Snap Inc. – Pain not gain

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I see only pain for investors paying $22.5 at the IPO.

• $20bn – $25bn is at least 32% too much to pay for investors who will also have no say whatsoever in how the company is run despite having significant skin in the game.
• Snap Inc. has published its S-1 document allowing for a fundamental-(ish) based valuation to be made for the first time.
• Given that Snap Inc. has no profits and no cash flow, only an analysis based on revenues and users is possible at this point.
• At the end of Q4 16 Snap Inc. had 158m daily active users (DaU) from which it generated $166m in Q4 16 and $405m for the full year.
• I think that the most applicable peers for Snap Inc. are Facebook which owns Snap Inc’s two biggest rivals, LINE which is very similar company based in Japan and Twitter which operates in a niche just as Snap Inc. does.

DaU based valuation.

• For DaU, the only reliable comparison is Facebook as the other peers do not reliably disclose this metric.
• Facebook has 1.2bn DaU and an enterprise value (EV) of $339bn giving EV / DaU of $283.
• By comparison Snap Inc. at the IPO EV of $21.5bn looks cheap with an EV / DaU of just $136.
• However, Facebook generates 6.6x more revenue from each of its users than Snap Inc. and therefore I think each Snap Inc. user has much lower value.
• Furthermore, I remain concerned that Snapchat’s core user base of 12-24 year olds is not as interesting to advertisers as the older demographic groups.
• This is because this age group does not have a lot of money to spend on products and therefore is of less value to advertise to.
• This combined with the fact that Snap Inc. has only 14% coverage of the Digital Life pie compared to Facebook at 36% means that its long-term potential in its current business is much lower.
• If I adjust Facebook’s EV / DaU to account for these factors, I find myself willing to pay around $80 per user giving me an EV estimate for Snap Inc. of $12.6bn.

EV/Sales based valuation.

• The peer group of Facebook, Twitter and LINE Corp is trading on a forward EV/Sales multiple of 6.0x for 2017E and 5.0x for 2018E.
• Given, Snap Inc.’s current growth rate and its medium-term potential (see here), I think that the company could conceivably generate revenues of $800m in 2017E and $1.2bn in 2018E.
• Being generous to Snap Inc. and because it is growing much faster than the peer group I can give it a 300% premium to its peers giving an EV valuation of $12.0bn based on 2017E and $21.6bn based on 2018E.
• The average of these two is $16.8bn with which I can be comfortable assuming flawless execution, continued rapid growth and a move into generating profits.

Corporate governance.

• Very much like Facebook, Alibaba, Baidu and Google, the founders will continue to control the company with the new investors being sold non-voting shares and having no say in how the company is run.
• While, this is an acceptable structure in early stage, private companies, I think it has no business being present in large capitalisation, publicly listed companies.
• This is because history has shown that while things are going well, this is not a problem but when things go wrong, the problems tend to be much worse and last for much longer than they would otherwise if minority shareholders had a say in management and strategy change.
• This happens because founders tend to be emotionally attached to their companies to the strategies that they have created and as a result they hold onto them for far longer than they should.
• In my valuation of Snap Inc., I would normally take a 30% discount to my fair value in order to compensate investors for the extra risk taken but to be as generous as possible to Snap Inc., I have not included this here.

Take Home Value.

• The result of this analysis is an enterprise value for Snap Inc. of between $12.0bn – $16.8bn with the midpoint at $14.4bn.
• Adding back the $1.0bn of net cash the company has on its balance sheet gives me a fair value, in the best instance, for the equity of the company of $15.4bn.
• This is some 32% below the midpoint of the range reinforcing my previous opinion (see here) that this is an IPO to be avoided at all costs.
• I would rather own Microsoft, Tencent or Baidu.