Here’s why Snap is playing it safe with investors

Evan Spiegel
Snap CEO Evan Spiegel. Snap Inc.

Snapchat executives hit the road on Friday to lure investors into what could be the biggest tech-sector stock offering in years.

The schedule of meetings will take them to London on Monday, and New York on Tuesday, and eventually across the US. And if it’s like other high-profile tech deals of recent years, they will draw a standing room only crowd of analysts and fund managers looking to get a feel of what the buzz is about.

Already, though, Snap Inc. has raised some eyebrows on Wall Street. After people close to the company floated the idea that it would be valued at up to $US25 billion — for months — it hits the road with a price range that puts its maximum value at closer to $US22 billion.

It’s not a massive difference, but it was enough to raise the question of what happened. There are plenty of reasons for investors to be sceptical of the company’s disappearing message app. One is simply that its user base is young, and that means plenty of decision makers on Wall Street won’t even understand what it is.

Snap knows this and one video posted on its website for investors Friday is simply a lesson on how the app works. People close to the company said that preliminary meetings with investors and analysts, late last year, included this lesson.

Then there’s the question of its valuation. Even if $US22 billion is lower than it might have sought, the company only reported $US400 million of revenue in 2016 and no profits. Also, it has a share structure that means investors paying that will get no say in how it is run.

So is that all getting baked into the price already? Maybe. Reuters reported that one reason for the slightly lower valuation reflected feedback from those preliminary meetings.

Playing it safe

One person close to the situation told Business Insider that Snap is playing it safe with the intention of going higher as soon as demand merits. Conversely, asking for the full $US25 billion and being forced to roll it back if investor demand isn’t high enough would be a worse outcome that taints the company’s trading debut.

Snapchat app

The company said Thursday it was seeking to price shares at $US14 to $US16, but this person — who asked not to be identified discussing the situation — said the only acceptable price, in reality, will be $US16 per share or more.

This person expects Snap’s order book to be oversubscribed, meaning there will be demand for more shares than it is selling.

“If you look at Twitter, Facebook, or Alibaba, there’s a pretty consistent playbook that many companies run,” a pre-IPO investor in Snap, who also asked not to be identified, told Business Insider. “They come up with range that’s very attractive and then they walk it up.”

A spokesperson for Snap declined to comment.

So is it worth it?

Among the risks investors are likely to focus on is a slowdown in user growth. In the fourth quarter, for example, Snap says it had 48% more users than a year earlier. That’s the slowest growth rate for any of the 12 quarters for which it reported numbers.

“The deceleration in user growth is a clear indicator that Snap is losing its snap,” said Lee Bressler, portfolio manager at Carbon Investment Partners, a small hedge fund. “Instagram’s stories feature is a direct competitor and will continue to take market share. This could be the next Twitter, or worse, Myspace.”

Twitter, which went public in 2013, is struggling to grow its user base and investors who held the stock for the last three years have been punished for it: at about $US16 a share currently, the stock is well below its IPO price of $US26.

Spiegel is set to respond to concerns around its slowing user growth in investor meetings. As Business Insider previously reported, he plans to emphasise quality of engagement over quantity of users. He wants his existing users to really enjoy the product and is focused on innovating to make it more usable.

Part of that means users must have higher-end smart phones. Snapchat works best on iPhones, and while some problems persist on Android and other phones, Spiegel says he will not dilute the product to make it work on every phone.

So unlike Facebook, which has nearly 2 billion users around the world, Snap will not focus on non-iPhone-using customers in places like the developing world because those markets are not easily monetized. The logic is that advertisers want to reach North America and develop Europe rather than the rest of world.

In the company’s roadshow materials, it said its biggest revenue opportunity is the growing budget for worldwide mobile advertising, which could reach $US196 billion by 2020 from $US66 billion currently.

Snap’s business is to “create the best camera platform so we can drive engagement and monetise that engagement through advertising,” Chief Strategy Officer Imran Khan said in the video.

Growing revenue

Focusing on revenue growth makes sense for Snap’s executives because of the blistering pace at which sales are increasing. The company sold its first ad at the end of 2014, but really started to monetise the business with the hire of Khan in 2015. His team grew revenues from $US58.7 million in 2015 to $US404.5 million in 2016. Last summer, the company launched Snapchat Partners, an advertising API, to expand the advertising business.

Consumer tech investors Goodwater Capital estimate Snap will grow revenue to $US1.10 billion in 2017, $US1.94 billion in 2018, and $US2.75 billion in 2019. They estimate the company will turn its first profit in 2020.

Certainly, the company’s existing backers are betting that the stock will be more like Facebook — which is up 250% since its 2012 debut — and less like Twitter.

Of course, Facebook’s stock famously tanked in the months after its debut, losing about half of its value and raising questions about its pricing, though the company has now far surpassed that initial valuation.

“While on an absolute basis, the valuation appears high from an investor’s risk/reward perspective, I think Snap becomes very much the next Instagram, or possibly bigger,” the existing Snap investor, whose fund has a $US150 million stake in the company, told Business Insider.

Instagram, a photo-based social media network, is owned by Facebook.

Facebook has “consistently tried to kill Snapchat off,” the investor added. “It’s a risk, but what helps me sleep well at night is that Snap has consistently out-innovated Facebook for five years and I think that is likely to continue.”

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