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| Snap proved again new tech ventures can achieve billions in market value without earnings. At least not yet. |
Snap, like other tech darlings, is a young company, born in dorm rooms and frat houses at Stanford. It has made a splash among the young set and has regularly added features to its product line to hang on to the short attention spans of its audience. Like other tech darlings contemplating public offerings, it passed the Unicorn test ($1 billion in private-company valuation), fended off larger companies interested in the product, talent, and users (Facebook), and followed the IPO timetable scripted by its New York bankers.
(Morgan Stanley and Goldman Sachs acted as lead banks on the underwriting.)
Like other tech darlings before and after an IPO, Snap disclosed performance to the financial world for the first time. No surprise. The company has had growth surges that would cause any venture capitalist to swoon and has amassed over 100 million average daily users. Like many tech darlings, the company doesn't make money. And in its IPO prospectus, it suggested it won't make a dime at least for a few more years.
So how does the company (and its club of bankers who helped set its IPO share price) rationalize being valued in public markets at an amount above $25 billion ($32 billion as of Mar. 6)?
How does a company founded and run by twenty-somethings, reporting a string of start-up losses, justify a market valuation that exceeds older companies with decades of track records (and earnings)? Compare Snap's $32 billion market value with well-established companies like Nike ($90 billion in market value), Target ($30 bil), Goodyear ($9 bil), General Mills ($35 bil), or HP ($29 bil). .
What do the numbers suggest? Where will the numbers go? What could happen to that vaunted valuation?
No doubt Snap wanted to avoid the first-day-of-trading snafus Facebook experienced in 2012, when it went public under the auspices of the Nasdaq exchange. The first-week, mechanical mix-ups in Facebook's IPO offset some of the joys of Facebook finally becoming a public company. Snap elected to list with the New York Stock Exchange.
Highly publicized IPO's, especially those where there is strong, popular demand for the new stock, are usually accompanied by the first-day bump in price, or sometimes spiking surge. Snap's shares experienced a 44% increase in price the first day. That often leads to the inevitable response from market watchers who wonder how the investment bankers might have under-priced the deal. That 44% price increase represents an amount not received in proceeds by Snap, the issuer of new shares. Snap raised $3.4 billion in cash from the IPO. A 44% increase implies it could have raised $4.9 billion.
Investment bankers often explain first-week spikes are typical in IPO's and are often followed by dips, where the shares settle back into a price range reflected by the initial offering price.
Keep in mind Snap is a company that didn't exist six years ago (or perhaps it did so in dreamy debates among Stanford students in a dining hall). And it reported $515 million in losses for 2016.
Market valuations are based mostly on promises and expectations of revenues, earnings, and cash flows over an extended period. Snap's $32 billion valuation, therefore, should reflect investors' confidence that revenues will soon top $1 billion and glide toward the tens of billions and earnings will eventually flip and turn into a flood of profits and cash flows.
Can Snap get to $1 billion in revenues quickly enough? Investors who bought and will hold the stock likely think so. The company reported $165 million in recent quarterly revenues, a total that puts it on a pace to eclipse $600 million in revenues in 2017.
Some may opine otherwise. In this digital-advertising sphere, revenues are tied closely to user numbers: views, users, clicks, daily volume, etc. The fundamental question will be whether it can continue growth in usage in the way it presided over it the past few years. How many more potential users are there around the world? Or what fascinating image technique (or filters or trickery) can the company devise to (a) keep current volumes and (b) attract the tens of millions who haven't bothered to try the app? How will competitors siphon off some of that potential growth? And will Snap try to achieve it via acquisitions or partnerships with others?
Right now, Snap has significant costs, which explains much why it is losing money. That's not a surprise for companies only a few years old. New companies incur the expenses necessary to build a market or create demand for the product. Once product demand (or product awareness or product popularity) is established, the company can strike out certain promotional and brand-awareness expenses. (It reports $290 million in annual sales and administrative costs, for example.)
Snap also had $185 million in research-and-development costs in 2016. For new technology companies, that's not a surprise. Technology is the beacon that leads to the features that attract the users, which generate the revenues. For many technology companies, however, R&D expense doesn't eventually disappear; it remains steady, as the company must continue to grow, adapt, evolve or die, as they say.
Last year's loss translated into an operating cash-flow deficit of $615 million. Companies, of course, are supposed to generate cash-flow surpluses for their stakeholders, and they can't bleed cash indefinitely. With the $3.4 billion in new cash (from the IPO) and $1 billion it already has on the balance sheet, it can bear another two or three years of big losses without new funding.
The company has no long-term debt. That helps when it is not generating positive cash flow: No worries about generating steady, predictable streams of cash from operations to meet interest payments. It also has little need to borrow in substantial amounts to fund huge investments in plant and property. As a new public company, nonetheless, once a quarter it will need to explain performance thoroughly and present optimistic projections for how profits will come about eventually.
With over $4 billion in cash after the IPO, it has a buffer to get it through periods of losses and has a source to make small acquisitions (not big, notable ones), if it thinks that's necessary to compete with, say, Facebook's Instagram, Google's own image ventures, and any other upstart.
Investors will give it a cushion of about three years of losses and cash-draining operations before they get antsy or even uptight (in the way investors of no-profits-yet Twitter have become). A $25-30 billion valuation tolerates losses in early years, but means an avalanche of profits in the billions are on the horizon. In a rudimentary (and crudely computed) way, a $25 billion valuation means the company is expected to generate operating cash flows within five years of at least $1 billion/year (that's profits, not revenues), remain on that plateau and grow from there at a rate of at least 2-3 percent/year.
Is that possible?
Or will Millennials have moved on to the next new thing?
Tracy Williams
See also:
CFN: Alibaba's IPO, 2014-15
CFN: Facebook's IPO: What Went Wrong? 2012
CFN: Facebook's IPO: The Lucky Underwriters, 2012
CFN: Twitter's Turn to Go Public, 2013
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