by Clement Thibault
Snap (NYSE:SNAP), which describes itself as a camera company because of its Snapchat app, is set to report Q2 2017 earnings this coming Thursday, August 10, after the closing bell. Wall Street is looking for an EPS of -$0.14, and 187 million in revenue.
After lots of buzz and many rumors throughout 2016, Snap went public on March 2, 2017. It was one the biggest, most highly anticipated IPOs in recent years.
Pre-listing, the company was valuated at $20 billion dollars. Many believed Snapchat had enough promise to transition into the second coming of Facebook (NASDAQ:FB)—the next red-hot social network for millennials.
Others, and count us among them, were more skeptical. We noted problems with Snap's historical user and revenue growth and said we couldn't see a path to real growth for the company even after it became a publicly traded entity. The corporate governance structure surrounding the offering was also shaky, with a multiple share classes on offer, but no voting rights attached to the publicly traded offering. Finally, we anticipated lots of volatility during the first months of trade.
It's now five months in and here we are. Would it be OK to say we told you so?
Five Months After the IPO...What Just Happened?
Snap shares were issued at $17. The first shares began trading on the NYSE at $24. Within two days, the price skyrocketed to over $29, only to gradually descend into oblivion, currently trading around $13 and likely headed lower.
From our point of view it's been one of the most predictable IPOs in recent years. Was the IPO price blatantly inflated? For sure.
As we said to the Verge in early March:
“Snap Inc.'s valuation at $17 a share, or $24 billion as a business, is a stretch at best - and most likely one of the most overvalued IPOs in recent years”.
A euphoria-induced bump in price during the stock's first days of trading, only for the market to finally focus on the underlying problems faced by the company? Absolutely. This is what we said to the LA Times:
"During an IPO there’s a sense of euphoria, and people like to think they’re part of the latest and greatest thing, but current pricing does not reflect the risks and challenges the company will have to deal with later on".
No surprises so far. Anything else?
Exclusion from the S&P 500
In our pre-IPO post (link above), we outlined problems with the voting rights for the shares issued by Snap. In a nutshell, there weren't any. Snap's founders decided to keep the cards as close to their vests as possible by not allowing outside investors to weigh-in on the direction the company should take.
Apparently, we weren't the only ones who found that decision troubling. This past Tuesday, the S&P 500 decided to exclude Snap from the popular index after reviewing its voting structure and corporate governance practices.
This is a blow on a number of fronts. To begin with, it undermines the legitimacy of the Snap founders' corporate governance – which doesn't inspire confidence. Second, many exchange traded funds (ETFs) closely follow the SPX and are obligated to purchase shares of those companies listed on that major index. The biggest ETF in this category is the SPDR S&P 500 Fund (NYSE:SPY), with $243 billion in assets.
That hammers the stock on the demand side, but perhaps the blow is on its way via the supply side too.
SNAP Supply and Demand
When Snap IPO'd in early March, it released about 300 million shares to the public, which represented only 25% of the 1.2 billion total shares available. The other 900 million shares—most bought by insiders of one sort or another including early, pre-IPO investors and key company executives or employees—were locked-up until a series of specified dates, thus could not be sold beforehand.
For the earliest investors, which includes the founders, this date was Monday, July 31. As the first SNAP lock-up unwound, total shares available rose by about 400 million. The price dropped 4%, but recovered later in the day. Unfortunately for investors, another wave of unlocked shares are poised to hit the market on August 14, when the remaining shares will become available. By the end of August, 97% of the total, publicly tradeable shares issued will have hit the market.
Should early investors or company employees decide to cash out, we could witness a classic supply outweighing demand situation. With Snap shares already in major downtrend, who wouldn't be nervous about buying the stock at this point.
Bring In The Drones
Snap is reportedly seriously considering drones as its next move. More precisely, photographic drones that allow users to take selfies. Along with reportedly developing its own drone and and acquiring L.A based custom drone maker Ctrl Me Robotics, Snap is hunting around for yet another drone manufacturer to acquire, this time equipment with embedded face recognition.
Although Snap sees itself as a camera company, this drone venture is a departure from its core business, at a time when its core business has hardly been established. Growth of Snapchat, the company's main product, has been unimpressive thus far. In the last quarter, Q1 2017, the company added 8 million daily users, up 5% from previous quarter, Q4 2016. Overall, Snapchat expanded from 158 million users to 166 million users.
Approximately eight years ago, when Facebook was still a very young company, it had about the same number of daily users; during Q3 2009, Facebook reported 144 million daily users. Three months later however, Facebook had already reached 185 million users, 41 million net additions in one quarter, or an expansion of 28%. If you compare that to Snap's quarter-on-quarter numbers, it's clear why the company should remain focused on its core, rather than on external ventures.
As well, drones may not be the right direction either. GoPro (NASDAQ:GPRO) the last camera company that played with drones, releasing its Karma drone in October 2016, eventually got burned. Initially, excitement over the new product spurred a 100% surge in GoPro's share price, from $8.6 to $17.6 in just four months. But the novelty quickly faded and the company's value was cut in half again. Today, shares are trading at $8.
And Then There's Alphabet
One of Snapchat's ongoing issues as a product is the lack of unique features, and its inability to legally protect its core elements. Facebook engaged in a social media war against Snapchat via Instagram, replicating some of Snapchat's user experience on their own product, thereby implementing Instagram Stories. This copying strategy worked well for Facebook as can be seen by the lack of significant growth for Snapchat.
It's now Alphabet's (NASDAQ:GOOGL) turn to take a page from Snap's playbook. After failing to create a meaningful presence in the social media world, Alphabet reportedly offered $30 billion to acquire Snapchat in late 2016. Both companies are denying the report but the chatter persists.
Alphabet is now trying to replicate Snapchat's 'Discover' feature, but not for social media. The advertising giant is reportedly close to launching 'Stamp,' a feature that would allow news outlets to share slideshows of photos, videos and text. The strong resemblance to Snapchat's Discover comes from Stamp enabling users to control their information flow, much as they can via Snap's Discover, allowing users to freely and quickly skip content they're not interested in.
Discover is a big value proposition for Snap. It enables publishers to push targeted content to a younger audience as well as generates revenue from advertising between stories. Snap's exclusive content deal with NBC for the 2018, South Korean Winter Olympic Games is exactly the sort of media buy Google's Stamp initiative could derail, should it gain traction.
Conclusion
As we've made clear before, we're not fans. Not of Snap's growth prospects, nor of its corporate governance, nor of its ability to create a moat around its offering, nor of its share pricing—neither its $17 IPO price nor the current $13. Given Snap's anemic user growth and murky prospects, we remain uncertain about the company's future.
We're looking to this Thursday's earnings report to provide some sign regarding whether there's been any encouraging movement on the user growth front. To be honest though, we don’t expect anything like Facebook's growth at this stage.
The only thing we think Snap has going for it right now is its low Price-to-Book value of 4. That's primarily because the company has about $4 billion in assets (mostly cash) with few liabilities.
But of course, there's no reason to buy cash at a multiple of 4. This also makes it difficult for us to even begin to think about a potential entry point. Right now we're not sure if we'd ever want to become Snap shareholders.