The brave new world of social media IPOs

A couple of weeks ago Snap shares received their first ‘buy rating’ from Monness Crespi Hardt, a major stock and financial advisory firm in the US. It was a major coup for the latest technology/ social media start-up that went public with its IPO in March 2017.

The maker of the widely popular ephemeral photo-sharing app Snapchat (and a host of lesser, albeit promising, spin-off products like Snapchat Specs and Snapcash), Snap’s IPO was widely touted as the next big tech IPO along the lines of Facebook and Twitter and drew parallels with the IPO of Alibaba.

Snap went public, pricing their initial public offering at $17 a share to raise $3.4 billion in capital. The next day, the price of Snap stock had ballooned by over 41% above the issue price to approximately $24; there were widespread news pieces circulating on how investors ranging from schools to church groups had reportedly made a killing by buying in early.

However, as with all IPOs, Snap had a number of detractors, pointing to some fundamental concerns (euphemisms for flaws) in the company’s business model. They pointed to the fact that earlier IPOs of tech giants like Facebook and Twitter, both of whom are social media apps with large followings, have in the long run underwhelmed investor expectations of meteoric growth.

However, if one rule holds true in this brave new world of tech/social media IPOs, it is that the old rules that govern company valuations and business models simply do not apply anymore.

The stock offered as part of the Snap IPO was common stock so buyers have no voting rights. Even so, the company does show a lot of promise; the widely popular photo-sharing app, once gaining notoriety for sexting and encouraging risqué and risky behaviour in teens and tweens, has matured tremendously with its product offering.

The company now not only offers their signature photo and ephemeral message sharing service but have strong revenue streams from the ads and third party content sharing on their platform. Snap today boasts an active user base of 158 million, a majority of whom are in the highly sought after 18-34 year demographic, of which the most active users are under 25 who share and create 2.5 billion pictures on the service a day. To give you an idea of how fast and furious traffic is on Snapchat, there are reportedly 8,796 pictures sent every second on Snapchat. Every hour, there are over 10 years’ worth of photos available to view on the site.

The company now wants to build on this success and delve into a related hardware augmented reality peripheral Snapchat Specs, and even a payment channel Snapcash.All of this looks great on paper, apparently enough to make a good number of investors salivate but then comes the other numbers. From a traditional business standpoint, Snap’s revenue mix right now is unhealthily dependent on advertising (accounting for 98% of current revenue) and while the company’s revenue has steadily grown, from $58.7 in 2015 to $404.5 million in 2016, so have their expenses and resultantly their losses. The company posted a net loss of $514.6 million in 2016 which was $372.9 million in 2015. Like a number of start-ups plagued with initiation costs, the company claimed that it may never be profitable despite the fact that global revenue per user for the site and app continues to grow.

Then there are other concerns on critical areas of strength the company touts –their young and very active user base. While 150 million youngsters averaging over 20 visits to the service every single day is a strong measure indeed, there are some worrying signs.

For one thing, while the user base of Snapchat continues to grow, the rate has somewhat slowed to around seven percent in daily active users, which the company recognises as “pressured” of late.

Then of course there is the built-in Achilles heel of any company with an overwhelming young customer demographic like Snapchat: brand loyalty. Youngsters tend to be early adopters of any new technology and are notorious for abandoning older technology platforms for new offerings. There is also concern about how younger people engage with advertising on social media in general, with a number of surveys claiming that over 70-80% of users actively skip ad content if given the opportunity. Lastly, there is the fact that the competitive space in Snapchat’s product category continues to be crowded, with for example, Facebook and Instagram, both bringing out competing services (Facebook Stories and Instagram Stories).

Despite these areas of concern, Snap continues to show tremendous promise and have achieved a critical mass of loyal customers they can use to broaden their appeal. The company has already made great strides with offering augmented services such as filters for geo-locating users and displaying overlays on the faces of users. They are also working with their partners in Google Cloud and Oracle Data cloud to provide advertisers with better customer preferences and behaviour, thereby giving them more opportunities for more targeted advertising and with stronger calls to action.

Furthermore, despite all the naysayers, Snap have continued to outperform their IPO price and at the end of March it was being traded at $22.54. When giving their buy rating to the stock Monness Crespi Hardt noted in a memo to investors that it recognised potentially giving too much credit for unproven skill in building a business rather than just a product, but “we see more to Snap than many suggest, and the company still has the potential to outpace the revenue growth of its peers.”

While that vote of confidence is rare for Snap considering that the company had far more recommendations for sell and a few for holding on to its stock, they still continue to perform on the stock exchange showing that for some investors the old rules certainly don’t apply as stringently in this brave new world of social media IPOs.