Snap Inc (NYSE:SNAP), the parent of photo-based social network Snapchat, opened its publicly traded life more than 40% higher last Thursday, and SNAP stock gained another 10%-plus on Friday. That’s easy money for pre-IPO investors, who celebrated a big day.
But Monday saw a 12% dip, and it looks like Tuesday is going to show some weakness in Snapchat stock as well.
A few trading sessions are just the blink of an eye, relatively speaking. But what we’ve seen so far might be a foreshadowing of stormy seas ahead.
If you’re thinking about buying SNAP stock, now might be the worst possible time.
History Is Not on the Side of SNAP Stock
The Snapchat IPO has been one of the biggest and most highly anticipated tech IPOs in years. Wall Street was certainly whipped into a frenzy. But traders looking to get a stake in Snap Inc have plenty of tech IPO history to consider.
The SNAP media circus was nothing compared to the excitement surrounding the Facebook Inc (NASDAQ: FB) IPO back in 2012. The $3.4 billion Snapchat IPO also paled in comparison to the size of the massive $25 billion Alibaba Group Holding Ltd (NYSE: BABA) offering in 2014.
Both BABA stock and FB stock closed higher on day one, albeit Facebookc’s gain was negligible. However, within months, both stocks had entered a nosedive. Six months after their first day of trading, Facebook was down 38.4%, and Alibaba was off 12.8%.
Both of these companies are solid companies with strong growth numbers. But their post-IPO weakness wasn’t surprising — Reuters reports that eight of the 10 largest tech IPOs in history delivered negative returns of between -25% and -71% in the year following their first day of trading.
Beware the Lock-Up!
One of the major reasons why these IPOs typically perform so poorly in their fort year of trading is because of the so-called “lock-up expiration.”
When a company goes public, the last thing the it wants is for insiders to immediately cash out by dumping millions of shares into the market. To prevent that dump, shares owned by insiders and majority shareholders are typically restricted for a set amount of time. Once a stock has three to six months of public trading under its belt, insiders are free to sell their shares.
Most insiders don’t ditch their shares at the first opportunity. But Silicon Valley companies like Snap Inc have relatively young insiders and investors. People in their 20s or 30s may find it impossible to resist the temptation to become instant millionaires.
SNAP actually has two different lock-up expiration dates:
- The first date is 150 days (five months) after the offering for all of the pre-IPO investors. This group includes insiders and private investors.
- The second expiration is one year after the IPO and applies to 50 million of the 200 million shares sold in the IPO.
SNAP Stock Might Have Started Out Overpriced
The final reason not to buy SNAP stock is that it may not even be a good investment in the first place.
As Twitter Inc (NYSE:TWTR) investors know all-too-well, popularity does not equal profitability. Sure, Snapchat has 158 million daily active users and $404 million in revenue in 2016. But it also reported a net loss of $514 million on the year.
In fact, within hours of the Snapchat IPO, Pivotal Research Group initiated coverage of SNAP stock at “Sell” and set a $10 price target. That target represents roughly 60% downside from Snapchat’s Day 1 closing price.
“I could generate $1 billion in revenue if you gave me $2 billion today,” analyst Brian Wieser said of Snapchat’s finances thus far. “That wouldn’t make me successful.”
At this point, there is simply too many uncertainties and headwinds to make SNAP stock a smart investment. If you believe in the Snapchat story, you’d be wise to stay on the sidelines for now and wait for a better entry point.
Pay close attention to the behavior of the stock leading up to the two lock-up expiration dates. If SNAP is weak headed into the expiration, the lock-up dates may serve as good long-term investing points.
As of this writing, Wayne Duggan was long BABA stock.