Today is lockup expiration for Snap Inc (NYSE:SNAP). And yes, it looks like Wall Street is not too thrilled. In early trading, Snap stock gave back 3% to $13.41, before settling at a 1% loss as of this writing.
For those unfamiliar with the treacherous world of initial public offerings, the lockup is a contract that prohibits insiders — such as founders, employees and directors — from selling their shares for a certain period of time. The main reason for this is that an IPO often needs time to get seasoned in the marketplace.
Snap stock has had an interesting public life so far — down about 20% from its IPO and 54% from its all-time high — so it’s worth reading into what the ultimate impact of the lockup expiration may be.
What the Lockup Expiration Means for Snap Stock
First of all, Snap’s approach is different from what is typical. An IPO will often allow for all shares to be sold after six months, but with Snap stock there are two tranches. Today, the lockup expiration frees up 400 million shares for sale. In a few weeks, there will be an additional 782 million shares available.
This is important because there were only 200 million shares issued when the company came public. So there will be potential avalanche of Snap stock that could hit the markets.
Yet this does not necessarily mean you should panic. Just because the shares can be sold does not mean that they will. After all, many insiders may decide to wait for a better price, since Snap stock is already off 45% from its day one closing price of $24.48.
Something else to keep in mind: The officers of the company — which have major holdings — generally have other restrictions on their ability to sell. And it never looks good when they start dumping their holdings.
Given all this, it’s probably a good bet that the lockup expiration will really have a moderate impact on Snap stock. If anything, it appears that part of the recent weakness has already reflected this.
Instead, when it comes to Snap stock, the major focus should be on the fundamentals. And unfortunately, they are far from inspiring.
Fundamentals Are the Real Problem for SNAP
As seen with the latest earnings report, Snapchat is showing that it is getting tough to crank out user growth. There was only a 36% increase to 166 million DAUs (daily active users), which was below the Wall Street consensus of 167.3 million. A year ago, Snapchat was growing DAUs at 100%-plus.
Snapchat management provided various excuses for the drop off, such as seasonality and other technical issues. But of course, there is an elephant in the room — Facebook Inc (NASDAQ:FB).
For the past year, Mark Zuckerberg & Co. have aggressively leveraged Facebook’s Instagram platform to blunt the threat of Snapchat. While much of FB’s approach has been to copy key Snapchat features, it’s worked quite well, with Instagram Stories gaining tremendous traction. Since April, Instagram Stories has added a hefty 50 million users to 250 million.
This has definitely put Snap Inc CEO Evan Spiegel in a tough position. The fact is that Wall Street is banking on strong top-line growth, as seen with the nose-bleed valuation (Snap stock trades about 30 times revenues).
But if the next couple quarters show continued deterioration in the user base, the impact on the shares is likely be significant.
After all, just look at what happened to Twitter Inc (NYSE:TWTR) last week. Even though the company beat the consensus for revenues and profits, it did not matter. Investors only cared about the lagging user growth. As a result, TWTR stock got slammed.
For the most part, the digital world can be brutal. There are many examples of IPO highfliers that have quickly flamed out, from Groupon Inc (NASDAQ:GRPN) to Zynga Inc (NASDAQ:ZNGA).
Now this is not to imply that Snap is going to follow the same path. No doubt, the company has a great brand and deep loyalty with the millennial demographic, which is tough for advertisers to reach.
But Snap still needs to find ways to kick user growth back into gear. And it won’t be easy, since Facebook will definitely not let up in its fight.
Tom Taulli runs the InvestorPlace blog IPO Playbook and operates PathwayTax.com, which provides year-round tax services. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
