There is now less than a week until the Snap IPO debuts, and analysts from everywhere have talked about the biggest tech IPO in years. The hype is so big that the NYSE is launching a trial run of their IPO this Saturday to make sure that it can handle the expected demand.
But with hype comes scrutiny, and there is a lot to scrutinize Snap and Snapchat about. Snap wants investors to think that it will become the next Facebook, a large, successful, and profitable tech company which thrives off the power of advertising. But pessimists look at Snap’s slowing growth and unprofitable numbers and worry about how it could be the next Twitter, a social media website that is flailing about trying to make money.
It is impossible to know for certain which route Snap will follow. After all, Twitter surged out of the gate in its IPO while Facebook stumbled, a complete contrast to their performances today. But Snap CEO Evan Spiegel’s explanations for Snap’s issues are problematic, and investor should be wary of his ability to fix things. Under these circumstances, Snap is more likely to look like Twitter and probably should be avoided.
Why Revenue Growth is not good enough
If you have not been keeping up with this IPO, the general problem with Snap are its heavy losses. Snap reports net losses of about $515 million in 2016 and $373 million in 2015 according to its own SEC filing. It is also heavily valuated with a price to sales of ratio of over 50.
Tech companies losing money is hardly unusual, though they justify it by claiming rapid expansion. But in Snap’s case, its user growth rate slowed in the second half of 2016, which is spurring fears that Snap could be a massively unprofitable company without high growth prospects.
Spiegel is trying to explain this slowing user growth rate by claiming that it is due to “performance issues we face on Android in the last two quarters” with lower-end devices and that Snap has “been investing a lot in fixing that.” He also wants investors not to look at its slowing user growth, but its revenue growth which shot up from $58 million to $404 million from 2015 to 2016.
This justification is not good enough. Snap’s revenue growth comes from its decision to finally allow advertising in late 2016. And a large part of Snap’s appeal is that it has mass appeal with teenagers and millennials. Snap could theoretically ramp up advertising with this key advertising demographic, continue to exponentially increase revenue, and solve its profitability problem.
But will teenagers stay with Snap if it ramps up the advertising or will they just flock to similar social media sites? Snap may not want to admit it, but the emergence of competitors like Instagram Stories is a factor behind its slowing user growth rate. While Snap certainly can make more money through advertising, it can only do so much with a limited user base due to millennials’ disdain for advertising. And with the aforementioned competition, I remain skeptical towards whether it can get the high growth rates which initially attracted investors.
Betting on Spiegel?
Snap has problems which it needs to fix, but the other question is whether it has the personnel who are capable of fixing it. And that brings up the problem of Snap’s problematic voting structure with this IPO – or rather, its nonexistent structure. As Quartz noted back in early February, the shares being offered in this IPO are nonvoting shares, which means that power will be placed overwhelmingly in the hands of Spiegel and his backers.
This is not too different from how other tech companies like Facebook offered extremely limited voting rights, criticized by Hilary Clinton, and Spiegel wants to persuade everyone he is the next Zuckerberg. But at 26 years old, does he really have the experience to guide Snap through these aforementioned problems? Investors could find themselves in the unenviable situation of watching Spiegel, who at times seems to care about Snap’s vision of being a camera company more than cold reality and numbers, do his thing while lacking the votes to limit him at all.
High Rewards, but too High Risk
The Snap IPO will be big despite analyst concerns, and the potential rewards are immense especially as Snap lowered its valuation and pricing recently. But there are severe problems with this company’s high valuation, massive losses, and slowing growth rate, and one analyst called investing in Snap “an act of lunacy.”
I would not go that far, but Snap is more likely to be the next Twitter than Facebook in the long run. I expect Snap to storm out of the gate next week thanks to investor hype, but the fundamental issues plaguing this company should cause Snap’s value to decline. While there may be money to be made in the very ground floor if you can get Snap stock at the very start, there is too much risk for most investors.