Why to Be Leery of Snapchat's Expected 2017 IPO, Despite the Buzz

The internet is abuzz with IPO fever on the news that Snapchat might make its public debut in March for $25 billion. But can it justify its valuation?

Investors should be wary. The history of tech IPOs is filled with successes but also failures.

If you had invested in Facebook's IPO in May 2012 for about $38 you would have watched it hit $19 by August. Investors who could stomach the 50% drop then watched as Facebook's stock climbed as high as $132 this past October, a 247% return on the initial investment.

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Conversely, if you invested in Twitter's IPO in Nov. 2013 for $41.65 you would have watched it launch up to $69 by the end of the year and then fall $30 by May 2014. Currently the stock trades at about $19, a loss of 54% since the IPO.

Snapchat is a mobile application where messages and photos are permanently erased 10 seconds after being opened. The app's initial claim to fame was as a platform for teens to communicate (including sexting) without evidence to regret down the road.

Over the last two decades Wall Street has seen more of these tech companies with massive user bases generating lofty valuations based almost entirely upon future projections. The assumption is that if you have a lot of users you can charge advertisers a lot to get access to those users. But the reality has often been different. 

Snapchat's ad space isn't as in-your-face as Facebook's but it does have a dedicated page full of ads that users must interact with to see certain content. That ad space is full of big brands, including the NFL, Cosmopolitan, MTV, CNN, National Geographic and a dozen other brands targeting millennials.

Recently, Snapchat passed 60 million daily users in the U.S. and Canada. By comparison Facebook has 175 million daily users and Twitter has 66 million daily users in the same countries. 

Based on these numbers the $25 billion valuation looks too high.

The app's messaging capabilities are done better by Facebook and the lack of conversation history is a limitation that may grate on users.

In addition, unlike Facebook, Snapchat is not used much by generations older than 30, which means that the company's average revenue per daily user is unlikely to be as high as Facebook's.

Investors shouldn't expect the company's user base to grow unless it creates innovative new products and applications, or makes an acquisition.

Snapchat's best bet is to avoid competing directly with Facebook. To its credit, the company seems to understand as much and has unveiled a pair of sunglasses capable of taking video and developed a popular network. Snapchat may evolve into a competitor to GoPro, focusing on action video. 

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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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