The Lessons Learnt from Snap’s IPO

by Assaf Gilad (Zirra) & Chaim Schiff (PrivatEquity.biz)

Four months following its IPO, Snap’s stock price was crashing at about 45%, and investors start learning their lessons after investing in an overpriced company. Investment in the company was recently compared by NYU professor Scott Galloway to driving while being drunk, and underwriter Morgan Stanley changed its tune toward the company, saying they “were wrong about Snap’s ability to innovate and improve its ad product this year.” It now seems that Snap is another example of an excessively overvalued Silicon Valley unicorn.

After the recent collapse of Snap and Blue Aprons’ stocks, Pre-IPO companies such as Dropbox, Spotify, and Uber might postpone their plans to go public, and stay away from the scrutiny of the investors in the public market. However, when the window of IPO for tech companies opens up again, and it will sooner or later, it will become necessary to learn the lessons from Snap’s IPO. Here are a few of them:

1. Don’t disregard preliminary signs of slowing growth: Snap’s IPO was based on a significant growth in user base and revenues, and a clear estimation as to when the company turns profitable. That is great- but not enough to have a successful IPO. It is now clear that Snap had to make sure that the growth is sustainable. Indeed, Snap experienced a fantastic surge in revenues, which increased nearly 600% from 2015 to 2016 and reached more than $400 million. In addition, the number of users has also doubled within two years, from 80 million at the beginning of 2015 to about 160 million at the end of 2016. However, investors that were quick to heavily invest in Snap in the days that followed the IPO didn’t see — or didn’t want to see — the signs of slowing growth in Snap’s adoption and engagement data that were already public knowledge before the IPO. The fourth quarter of 2016 saw a low level of acquisition of new users. In fact, the holiday season was the weakest in this regard; with only a 3.2% growth rate to reach 158 million users, about a fifth of the rate of increase it experienced two-quarters before, and lower than Facebook’s. The first quarter’s earnings have made the full picture even clearer, confirming the slow growth. Daily active user rate rose by 5% only (Instagram Stories grew by 25%), and revenue per user declined by 14%. The same lesson that might have been learnt by Blue Apron’s investors lately. Even before Amazon acquired Whole Foods, there were signs that Blue Apron is suffering from a halt in user growth, a growing cost per customer, and higher churn. As in the case of Snapchat, low barriers to entry, brought competitors to replicate their products.
2. Be patient. Don’t rush to go public: It took Facebook eight years to file for an IPO, and it has done so three years after turning profitable and after years of growing steadily. Snap, or Blue Apron, are younger companies that enjoyed a rapid growth but at the same time may yet be immature to go public. On the date of IPO, Snap was still short of ad measurement and ad-serving platform. That gave Facebook, who already has such systems, an immediate advantage after developing a Snap replica.
3. Make sure you have a product- not a feature: Snapchat is a stand-alone application that is used by 166 million on a daily basis. However, since the summer of 2016 Snap found it hard to keep its uniqueness and grow with the aid of the network effect. Snaps’ features such as disappearing photos, animated lenses and stories were easily replicated by other highly engaged social networks such as Facebook Instagram, Whatsapp, and Messenger. Instagram Stories quickly grew to 250 million daily users, adding 50 million users each quarter on a constant basis. According to Morgan Stanley, this might have slowed down snapchat’s adoption, bringing down the estimates for daily users by the end of 2017 from 185 million to 182 million. In addition, Instagram’s is competing aggressively not only for Snap’s users but also its advertisers, offering them sponsored lenses for free. Snap claimed itself a “camera company” and even acquired a bunch of augmented reality startups lately, but so far its business model focuses on solely on selling ads, just as its competitors.
4. Give your employees enough stocks, align their interests with those of the company make them want the company to succeed: Snap’s employees have to wait much longer and work harder in order to enjoy the fruits of their stock options. In addition, their most common awards granted, restricted stocks units, suffer from a higher degree of taxation (47%). Snap disregarded these needs, and was late in launching new platforms: the employees aren’t incentivized enough to work hard in order for the stock to do well, as in other tech companies who went public. For instance, only app. 25% of Snap’s stock awards granted to employees had vested by the end of 2016. In contrast, at the time of Facebook’s IPO, 66% of its stock awards were already vested. Moreover, Snap’s employees will have to wait longer for the lock-up period to end in order to sell their shares, following the IPO, and to do so only after Q2 earnings on August 10. Many of them are afraid from another dipping in the stock price, either because of the earnings or because of the lock-up’s expiration that could lead investor and employees to “dump” their shares. Already now, at $15 per share, down roughly 38% from its $24 opening day trading price, almost at an all time low, many employees would probably feel they are better off taking home whatever they can sell and care less about the price holding up.
5. **The public market is not necessarily more rational than the private market:**Was the public market behaving rationally in the case of Snap’s IPO? It depends on who you ask. Some will say that Snap’s IPO was the classic example of a rational market that calibrates its pricing as a result of the company’s financials and market adoption. The same people will claim that Morgan Stanley, Snap’s underwriter, slashed their company’s target share price from $28 to $17 after learning that Snap is experiencing some challenges with the development of advertising platforms and with improving their results. This would never have happened in the private market, in which valuations are sometimes very far from results, and sometimes depend on valuations in previous rounds and on investors and entrepreneurs’ prestige. The same thing happened to Blue Apron: the company’s valuation has cooled down 40% in comparison to its valuation in the last pre-IPO round. But Others will suggest that it was the public market that inflated Snap to high valuations such as $24 billion in the first day of IPO, then to $28 billion, and then to $34 billion. This, despite the fact that Snap has never made a profit and its S-1, warned of slowing user growth and growing competition from well-funded social networks. Some will call it irrational. Morgan Stanley expectations of Snap were very high until recently, but when it corrected its forecasts earlier this month, it wasn’t the first time. In April, Business Insider published a story about the fact that Morgan Stanley had to correct its equity research on the company, cutting Snap’s 2025 adjusted EBITDA from $6.57 billion to $4.92 billion, and the free cash flow from $4.05 billion to $2.42 billion. Surprisingly, the correction did not change the $28 target price of the stock. Morgan Stanley is not the only one who floated Snap in the weeks and months following the IPO. Citi, also a part of Snap’s rallying IPO, rated Snap a buy until June, and according to S&P Capital IQ, the average rating on Snap is still “Buy.” In fact, more than the underwriters, it is the institutional investors who were flocking to buy Snap stocks in the days after the IPO that created the major inflation in the share price. Their hunger for young and trendy tech companies, together with the hype behind Snapchat’s growing revenue in 2016, was the main reason behind Snap’s stock rally last March. Rational is not the word we would pick to describe it.