Snap's proposed valuation has raised some eyebrows on Wall Street, as people close to the company had for months floated the idea that it would be valued at up to $25 billion.
One person close to the deal, with a vested interested in seeing it succeed,told Business Insider that Snap is playing it safe with the intention of going higher as soon as demand merits. Conversely, asking for the full $25 billion and being forced to roll it back if investor demand isn't high enough would be a worse outcome that taints the company's trading debut.
Though the company said it was seeking to price shares at $14 to $16, this person said the only acceptable price, in reality, will be $16 per share or more. This person expects Snap's order book to be oversubscribed, meaning there will be demand for more shares than it is selling.
A hedge fund manager who attended the New York meeting told Business Insider "the bankers are being smart about the pricing."
"You could make the point it's too low, but the bankers are being smart enough about not having another Facebook," he said, referring to the famous plunge that Facebook's stock took in the months after its IPO before shares eventually recovered. "I think they’re pricing it at a very reasonable amount. Even if you’re skeptic, the valuation is coming out at a level where you almost have to look at it."
"If you're bullish, what you want to spin is at the end of day is that Facebook's market cap is $385 billion. Snapchat is coming about $20 billion enterprise value. When you think of enterprise value to opportunity set, it's a fairly palatable valuation ... A similar way to look at it as to look at Twitter as a comparison, with a $12 billion market cap. They have a user base problem, monetization problem and they’re still worth $12 billion. The premium that Snapchat is coming out as versus Twitter isn't that bad, for what I’d argue is a much better program."
Addressing Snap's valuation, Madhvani told Business Insider: "Is it worth that? I think you can see a clear path to where they're going to get to monetization of 1.5, 2 billion quite easily from what they are at the moment. But can they go massively beyond that? That's the bet you're really taking."
"With expansion beyond the core audience likely challenging, sustainability of engagement concerns to persist, and margins structurally lower than peers, we do not see upside to the $14-$16 IPO valuation range."
Another investor, who specializes in tech, put it this way: "I'm bullish in in the sense that I think Snap can be a multibillion company that generates lots of profits and revenue... But the question for me is if you're trying to go public at $22 billion and you have no profits today, if you're an investor, you really need to be compensated for that risk. You need it to be a $50 or $70 billion company for it to be worth it. I'm bearish on their prospects of getting to that level."
BULL: Snap's slowdown in user growth
In the fourth quarter of 2016, Snap says it had 158 million daily users, an increase 48% from a year earlier. That's the slowest growth rate for any of the 12 quarters for which it reported numbers.
It's hard to make a bull case for a statistic like declining growth, but one person close to the deal laid out a counter-argument to those concerns. Essentially, this person said, Snap emphasizes quality of engagement over quantity of users. Spiegel wants existing users to really enjoy the product and is focused on innovating to make it more usable.
Part of that means users must have higher-end smart phones. Snapchat works best on iPhones, and while some problems persist on Android and other phones, Spiegel says he will not dilute the product to make it work on every phone. At the roadshow, Snap attributed the slowdown in growth to persistent problems with accessing the app on Android.
So unlike Facebook, which has nearly 2 billion users around the world, Snap is not focused on non-iPhone-using customers in places like the developing world because those markets are not easily monetized. The logic is that advertisers want to reach North America and develop Europe rather than the rest of world.
Investors focused on Snap's declining user growth during pitch meetings, according to those in attendance, with many trying to understand the causes of the slowdown and how much of an issue it might be.
"The deceleration in user growth is a clear indicator that Snap is losing its snap," said Lee Bressler, portfolio manager at Carbon Investment Partners, a small hedge fund. "Instagram's stories feature is a direct competitor and will continue to take market share. This could be the next Twitter, or worse, Myspace."
Another prospective hedge fund investor who attended the roadshow and decided not to invest in the IPO said that, essentially, there are two precedents for a social IPO.
One is a massive success, with user growth, and some monetization issues — that's Facebook. The other, Twitter, never had an issue with monetization but had the user growth issues. That's why people are "freaked out" about Snapchat's user growth, this person said.
Twitter, which went public in 2013, is struggling to grow its user base and investors who held the stock for the last three years have been punished for it: At about $16 a share currently, the stock is well below its IPO price of $26.
"For whatever reason, user growth slowing this early on is the concerning sign," the person said.
