Is Snapchat a Good Investment?

Snapchat’s going public!!!!!

Your favorite app to share pictures of yourself with a dog face (or whatever other pictures you don’t want saved by the recipient….) is going public!

That’s right, Snapchat is likely going to be one of the biggest tech IPOs in history. Here’s what you need to know:

Crash Course: IPO (H2)

An IPO, or Initial Public Offering, is when a company transitions from a private company to a publicly traded one, making shares of that company available for average Joe investors to purchase.

When it first came out in 2011, Snapchat originally advertised itself as a new way to chat. Your pictures and videos would be deleted permanently after being viewed by the recipient. Because of these features, Snapchat found itself being used primarily as a tool for sexting.

via GIPHY

The company is moving away from that image. First, they introduced “stories”, a feature where your pictures and videos would be saved for public viewing for 24 hours at a time. Later, they would add the ability to replay “snaps” that were sent to you privately. While still keeping their original idea of quick pictures and videos that will be deleted, they have expanded to become more of a classic photo and memory saving app. You can even save your own snaps.     

At a potential valuation of $25 billion dollars, Snapchat stacks up favorably against the other big tech titans. That lofty valuation puts them in third place, right behind Alibaba and Facebook, above both Twitter and Google.

grapph

That’s some serious competition, but how do Snapchat’s financials measure up against their more illustrious peers?

A good way to compare across companies is to look at what they were all doing pre-IPO. Facebook, for example, generated $3.20 in revenue for every one of its North American users. Snapchat brings in $2.15 per user.

Of course, we have to remember Facebook and Snapchat are different companies, but it’s a start. Snapchat is a niche app, used mostly by those in the 18-34 age demographic. In that sense, it’s much more similar to Twitter before it went public.

Before Twitter went public, it was viewed very similarly by the investing community, a niche messaging app that they believed would have trouble expanding beyond its existing user base. More than two years later Twitter is still going strong. The app is used by news companies and public personas a like. No one loves a good tweet more than President Donald Trump.

So what sort of money was Twitter pulling in pre-IPO?

According to Statistia, in Q3 2013, right around the time Twitter went public, they reported an ARPU, or average revenue per user, of $2.65. The previous quarter, they were making $2.20 off every user.

Those numbers are pretty much in line with Snapchat.

The similarities don’t end there. Snapchat boasts more than 150 million users a day, and is growing quickly. Compare that to Twitter, which has about 140 million users interacting with their service today.

Twitter went public about seven years after its founding. Snapchat is only 5 years old. Snapchat has already surpassed Twitter and they haven’t even gone public yet, a feat Twitter accomplished in the tail-end of 2013.

A lot of analysts are comparing Snapchat to Facebook, but that would be doing the company a disservice. Facebook is a different company, and have a much wider pull. According to Bloomberg, in December of 2016, Facebook had 1.2 billion active daily users. Snapchat had 160 million.

Hold the phone (H2)

However, a Snapchat IPO isn’t necessarily an automatic home-run.

A cause for concern rests with Snapchat’s business model. In the fourth quarter of 2016, Snapchat’s cost of revenue is around 93%, which means 93 cents of every dollar they earn goes towards paying off their bills. Despite most of your snaps vanishing into thin air after use, they are actually all stored somewhere. Snapchat spends a lot of money storing that data on Google’s servers.

In their SEO filings, the company reported revenues of $400 million in 2016. Their costs were $450 million. For those of you following at home, that means they lost money.

That in itself isn’t a huge worry. Twitter lost money before it went public too, and today their cost of revenue is around 30%. What’s more worrying is that Snapchat is losing money at an unprecedented rate.
graph
Source: Bloomberg

Free cash flow is a measure of a company’s financial health. Think of it like the disposable income of a company. As you can see, on a free cash flow basis, Snapchat is performing terribly. When you line them up against comparable companies such as Twitter, Facebook and Zynga, you see just how stark the difference is. For every $100 in revenue, Snapchat ends up with -$120.

Ouch.

A lot then, is riding on Snapchat’s ability to grow, and grow fast.

The future (H2)

The IPO then, might be an exercise in marketing. Snapchat is likely hoping to generate a lot of buzz and hype by going public. It also doesn’t hurt that they are expecting to raise $3 billion dollars in the process. That money will go a long way to keeping the company afloat while they refine and hone their strategy.

Snapchat is trying to become more of a lifestyle and memory-capture company. They recently entered the wearables market with their Spectacles product, a pair of video-recording glasses. They plan to significantly broaden the distribution of Spectacles and are committed to making more investments into product innovation. So far the glasses have only been available in limited quantities, sold through pop-up vending machines across the country. The hordes of people lining up to get their hands on a pair of spectacles, shows the company did a good job building hype around their new product offering. With that in mind, it’s easy to see how an IPO might be part of a larger marketing plan to grow awareness of the brand and fill their coffers before the push for global domination.

It remains to be seen if they will be successful. Snapchat is going public, but if you jump in be prepared for more of a roller coaster than a relaxing road trip.

Still unsure weather or not Snapchat is a good investment?

Take the WSS course, VALUATION: INTELLIGENT INVESTING and learn how to figure out the value of a business and if it’s going to be a good investment.

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