I was eagerly anticipating the initial public offering of Snap Inc. (NYSE:SNAP), because I thought SNAP stock might make for a good trade. I’d hop on right after the stock opened, ride it up a few dozen points and short it before the inevitably decay. Well, that didn’t quite work out.
I watched SNAP stock open and snake higher for a couple of days, but not insanely so. The momentum wasn’t there, so I just sat on the sidelines.
A miniature version of this scenario has played out a bit so far, with the high hitting $29.44 and closing Wednesday at $22.81. Still, everyone has an opinion on Snap Inc. stock. When an IPO is this controversial, it’s always a good idea to evaluate it beyond the initial hype and see what’s what.
Oh, SNAP! That’s what’s what!
Are you kidding me? You know a company isn’t in the fittest of shape when your teenage daughters mutters, “how do they make any money?” That’s a bad sign for a long. That’s especially true despite Snapchat boasting a strong user base with a product that is both fun and addictive.
The prospectus shows Snap Inc. lost $514 million in FY16 on only $404 million in revenue. Of that revenue, 96% comes from advertising. That’s not necessarily a red flag since Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB) are effectively one-trick ponies in the same regard. Except these two companies dominate their market. Snapchat has competition from Facebook’s Instagram, which has twice the user base (300 million) and it is hardly a proprietary model. Not to mention that FB just launched a Snapchat Stories clone in Facebook Messenger.
Worse yet, I didn’t see anything about long-range ad contracts. Advertising businesses are made on good relationships with ad buyers. With GOOGL and FB, advertisers have a pretty good set of data regarding what ads are worth. With Snapchat, the jury is still out. That’s partially because my kids also showed me that SnapAds are ten second videos dropped into user stories. First, that’s annoying for a micro movie. Second, you can just swipe the ad away and it still gets billed to the ad buyer!
Then there’s the bandwidth issue. Snap Inc. has to store and send each snap, which costs money. And apparently that cost exceeds the revenue generated from each snap. This doesn’t surprise me at all. If you’ve been following the travails of the interactive division of Walt Disney Co (NYSE:DIS), you know that Disney shut down the massively popular Toontown and Club Penguin websites. Despite the enormous number of users, all that bandwidth cost too much money.
If Disney couldn’t do it, why put your faith in Snap Inc.?
Breaking down the data further, the numbers really stink. Over at Bloomberg, we see that Facebook had $3.20 in revenue for each user pre-IPO. Snapchat does have about $2.15 per user, but the difference is that Facebook had some proof of concept as far as advertising revenue.
Plus, there’s terrible cash burn. Again, pre-IPO, as a percentage of revenue, we’re looking at -110% for Snapchat versus less than -10% for Facebook. Finally, unlike many IPOs that have relative small floats, SNAP had tons of shares to trade. That’s one reason the stock didn’t run up. That also means the shares will be easy to short because there will be plenty available.
All of that being said, SNAP raised $3.4 billion in the IPO and will net about $2.3 billion. I’m reluctant to short despite the lousy financials and lousy prospects because I only short stocks that are insanely overvalued and are clearly headed off a parabolic blow-off top, or if there is a very credible risk of bankruptcy.
Aggressive traders may want to short. I certainly would not buy SNAP here, or anywhere.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
