SNAP INC. IPO: Will It Live Up To The Hype?

Ahead of its initial public offering, Snapchat’s parent company Snap Inc. is set to generate a fortune for its founders and initial investors, yet its success, in the long run, is highly debatable.

Snap Inc.’s initial public offering, which will likely occur next month, promises to mint a fortune for its founders along with a number of Silicon Valley venture-capital firms, Benchmark and Lightspeed Venture Partners being the largest external investors in the company. Benchmark currently holds 131.6 million shares while Lightspeed holds 86.6 million, which would amount to $2.1 billion and $1.4 billion at Snap’s year-end estimated the fair value of $16.33 a share. Moreover, founders Evan Spiegel (CEO) and Bobby Murphy (CTO) have holdings that would be worth roughly $3.7 billion each when priced at $16.33 a share.

Based on the estimates, Snap’s net worth is roughly $21 billion, nevertheless, it could price shares in its IPO at a valuation of up to $25 billion. Once shares begin trading on the New York Stock Exchange, the valuation could rise or fall before investors can begin selling their stakes. Nonetheless, simple mathematical aptitude is all that one would require reaching the conclusion that Snapchat’s upcoming IPO is an incredibly risky bet for prospective investors. This is due to the fact that the company’s sales are required grow at lightning speed in order to support the price at which Snap Inc. is currently set to emerge onto the market. Once more, matters are hardly helped by the fact that the app’s user growth rate is slowing dramatically since its debut, as Snap Inc. user data currently explicates:

snapchat daily average users

Moreover, sales, rather than earnings, are paramount for start-up businesses, since most of them, Snapchat being no exception, have yet to produce any profit by the time they go public. Price-to-sales ratios, then, are far more telling than price-to-earnings ratios. For instance, Snapchat parent Snap Inc. will, at its initial public offering, have a price-to-sales ratio of 55.6, assuming that it comes to the market valued somewhere within the $20-25 billion thresholds as reported by The Wall Street Journal. This figure would be greater than any other major US IPO in decades, according to Jay Ritter of the department of finance at the University of Florida.

However, price-to-sales ratios almost always decline as a business grows. So, in order for the stock price of a company to not fall alongside its ratio, revenue must ascend just as quickly as the ratio falls. This is seriously unlikely for Snapchat if we consider it alongside similar IPOs in the past. Over a five-year period, Google’s (GOOG, GOOGL) P/S ratio fell from 10.3 to 4.9 (-52%) after its initial public offering, and Facebook’s (FB: contextualizeUS) P/S fell from 25.3 to 11.1 (-56%). Furthermore, according to FactSet, the median internet company’s price-to-sales ratio by the time of its fifth birthday was a mere 2.8. To sustain growth, Snap Inc. would be looking at a revenue growth rate of 63% per year to be maintained over a five-year contextualise the difficulty of that target, consider US IPOs that went public between 1996 and 2007 had revenue growth rates of just 26% per annum when considered over a five-year period, according to Ritter and his peers.

Thus, although Snap’s IPO might be garnering a great deal of hype in the present, if we consider that its ratio in five years will be roughly equal to what Google had on its fifth year on the stock market, the apps sales must increase more than 10-fold — and that’s only so that its parent company’s stock price can stay even, let alone ascend.

(Kathleen Craig, Technical Analyst)

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