Snapchat: IPO With a Message

Snapchat, as of summer 2017, is a company which will likely have two outcomes in the next 6 years. First, the fact SNAP down-selected Google for its cloud-base has mated the company to Google, and also lends itself as an acquisition target should Google seek to further expand its social media presence further down the road. Although SNAP is bleeding cash quicker than a bachelor in Vegas, it has one useful metric that has some value in the tech space: user data.  A perfect example of this I mention in my Groupon article is the LinkedIn acquisition by Microsoft (MSFT).  Oh, and just to remind you, LinkedIn was public for 6 years…

If SNAP manages to continue user growth over the next 5-10 years, whether profitable or not; the company’s data will be of huge value for other tech giants.  This isn’t necessarily advertising value either, because if you go back to the Microsoft/LinkedIn scenario, Microsoft utilizes LinkedIn’s data for big data business intelligence analytics.  This translates into being able to change Microsoft’s products and services based upon what their LinkedIn users are trending, posting, pushing on their profiles, and clicking.

The second route is more gloomier, as SNAP has the risk of phasing out as a “fad” along with high cost of customer acquisition and risk of future company health.  Why? Few reasons:

  1.  SNAP claims its company’s core identity is as a camera company, when truly, it’s a social media company that specializes in camera filters and has a one-off spin from Google Glass.  Not communicating or embracing your company’s true identity can lead to skewed management priorities in the future and potentially affect corporate guidance and ultimately sales.
  2.  SNAP’s costs of gaining more revenue are astronomical.  In the end, when the investment musical chairs stop, the only thing that matters is whether your company is actually turning a profit or even expects to turn a profit. This looks like it is not in the cards until at least 2019/2020 if it even happens at all.
  3.  SNAP’s competition from Facebook’s (FB) Instagram is overshadowing any growth potential the recent IPO could generate.
  4.  Finally, one of the kings of valuation: Cash flow.  It’s negative, and man is it negative.

This, ladies and gentlemen, is the the investment paradigm that I find frustrating as a millenial investor. If you looked back thirty years ago, companies were valued based upon their solid numbers and trends of earnings. Then, we as a population began to value based off of potential future earnings and cash flows. Enter 1999 through 2001, and valuations went out the window when the psychotic frenzy of buying with margin into overhyped tech companies drove one of the famous bubbles we all know and fear.  So then, I look at a company like Snapchat, and the message that the IPO’s valuation sent when it first went public.  The message is clear: Popularity > profits, and if you aren’t popular, being a tech company lends you to no traditional valuation metric because of the nebulous potential your company might have.

If you don’t believe me, then I beg you to watch one of my favorite TV shows CNBC’s Shark Tank.  When you do, count the number of companies who come on the show with insane valuations; asking $100,000s of dollars of small stakes in companies that haven’t even made one sale yet.  One thing you might notice is most of those types are application-based products or tech space companies.  Snapchat (SNAP), although with a huge user base and massive revenue growth, has an expense curve that matches the revenue growth.  So at the end of the day, if you’re making $50 million, then grow to $500 million, but are spending a proportionate or even higher amount each quarter, are you really growing?

Conclusion

So are there profits to be made in SNAP as an investment opportunity? Sure.  Ahead of earnings today, I’ve opened an at-the-money debit spread as a speculative play for their earnings announcement. Of course, this is playing the downside, as the probability SNAP will post an improved situation since last quarter doesn’t look to be highly probable. I think patience is key with this company, as the valuation is close to that of a single-digit stock, then it poses a low-allocation buying opportunity as a speculative play.