Shortly after Snap, Inc.’s (Nasdaq:SNAP) initial public offering, Robert Frazier recommended SNAP for 2017. But Tony Mitchell, another Marketocracy Manager, says SNAP is overvalued, will take too long to grow into its valuation if it ever does, and presents too much risk to invest in at this time.
Snapchat co-founders Bobby Murphy, left, and CEO Evan Spiegel, center, ring the opening bell at the New York Stock Exchange as the company celebrates its IPO, Thursday, March 2, 2017, in New York. (AP Photo/Richard Drew)
Tony started his Internet fund at Marketocracy in October, 2000. His returns have averaged 16.95% since then, which compares nicely to the S&P 500’s 5.11% return over the same period. Before taking anyone’s investment advice, you should always check out their track record. Here is Tony’s.
Ken Kam: Your internet fund has done well with picks like Facebook, Apple and Priceline – don’t you see the same future for SNAP?
Tony Mitchell: SNAP’s founders and backers were brilliant to take it public at the time that they did to maximize the share price, but we may have already witnessed the 52 week high for SNAP as profitability, growth and sustainability are already in question.
I think SNAP is a fun app and I even like the idea of Spectacles, however, I don’t see it being as sustainable as Facebook, and I foresee the possibility of it crashing harder than Twitter did, and therefore it poses too much risk to invest in.
Kam: SNAP recently received two new buy recommendations from analysts covering it – what is it, that you are seeing, that they don’t?
Mitchell: In valuing a business for the long term, and I am a long-term investor, there are two commonly accepted approaches worthwhile in using, which are:
- A valuation based on the future economic benefit stream provided by the business, or
- A valuation based on the assets of the business.
Some analysts may use a market approach based on guideline companies comparable to the subject business, and this could provide a fair market value, however in the long term what matters most and eventually dictates the value of the stock is the net operating profits and free cash flow of the business.
The market approach is more suspect to the Systematic and Company Risk, and in this case SNAP should also be discounted for a non-controlling interest.
Therefore, even when I looked at the guideline publicly traded company market approach for a valuation, I find SNAP currently overvalued and don’t see it growing into its valuation anytime soon.
Kam: Can you break that down further and explain why?
Mitchell: Sure – I would have liked to value this company based on the future economic benefit stream that it will provide its shareholders, but this is nearly impossible to do at this point, and there is very little in tangible assets so I had to start with a market approach using guideline public companies and in a simplified overview of the process, I looked at SNAP in comparison to some other social media and technology companies.
I must stop there for a minute because some readers are probably thinking to themselves that SNAP says it is a camera company and not a social media or technology company. To which I say, if we compared SNAP to Kodak and Polaroid, we should stop here because we all know what happened to those camera companies and a comparable valuation to them would be fruitless.
Therefore, I compared SNAP to Facebook, Apple, Twitter, Google and Netflix as seen in the chart below using revenues of each, for the Last Twelve Months (LTM), as this is about the only fair comparable metric that can be used. (all numbers in millions)
Comparisons are based on deriving a multiple that can be used to project the value of a subject company (SNAP), and in this case is based on the Revenues / Market Cap. In the last two lines of this chart, I generously projected growth of 50% and 100% for the next two years for SNAP to see if it may grow into its current market valuation. Here is what I see from my chart:
- SNAP’s current market valuation based on its LTM revenues is producing a multiple of 64.4 versus Facebook at 14.6, Netflix at 7.0, Google at 6.3 and so on.
- Even if SNAP grew its Revenue 100% in 2017 to $808 Million, its multiple would still be 32.2 – which is still more than 2x that of Facebook’s.
- Even if SNAP grew its Revenue another 100% in 2018 to $1.6 Billion, its multiple would still be 16.1 – which is still above that of Facebook’s today.
- Based on these comparisons alone, I would give SNAP a multiple based on revenues somewhere between Facebook and Apple.
Kam: Why so low?
Mitchell: In performing a valuation, there are many factors that must be considered and I’ve listed 3 below that weigh heavily in my judgement of a valuation for SNAP:
Non-Controlling Interest – It is common practice to discount non-controlling interests of businesses being valued and the shares of SNAP being traded publicly have no voting power whatsoever, which is unprecedented for a public company. Below is a quote from the prospectus SNAP filed with the SEC:
Although other U.S.-based companies have publicly traded classes of non-voting stock, to our knowledge, no other company has completed an initial public offering of non-voting stock on a U.S. stock exchange. We cannot predict whether this structure and the concentrated control it affords Mr. Spiegel and Mr. Murphy will result in a lower trading price or greater fluctuations in the trading price of our Class A common stock as compared to the trading price if the Class A common stock had voting rights. Nor can we predict whether this structure will result in adverse publicity or other adverse consequences.
Growth Of Daily Active Users (DAU) – DAU has already begun to slow and advertising revenues should correlate directly to this metric providing doubt that SNAP’s growth will continue at a pace to reach 50% growth in 2017 let alone 100% growth. SNAP’s DAU growth has only been about 50% year over year for the last two years as seen in the chart below, and beneath that, is another quote, both directly from the prospectus:
SNAP, Inc. Prospectus
Daily Average Users
Daily engagement also influences our advertising inventory. We had 158 million Daily Active Users on average in the quarter ended December 31, 2016, an increase of 48% as compared to our Daily Active Users in the quarter ended December 31, 2015.
The rate of net additional Daily Active Users was relatively flat in the early part of the quarter ended December 31, 2016, and accelerated in the month of December. Although we have historically experienced lumpiness in the growth of our Daily Active Users, we believe that the flat growth in the quarter was primarily related to accelerated growth in user engagement earlier in the year, diminished product performance, and increased competition. We believe that diminished product performance and increased competition especially impacted the growth of our Daily Active Users outside of North America and Europe. Additionally, we believe that the increase in net additional Daily Active Users in December was driven in part by seasonal trends.
The rate of net additional Daily Active Users accelerated in the first half of 2016 compared to the second half of 2015, largely due to increased user engagement from product launches and increased adoption rates among older demographics and international markets. This created a higher baseline of Daily Active Users heading into the third and fourth quarters, so incremental net additions within these quarters were more difficult even with strong year-over-year growth. Additionally, in mid-2016, we launched several products and released multiple updates, which introduced a number of technical issues that diminished the performance of our application. We believe these performance issues resulted in a reduction in the growth of our Daily Active Users, particularly among Android users. Finally, we also saw increased competition both domestically and internationally in 2016, as many of our competitors launched products with similar functionality to ours.