On February 2, Snap, parent company of the popular social media app Snapchat, filed for its initial public offering (IPO) on the New York Stock Exchange under the ticker symbol, SNAP. The company’s decision to go public comes on the heels of a successful year that saw a 600% increase in revenue from 2015.
What is an IPO?
There are two basic types of corporations, public and private. Private companies are not heavily regulated by administrative agencies, they generally are not required to disclose much information to the public, and they are not required to allow third parties to buy a share of the company. On the other hand, public companies are closely scrutinized by the SEC, they must report financial information, and shares of the company in the form of stocks are traded and sold by the general public.
An IPO is a company’s first offering of stock to the general public. Companies decide to go public for several reasons including: raising revenue, attracting employees with stock options, and the prestige of being publicly traded. In order to make an IPO, a private company must file a registration statement which includes a prospectus. The prospectus records information like the company history, description of the proposed IPO, and a risk analysis for investors. Of particular importance to investors are the valuation of the company and the classes of stock to be sold to the public. The classification of stocks will dictate the availability of dividends and voting rights for stockholders which in turn affects cash flow and control of the company.
What do investors need to know about Snap’s IPO?
First, Snap valued the company at $20 to 25 billion which could prove problematic given that Snap, like many other tech start-ups, has yet to turn a profit. The company anticipates raising $3 billion from the IPO which would be the largest tech IPO since Alibaba raised $22 billion in 2014; however, the expected share price is unknown.
In 2016, Snap experienced significant growth from the previous year. In 2015 the company yielded just $59 million in revenue while recording roughly $372 million in losses. In 2016 Snap’s revenue spiked to $404 million, however, losses for the year totaled $514 million. With 158 million daily active users sending 2.5 billion “Snapchats” per day, as well as new investments from news outlets buying advertisements and channels to broadcast their stories all day, the company has significant upside, if the price is right. Snap cites its prominence among Millennials, along with future investments in hardware as further justification for the high valuation.
Snapchat is a brilliant idea that had changed the way Millennials around the world communicate with one another. Snapchat has captured the hearts and minds of this demographic by being fundamentally different from Facebook and Twitter. Snap’s unique hold on Millennials is partly responsible for its lofty valuation.
This IPO, however, is far from being a slam dunk for investors. Snap’s biggest obstacles include competition with rival social media network Facebook and a unique stock structure. Despite Snap’s remarkable increase in revenue in 2016 which outpaced Facebook’s growth of 54%, Facebook remains the leader in social media generating $27.6 billion in revenue last year. In addition, Facebook recently added social networking features to Instagram giving it the same capabilities as Snapchat. However, unlike Facebook, Snap does not pursue celebrity endorsements; instead Snap relies on user engagement in the app with other users and paid advertisers. Still, Facebook’s push to compete directly with Snap, combined with doubts about Millennials’ brand loyalty, add to the concerns about Snap’s IPO.
Finally, Snap is using a multi-class stock arrangement to centralize control of the company. Company executives, principally 26-year-old CEO Evan Spiegel, will have almost exclusive control over the company with 10 votes for each share of Class C stock they own. Investors with a prior stake in the company will receive Class B stock carrying one vote per share. Common stock, Class A, sold to the general public will have no voting rights, meaning shareholders will have no input as to the company’s decisions. The company also shows no intention of paying dividends. While multi-class stock arrangements and centralizing most of the voting power in key executives are common, issuing only nonvoting shares to the public in an IPO is atypical.
Only time will tell whether Snap’s bold strategy pays off and raises the expected $3 billion. Presumably, Snap’s executives did their homework and probed potential investors prior to valuing the company at 62 times revenue and issuing only nonvoting shares to the public. Snap’s grip on Millennials’ is strong and has proven its value over the past year, but competition from Facebook along with lingering questions as to whether Snap can grow its sales to reach profitability make this a risky investment.