Snapchat Begins Preparation for IPO This Week

SnapchatInvestors Preview Snap Financials

For the last few years, initial public offerings (IPOs) have been a barren wasteland of disappointment. Investors hope the upcoming IPO of Snap Inc.—more commonly known as the Snapchat IPO—will break the cold streak, but that really depends on whether Snapchat is a success.

Will Snapchat stock break up or down after entering the market? What will it look like after a year on the public exchanges? Like Twitter Inc (NYSE:TWTR)? Or Facebook Inc (NASDAQ:FB)?

No one can say for sure, because no one has been able to agree on a Snap valuation. In fact, we had no idea what the Snap financials looked like. All we knew is that the Snapchat IPO would be the big investing event of the year.

But there are a number of clues we can piece together. Bits of information leaked out during Snapchat’s private funding rounds. We can use this loose bundle of data points to sketch a rough portrait of the company. Oh, and we can look at the Snap financials released last week.

Did I forget to mention that? Snap disclosed its IPO documents last week, which is probably something that investors should keep an eye on. The investor prospectus enclosed in the S-1 Filing with the U.S. Securities and Exchange Commission (SEC) is crucial to pricing a Snap valuation. (Source: “Form S-1 Registration Statement,” U.S. Securities and Exchange Commission, February 2, 2017.)

Here are the highlights:

  • Snapchat will appear on the New York Stock Exchange (NYSE) under the ticker symbol “SNAP.”
  • The company wants to raise $3.0 billion from this IPO.
  • Between 2015 and 2016, revenues increased 589%, from $58.7 million to $404.5 million.
  • Net losses grew 38% from $372.0 million to $514.0 million.
  • The company has almost $1.0 billion in cash and cash equivalents.
  • The company expects high-growth for the next five years.

Other key elements—like the Snapchat IPO date and Snap IPO price per share—were omitted. No surprise there; high-profile companies usually wait until the last possible moment before declaring their IPO price. It helps them negotiate with the big players on Wall Street: the institutional investors. My guess is that Snapchat founders Evan Spiegel and Robert Murphy are probably in a lower Manhattan backroom right now.

More on the Snapchat Financials

If you look closely enough, the Snapchat IPO filing is stuffed with useful information. Nuggets of insight are hidden from plain sight, but an experienced observer knows where to look. For instance, here’s a little note that caught my eye:

We have three classes of common stock: Class A, Class B, and Class C. Holders of our Class A common stock—the only class of stock being sold in this offering—are entitled to no vote on matters submitted to our stockholders.

(Bolding added.)

Understand what that means. As a shareholder, you will have absolutely no power to influence the company’s behavior. Spiegel and Murphy are basically the “dictators in perpetuum” because they control a majority of the votes. They can basically do whatever they want, whenever they want, without much oversight.

This might seem like a radical maneuver, but it has become popular ever since Facebook’s CEO did the same thing. Mark Zuckerberg held onto his control over the company by issuing new shares that lacked the most essential part of common equity: voting rights.

If you don’t think the lack of voting shares has any bearing on the Snapchat valuation, then I’m not sure which world you’re living in. Mark Zuckerberg happens to be a phenomenal CEO for Facebook, but not everyone can be Mark Zuckerberg. Logic dictates that some founders/CEOs are going to end up being less successful. So maybe handing over full control to them isn’t the best idea.

It doesn’t matter that Snapchat has shown incredible promise thus far. It was a hot little startup; those firms can gloss over problems with enough flash and home-spun mythology. Being a public company is completely different. There are mandatory filings, market volatility, and a whole host of new regulations to contend with. And that’s just for starters.

More on the Snapchat Valuation

We all know that emotions make for bad investment decisions, yet most of us can’t help it.

Big opportunities (like the Snapchat IPO, for instance) can be blinding to even the most rational of people. That’s why it’s important to remember what a business actually does, where its revenues come from, and what plans it has for the future.

So here’s how Snapchat makes money, in its own words:

We generate revenue primarily through advertising,”  it wrote in the S-1 (Emphasis added). “We help our advertising partners generate a return on their investment by creating engaging advertising products that reach our large and desirable audience.” (Source: Ibid.)

By the end of 2016, Snapchat recorded $404.5 million in annual revenue. But our Snapchat valuation is supposed to be based on future revenues, so what we’re really looking for is how much that number could grow. There’s good news on that front. Snapchat’s revenues bubbled up 589% year-over-year, an astonishing number no matter how you look at it.

Can this growth continue? Snapchat has several reasons to think so:

  • Worldwide advertising spending is expected to reach $767.0 billion by 2020.
  • Mobile advertising could triple from $66.0 billion to $196.0 billion.
  • Video ads are moving from TV to mobile.
  • Snapchat users are highly responsive to ads (one campaign showed a 30% increase in subscription intent).
  • Snapchat users are in the “demographic sweet spot” (one campaign showed 88% of viewers were between the ages of 13 and 34).

In plain English, this means that Snapchat could become an advertising-driven behemoth like Facebook and Google (part of Alphabet Inc (NASDAQ:GOOG)). Spiegel and Murphy are fully aware of this possibility, as is evident from how they structured the Snapchat IPO documents.

User engagement was front and center: “Users visit Snapchat more than 18 times per day, and spend 25 to 30 minutes on Snapchat every day.” (Emphasis added, Source: Ibid.)

Advertisers worship that level of engagement. No wonder Facebook tried to buy Snapchat for $3.0 billion. It was scared. It wanted to crush Snapchat before it posed a significant threat, but Spiegel and Murphy were too smart. The young founders said “No” because they didn’t want to work for Mark Zuckerberg; they wanted to be Mark Zuckerberg.

Now that Snapchat is entering the market as a growth company, Spiegel and Murphy may get their wish. I expect the Snapchat valuation to vault from $25.0 billion in market cap to $100.0 billion. These massive returns are possible within nine months of the Snapchat IPO, meaning that both the founders could become deca-billionaires before the end of 2017.

Conclusion

I know 300% growth is a bold prediction, but look at the big picture. Tech bulls haven’t seen a promising IPO in years; they are hungry for a return. The Snapchat IPO in NYSE is an oasis for most tech investors, because that have to put their money somewhere.

Furthermore, Snapchat is only looking to raise $3.0 billion. That’s a relatively modest sum for a company with such explosive growth. In other words, it didn’t overreach by asking for too much money. It was a wise move to keep expectations favorably low.

It also seems keenly aware of reality, which I always value in tech companies. Just look at what it wrote about Facebook in its “Business Risks” section:

We face significant competition in almost every aspect of our business both domestically and internationally…For example, Instagram, a subsidiary of Facebook, recently introduced a “stories” feature that largely mimics our Stories feature and may be directly competitive.

(Source: Ibid.)

It didn’t complain about Facebook’s lack of originality; it acknowledged it as a threat. To me this reveals an impressive level of focus in management. Not buying into your own mythology is key to staying innovative and useful. It seems like Snapchat management understands that.