Snapchat is a great product with strong engagement levels. However, SNAP stock is overvalued at the current level.
Yesterday, the self-described "camera company" Snap Inc (NYSE:SNAP) went public in what was one of the most successful IPO listings in the past few years. Pushing aside all the valuation concerns, Snap shares listed on NYSE at a price of $24, more than 40% above its offer price of $17. After hitting a high of $26.05, Snap stock closed the day at $24.48, 44% above its initial price. So, if you are one of those people who held SNAP stock before it started trading on NYSE, congratulations! In all, more than 217 million shares of SNAP changed hands. Snap Inc raised more money through its IPO than all of the tech IPOs combined in 2016.
Snap Inc was initially aiming to go public at $14-$16 per share valuing the company around $19-$22 billion. However, due to the strong demand, the company raised the offer price to $17 per share. According to reports, Snap's shares were oversubscribed 10 times, in spite of valuation concerns. At the current valuation of $28.33 billion, Snap is trading at 70 times its 2016 revenues! The company currently is more valuable than many household names. At such an expensive valuation, the company has little room for errors.
Snap's listing was more like Twitter's.
There is a lot of buzz about whether Snap is more like microblogging site Twitter or like Facebook. At least on the listing day Snap had more in common with Twitter than Facebook. Like Snapchat, Twiter had raised its initial offer price in response to strong demand. Twitter initially stated that it would sell its stock as low as $17 per share. But the demand for its shares was so strong, Twitter finally priced itself at $26 per share. Like SnapChat, TWTR stock had seen massive listing gains. Twitter closed its first trading day with a massive 73% gain, while Facebook saw a measly 0.68% return. But Snap would like to go the Facebook way from here rather than follow Twitter.
Depending on whom you speak to, either Snapchat is a highly overvalued company with decelerating user growth and a very poor corporate governance structure or a company with a great product, strong engagement levels and an innovative business model which is more likely to go the Facebook way.
Snapchat is facing strong competition from "imitators".
Snap Inc has an innovative and hugely successful product. One of the hallmarks of a good product or service is the rise of imitators. Be it Uber (Lyft, Ola, Didi) or Amazon (Alibaba, Flipkart), innovative ideas have been imitated multiple times across the world. It should be particularly flattering for Snapchat when you have a tech giant like Facebook (NASDAQ:FB) launching products "inspired" by it. Of course, the imitation by Facebook is likely to be Snapchat's biggest problem.
With Facebook launching "stories" on Instagram, Snapchat will find it difficult to attract new users. Snapchat's daily active user growth slowed to 5.3% in the four months after Instagram Stories was launched, according to a study by New York City–based research firm 7Park Data. The study also found that the number of times Snapchat users used the app on a daily basis "declined significantly". As we have written in our previous coverage of Snapchat, the company has a core user base that is already seeing a deceleration in growth.
Another risk facing investors will be the sub-optimal corporate structure operated by a senior management team lacking experience. In a first for an IPO, the shares which Snap has offered through the IPO will carry no voting rights. All the voting rights exist with the pre-IPO shareholders. High expenses and cash costs to run the company are negative as well.
Fighting the duopoly.
Investors in Snap will be also exposed to a risk of an upstart facing aggressive competition from much larger companies. Snap will be vying for a piece of advertising market which currently is almost a duopoly, with Google and Facebook taking a huge chunk of the pie. In its S1 filing, the company has warned that, "We compete with other companies in every aspect of our business, particularly with companies that focus on mobile engagement and advertising,", "Many of these companies, such as Apple, Facebook (including Instagram and WhatsApp), Google (including YouTube), and Twitter, have significantly greater financial and human resources and, in some cases, larger user bases". The company has a promising and innovative advertising offering, but so far it is still mostly unproven.
Stay away from Snap Inc stock.
Snap Inc made a strong debut with its shares gaining a massive 44%. Given the strong demand and hype around the stock, the stock may trade higher for the next few days. However, in the long run, it is a risky bet. Snapchat has received a sell rating from multiple analysts including Pivotal Research's Brian Wieser who has a price target of $10. While Snapchat is a great product with strong revenue growth, given the current valuation we recommend that investors stay away from the stock for now. Snapchat's current valuation may turn out be as ephemeral as the pictures shared on the platform. If you are looking to invest in tech stock with more attractive risk-reward proposition here are our Top Stock Picks from technology sector which have outperformed the market by over 130% over the years.
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