Optimistic or overpriced?

Snap, Inc, the parent company behind Snapchat, is aiming high. Earlier this month, the company filed its IPO with the New York Stock Exchange and at an expected valuation of $25 billion. For perspective: no other tech company has made a bigger IPO since 2014’s listing of Alibaba, which, at $68 per share, stood at $21-25 billion while the company was valued at $168 billion.

Analysts like Neil Wilson at ETX Capital are of the opinion that the valuation, “by traditional yardsticks” is overpriced. This could be because the valuation is equivalent to company’s annual revenue multiplied 47 times. That is, quite frankly, absurdly high, indicating demand for the stock rather than its value.

Some analysts are up in arms about this, because previous tech IPOs have been made at far humbler ratios, including those of Facebook (28 times), Amazon (19 times), Google (16 times). Even Tesla valued its IPO at 14.3 times its annual revenue. These are world-changing companies with rock-solid business models and robust revenue streams.

Make no mistake, Snap Inc is ambitious. The start-up plans to sell 200 million Class-A common stock and will trade on the NYSE under the ticker ‘SNAP’. The total offering will rise to 230 million shares if the underwriters exercise their option to purchase the additional 30 million shares. Snap estimates that the net proceeds from the sale of shares will amount to $2.1 billion or higher.

The start-up plans to sell 200 million Class-A common stock and will trade on the NYSE under the ticker ‘SNAP’.

So why does Snap need money all of a sudden? Its revenue comes from advertising within the Snapchat app. In 2016, its revenue was $404.5 million, a six-fold increase on the $58.7 million made in 2015. However, net losses widened to $514.6 million from $372.9 million the year before, not painting an especially efficient picture, considering that it is a digital platform.

At the end of 2016, Snap had 158 million daily active users, up 48% from the same time the year before. But in the fourth quarter of 2016, year-on-year growth fell. There were some very public recent issues with the app, while Facebook and Instagram both snip at Snap’s heels with their competing apps.

“We intend to use the net proceeds… for general corporate purposes, including working capital, operating expenses, and capital expenditures. We may also use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies,” stated the company's S-1, which was filed with the U.S. Security and Exchange Commission. “However, we are not contemplating any material acquisitions at this time.”

I don’t see anything indicating development here; the accountant in me decodes “general corporate purposes” as more perks, “working capital” as overdue debts, “operating expenses” as salaries, and “capital expenditure” as fancy new offices.

So the real question is: Is Snap going public really that good of an idea?

Small companies, looking to further their growth, use IPOs to generate new capital. This can be used to fund research and development, capital expenditure or even to pay off debt. Another advantage is increased public awareness as a result of the coverage.

Newly public companies often face many challenges as well. The biggest change is the need for added expenditure on compliance and increased accountability. They also face pressures from the market, public and the press, which may shift their focus to short-term results. This can be an arduous task for a company yet to prove its business model, let alone, turn a profit. Dotcom bubble, anyone?

Small companies, looking to further their growth, use IPOs to generate new capital. This can be used to fund research and development, capital expenditure or even to pay off debt.

Unlike the past, these days any loss-making start-ups can tap investors for cash. But how much cash, and will it be enough? Let’s see: Perhaps the comparison with Facebook is too generous. Facebook was Facebook before the IPO, booking a $1bn profit in the prior year, while Snap just lost a whopping $514.6 million.

Twitter, though hugely successful and the primary method of communication for Donald Trump, had a mixed result after its initial IPO in 2014. Three years after going public, Twitter still has an identity crisis. While its stock was much overvalued on the first day of trading, it wobbled down to around its initial IPO valuation within one year. Its user growth also seems to be slowing down in contrast to Facebook.

So we have a couple of conclusions.

Firstly, Snap’s outlandish valuation is just that: outlandish. It will give a boost to the technology landscape but perhaps not for the right reasons, and will probably inspire a plethora of copycat IPOs. Conversely, Snapchat might be the next big thing, and getting in on the action early would mean big returns.

This won’t happen overnight, though: it took Microsoft, Apple and Google decades to give that kind of return to their shareholders. Even Facebook has suffered ups and downs in its fortunes after its IPO.

There is no reason to believe that every social media start-up will end up as successful as Facebook, let alone one whose very business model, profitability and market valuation is under question. As Twitter proves, canvassing eager investors for cash does not bring vision, strategy or guaranteed success to a company.

In short: Buyers beware!

Talha bin Hamid is an accountant by day and an opinionated observer of pop culture, an avid reader, a gamer and an all-around nerd by night.