In the company's roadshow materials, Snap said its biggest revenue opportunity is the growing budget for worldwide mobile advertising, which could reach $196 billion by 2020 from $66 billion currently.
Snap's business is to "create the best camera platform so we can drive engagement and monetize that engagement through advertising," chief strategy officer Imran Khan said in the video.
Snapchat runs television-style ads on its "stories" feature, which appear for users in between their friends' stories. It also partners with companies that sponsor custom filters, which users can apply to the images and videos they take.
One prospective hedge fund investor told Business Insider: "The way they're trying to pitch it is: 'User engagement is high, we're targeting the right demographics, the ROI are there for the advertisers.' I think advertisers would love that third avenue away from Facebook and Instagram."
"You look at the growth rate of digital advertising and how the market is evolving in digital, taking share from traditional broadcasters, and you look at the market cap. Snapchat is coming out at around $20 billion and it's not that crazy when you think of the total addressable market they're trying to go after."
One prospective hedge fund investor who decided not to invest in Snap's IPO said that the question of how to evolve Snapchat's advertising units was a concern coming out of the roadshow in New York on Monday.
Another New York hedge fund investor, who specializes in tech, said that he was concerned about whether Snap would be able to build out its management team to capitalize on its immense advertising opportunity. "I don't think Snap has had as much success [as Facebook] in the sales/advertising part of their business so that's a little TBD. It's kind of a bet on their management team, but I think the capability is there."
User engagement will still be key, the New York investor added. "What will matter is if existing users were making up three hours a day, and that goes down to two or one hour a day for whatever reason," this person said. This particular investor said they probably wouldn't buy when the stock goes public next week as it might be overvalued and could potentially be bought cheaper at a later date.
One hedge fund manager, who ultimately plans to invest in Snap, also told Business Insider:
"They are fairly direct that they're going after a specific demographic. Their ability to sort of expand the beyond 18-to-35-year-old demographic is fairly limited ... If you're underwriting an investment on Snap, you're not expecting them to go to the masses. My grandma in Boca Raton is not going to be using to Snap."
Madhvani at GP Bullhound echoed that sentiment. He said: "Facebook has kind of become this platform that spans generations — it's got such mass. Snapchat is still quite focused around a narrow demographic, and that's always going to be harder to monetize. They've not got the choices that a Facebook has."
BULL: The competition
The question of whether or not Snap should be concerned about Facebook — and Instagram, which Facebook owns — was an important element of the roadshow both in New York and London. In New York, investors asked Snap's management why they were not concerned about Instagram.
One potential investor who has decided not to buy into Snap's IPO said that Spiegel's answer to the Instagram was actually pretty reasonable. Essentially Spiegel said that Instagram's "Stories" feature, built to rival Snapchat "Stories," is more of a broadcast platform, meaning it's more geared at social media influencers, like celebrities, to broadcast to a larger platform. Snapchat stories, meanwhile, are more personal and meant to be shared between friends, Spiegel said. By his logic, the two should not be seen as substitutable products.
A current investor in Snap told Business Insider:
"I think Facebook is a huge company with a lot of resources. They're always going to be a risk because they're a fierce competitor with enormous resources. They've consistently tried to kill Snapchat off. [Instagram Stories] isn't their first clone, this is like their ninth. It's a risk, but what helps me sleep well at night is that Snap has consistently out-innovated Facebook for five years, and I think that is likely to continue."
BEAR: The competition
Not everyone is convinced.
"Instagram's stories feature is a direct competitor and will continue to take market share," said Lee Bressler, portfolio manager at Carbon Investment Partners, a small hedge fund.
Another investor, who specializes in tech and said they weren't sure if they would invest in the IPO because the valuation might be too high, said the decision comes down to two things: "What is the user growth opportunity for this company now that they're not the only game in town? And do they have the team to execute the business side of this the same way Facebook was able to do it?" This investor wasn't sure.
Atlantic Research's Cordwell assumed in his note that Snap will reach only 55% of Facebook's current monetization level by 2020, given Snapchat's heavy skew toward developed markets, its demographic skew toward younger users who are less likely to spend on advertisers' products, and the smaller amount of user data Snapchat has compared with Facebook, which could limit its potential among direct-response advertisers.
Snapchat will need to match Facebook's monetization levels on a per-hour basis if it is to ramp ad spending beyond the $2 billion a year at which Twitter began to run into revenue growth issues, he wrote.