reduction in it’s stock due to questions around the sustainability of future advertising revenue streams. Whilst there is significant upside potential of this young innovative company, fundamental analysis dictates a conservative approach for investors.

Market Noise and the Institutional Investor

Volatility in the tech space comes at no surprise, in a fast paced industry that continues to see drastic innovations and technological developments. Typically, approximately 85% of the allocation of tech IPOs is granted to institutional investors and 15% is granted to retail investors. In this case, the allocation was almost 100% to institutional investors. The anticipation and market noise leading up to the first day of trading resulted in a surge in the stock price to $28 per share, up $12 to $14 on the price listed in the prospectus. On the back of comparatively poor financial fundamentals, it is evident that many large institutional investors opted to flip the stock to generate significant profits. Typically these investors are rewarded with short-term allocations by underwriters for their large portfolios and frequent activity. These gains are largely offset by losses sustained by at least a quarter of buyers, who are expected to agree to a 1 year lockup. In a market driven by large investors, it is advisable for investors to exercise some degree of reservation in a highly volatile market.

Regulatory Concerns: Voteless Shares

The decision to issue shares without voting rights is a current point of discussion for many investors and commentators. Shareholder voting rights act as an accountability measure as it allows shareholders to have a say in the way in which the company is run. From a corporate governance perspective, this allows shareholders to guard against excessive corporate power. The Investment Advisory Committee (IAC) will be meeting this Thursday to advise on the potential impact of these voteless shares. The continued existence of the IAC is subject to review as part of the deregulation measures under the Trump administration.[1] The share structure essentially gives Snap access to public equity, whilst preventing shareholders from having a say in the decision making process. This represents a significant risk, as shareholders have no means to curtail an executive abuse of power. On the contrary, the decision by Snap to entrench its founders at the core of its decision making will allow the company to fulfill its creative vision. Ultimately it is evident that this decision poses a risk for potential investors and should be followed in the coming weeks and months. Managerial entrenchment is generally criticized due to the potential for corporate governance malpractice.

Final Word

The creative vision exhibited by Snap Inc has certainly generated much discussion on a global basis. The company is leading the way in redesigning social media communication platforms. Snap’s visionary approach and expanding product offering has enticed many investors so far. In particular, the monetization of advertising networks presents a real source of revenue growth going forward. However, recent declines in the company’s stock are indicative of a comparatively poor financial performance to date. With the stock now trading below it’s opening IPO price, a pending review of it’s voteless shares and significant operating losses, it is wise for investors to exercise a degree of caution.

[1] For further commentary see the article I wrote on March 2nd entitled “Proposed Deregulation of the Financial Sector: Commentary and Analysis”.

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