With the help of booming equity markets and investor hopes of buying into The Next Facebook™ at a relatively early stage, Snap Inc. priced its long-awaited IPO above its initial price range. And judging by reported demand for the 200 million shares Snap is selling through its offering, that same euphoria could lead shares to pop when they begin trading on Thursday morning.
But this doesn't guarantee that Snap will continue flying higher in the days to come. The red flags raised by Snap's IPO filing did much to increase the ranks of those worried about its ability to fend off Facebook (FB - Get Report) , appeal to more international and older users and post healthy profit margins in future years. And until Snap delivers numbers that refute at least some of these concerns, shares are likely in volatile ride.
On Wednesday afternoon, Snap priced its IPO at $17, above an initial $14 to $16 range. That means the company is raising $3.4 billion through its offering -- given its red ink and competitive pressures, that cash could come in handy -- and could raise up to $510 million more through an overallotment option that gives IPO underwriters the chance to buy an extra 30 million shares.
Based on an official share count of 1.16 billion, the IPO pricing gives Snap a $19.7 billion valuation. But after factoring accounting for the many stock options and restricted stock units (RSUs) set to vest, Snap is assigned a $23.6 billion valuation.
Based on 2016 revenue of $404 million, Snap is going public at a valuation of 58 times trailing sales. Assuming the company hits a reported 2017 sales target of $1 billion -- the slowdown seen in the company's sales growth in the fourth quarter suggests this isn't a given -- it's trading at nearly 24 times forward sales.
Jim Cramer sat down Wednesday with four market experts to talk about how to play the Trump tax plan. Click here to check out their recommendations.
Facebook currently trades at 10.5 times forward sales. Given Snap only began seriously monetizing its app last year, and likely has more room to increase average revenue per user (ARPU) for its core app, granting the company a higher forward sales multiple is in some respects understandable. But this needs to be partly offset by the fact that Facebook is incredibly profitable -- it produced a 52% reported (GAAP) operating margin last year on revenue of $27.6 billion -- and it's far from a given that Snap will produce similar margins anytime soon.
Snap had a GAAP net loss of $451.6 million last year, thanks to costs and expenses of $924.9 million. And the company's cloud infrastructure expenses are single-handedly set to total at least $3 billion over the next 5 years, given the $2 billion and $1 billion respective commitments it has made to cloud providers Alphabet/Google (GOOGL - Get Report) and Amazon (AMZN - Get Report) (hosting tons of user-produced video traffic is costly). Sales/marketing spend rose over 4-fold last year to $124 million as Snap got serious about selling ads -- it wouldn't be surprising to see 2017 spending be above $200 million -- and R&D spend more than doubled to $183.7 million.
And while Snap's modest Q4 ARPU per daily active user (DAU) of $1.05 bodes well on the surface for future ad growth, the fact that it doesn't have nearly as much data about its users as Facebook hurts its ad-targeting abilities. Moreover, the company doesn't have a core feed on which to show ads -- it places video ads within its Stories streams, and lets companies buy "sponsored" lenses and stickers that can be attached by users to shared content. And its relatively small user base -- DAUs were at 158 million in the fourth quarter, a small fraction of Facebook's 1.23 billion -- is a turn-off for some of the brand advertisers whom Snap is counting on so heavily for growth.
But perhaps nothing looms larger for Snap skeptics than the the threat posed by Instagram, whose user base from all signs has much overlap with Snapchat's. Instagram's launch of its own Stories feature has reportedly caused major traffic declines for some prominent Snapchat Stories accounts. It's also believed to be a key reason Snapchat's DAUs only rose by 5 million in Q4 and 10 million in Q3, after having grown by 21 million in Q2 and 16 million in Q1.
Jim Cramer and the AAP team hold positions in Facebook and Alphabet for their Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells FB or GOOGL? Learn more now.
The challenges faced by Snapchat, whose app is seen as confusing to many, in winning over users outside of the teen and 18-to-34 demographics, and in various overseas markets, also likely contributed to the DAU slowdown. Research firm MoffettNathanson estimates Snapchat reached only 23% of Americans over the age of 35 in the fourth quarter, as compared with 70$ of those in the 18-to-24 demographic.
Going forward, the fact that Facebook's WhatsApp and (judging by tests) Facebook Messenger are rolling out their own Stories clones won't help matters. It also won't help that Instagram is now selling ads against its Stories and supports a live streaming mode for the service, and is giving the users the ability to send Snapchat-like disappearing private messages.
For all these challenges, the nature of the Snapchat app, and the way that many of its daily users remain hooked on it, do provide something of a moat. The whimsical, irreverent nature of much of Snapchat's shared content makes for quite the contrast with Facebook and Instagram's core feeds. The fact that users don't have to worry about "likes" and public comments for shared items also goes over well with many (though it's worth noting the same is true for Instagram Stories), and the fact that Snapchat's app opens up to a camera view rather than a feed encourages the constant sharing of photos and videos in a way that other social media platforms arguably don't.
But Snap isn't being valued at over 20 times forward sales (in spite of massive losses) simply on the hope that it will hold onto its core base. Those granting it such a valuation are also hoping that the company will follow up on its meteoric rise from 2012 to mid-2016 by significantly expanding its base and making big strides towards better monetizing it.
With those who have doubts that these things will happen having just been given a lot of ammunition for their arguments over the last month, Snap could very well be a highly volatile "battleground stock," at least until its first-quarter results come out.