Snapchat's IPO is ready for takeoff, and there's enough fuel for it to soar or burst into flames

Evan spiegelLara O’Reilly/Business InsiderSnap CEO Evan Spiegel (white shirt) at an event in Cannes, France.

It’s showtime for Snapchat.

After five years of enchanting its teenage users, the mobile app-maker will put on a show for the Wall Street crowd on Thursday when it begins trading as a public company.

Will parent company Snap’s stock have a big first-day pop, in the style of other big internet IPOs?

Or will it take a nosedive, emulating Facebook’s surprise fizzle a few years ago?

At its offering price of $US17 a share, Snap is coming out with a valuation of $US24 billion. That’s a rich valuation for a company that lost half a billion dollars last year and which has only been generating significant revenue for one year.

But fundamentals may not matter much at a time when internet IPOs have been scarce and the overall market is at historic highs.

“Would I be surprised to see it double on the first day? Absolutely not,” said one fund manager who believes the stock is actually overpriced but could benefit from strong sentiment in the short term.

“Investors know they’re buying it at an insane valuation, but you’re counting on the tape driving it higher,” he said.

Eric Jackson, a hedge fund manager who is in the process of starting a new fund, says he wouldn’t be surprised to see Snap’s stock finish its first day in the low $US20s, suggesting up to a 40% pop from the $US17 IPO price.

Other investors note a relatively tight share allocation could help buoy the stock. Out of the 200 million shares being sold (not including the greenshoe), 50 million of the shares will go to investors who have agreed not to sell for one year. And the majority of the shares are going to big mutual funds which are typically long term holders.

“They’re trying to optimise the share price to attract a lot of long term capital,” says Eric Kim, a managing partner and cofounder of Goodwater Capital. “I think they could’ve priced higher. Every communication was that it was $US17-$US18.”

“I think people will say Facebook is 16 times the size even at $US24B and they’re saying they’re willing to take that bet that it will be that big in the future. I think there’s a lot of people willing to take that risk,” Kim said.

Snap, crackle, pop or fizzle

But Facebook is also a cautionary tale.

The world’s most popular social network went public in May 2012 on a wave of hype and exuberance. But things quickly veered off-script, with the stock finishing its first day of trading just 23 cents above its $US38 offering price. In the weeks that followed, Facebook’s stock lost 30% of its value.

“It will be interesting to see if the price holds through the week,” Lee Bressler, of New York hedge fund Carbon Investment Partners says of Snap’s stock price.

FacebookYahoo FinanceFacebook’s stock plunged in its first few months after the IPO

If the stock trades poorly, the IPO’s underwriters — Goldman Sachs and Morgan Stanley — will have to buy a huge amount of Snapchat shares in the open market to create demand and stabilise the stock, Bressler explained.

“So the question is: if it trades poorly, to what extent are Goldman Sachs and Morgan Stanley willing to step up and buy as much stock as they need to. In the case of Facebook, this was a really big deal and the banks ended up wearing the stock for a while,” he says.

Red flags and “idiot money”

And while Facebook’s weak spot in its 2012 IPO was its lack of mobile advertising revenue, many investors point to Snap’s slowing user growth as the red flag.

“The valuation implies that investors buy into the re-acceleration in user growth that is modelled by the underwriters. That is a bold assumption and requires major innovation by Snap,” says Bressler.

Another hedge fund manager, who wished to remain anonymous, had a more blunt view, ascribing the demand to mutual fund “dumb money.”

“The bankers who put this deal together, they must be having drinks right now laughing about this,” the fund manager says, citing the fact that the Snapchat shares being sold are non-voting shares, an unprecedented move for an IPO.

“It’s idiot money. Who would pay these kind of numbers for non voting stock?”

Biz Carson contributed reporting.

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