Snapchat, which is owned by Snap Inc., plans to pull off its IPO sometime in March. And yes, the deal is likely to be one of the hottest of the year.
Snapchat reaches 41% of all 18- to 34-year-olds in the United States — a highly sought-after demographic for advertisers. Snapchat also serves over 10 billion video views a day.
Oh, and the company has gotten nice traction with Spectacles, which are glasses that are connected to your smartphone and allow you to take photos and videos. It’s a pioneering case of the emerging category of augmented reality.
In other words, Snap Inc. appears to be a rare example of a company that can be successful in both the software and hardware worlds. Interestingly enough, there is buzz that the company’s CEO, Evan Spiegel, may be in the same league as Apple Inc.’s (NASDAQ:AAPL) Steve Jobs or Facebook Inc’s (NASDAQ:FB) Mark Zuckerberg.
While all this is certainly impressive, this does not mean that the Snapchat IPO will be a guaranteed winner. As the past few years have shown, there are lots of risks with new-fangled companies.
So what are some of the issues for the Snapchat IPO? Well, let’s take a look at three:
Snapchat IPO Problem #1: Reality Check
So far, there few concrete details on the Snapchat IPO because the S-1 has not been made available yet. The reason is that the company has elected to use a “confidential filing,” which is for operators that do not have more than $1 billion in revenues. But sometimes the S-1 can have some bombshells, which could gin up investor anxiety. A prime example of this was the Groupon Inc (NASDAQ:GRPN) offering. When the company filed its S-1, there was quite a bit of shock at the size of the net losses.
Now as for the Snapchat IPO, the big issue will likely not be the financials. Let’s face it, the company is still in the early stages of monetization, which began in 2014. So it’s reasonable that the losses will likely be large. And yes, because of the small initial base, the revenues will probably show substantial growth ramps. Instead, the area that could stir up the most interest is the user base. Is it increasing? What about the engagement?
Perhaps Snap Inc. is having a problem finding new users, since the service primarily appeals to a younger audience. If so, IPO investors may consider that the company’s growth potential is limited. In fact, this has been something that has dogged Twitter Inc (NYSE:TWTR). Will an older FB user move over to Snapchat? And why?
Right now, there does not seem to be a compelling reason as FB continues to bolster its platform — and the company is showing no signs of lagging engagement or user losses.
Snapchat IPO Problem #2: Valuation
Last year saw tepid IPO action in the tech space. But with markets in bull mode, there is likely pent-up demand for well-known offerings — and Snapchat should fit the bill. What’s more, Snap will likely limit the size of the initial offering, say to 10% to 20% of the outstanding shares. This should stoke the demand even further.
Yet, investors can often get carried away. In fact, there are already signs that the valuation could be stretched.
According to a report in The Wall Street Journal, Snap Inc. is forecasted to post $940 million in advertising revenues this year. In other words, if the offering is priced at $25 billion, then the multiple would be nearly 27. By comparison, FB came out at 19.4.
Snapchat IPO Problem #3: The Quarterly Grind
Consumer internet and mobile operators can quickly fizzle. For the most part, users can be fickle — especially young ones. Some example of implosions include GRPN and Zynga Inc (NASDAQ:ZNGA).
Although, this is not to imply that Snap Inc. is on the verge of oblivion. There are few signs of this. If anything, competitors like FB have continued to demonstrate their worry. After all, the social media giant has been adding plenty of Snapchat-like features to its Instagram property.
But Snapchat is still a young company, having been founded in late 2011. As a result, it’s still building its infrastructure and evolving its business model. So yes, there is a good chance that there will be volatility in revenues and the user numbers.
While this may not bother Spiegel — who has a longer-term view of things — Wall Street may not be so forgiving.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is a registered investment adviser representative (you can visit his site to learn more about his financial planning services). He is also the author of various books on investing like All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.