When Google went public it was valued at 23 million(29.22 million today). During that time, there was a rapidly growing market, Google had been profitable for 2 years (according to their S-1), and it was already the market leader in search. Google had a slew of competitors, so it wasn't without considerable risk, but it was clearly a company deserving of its valuation. That IPO was in 2004.
We now live in 2017, where nothing makes sense and facts don't matter (#alternativefacts). So Snap Inc (NYSE:SNAP), previously known as Snapchat, decided to go public at 25 million. I imagine the thought process went something like "what the hell why not". So this article is all the reasons "why not".
1. Snap is spending an inordinate amount of money on G&A expenses. It accounts for 40% of their revenue. WHY?! Facebook's (NASDAQ:FB) G&A expenses accounted for only 8% at IPO. Twitter's was 13%. The article linked above sites some possible explanations, such as the company's youth, as to why the expenses are high. The explanation they came up with is:
"G&A costs can be thought of as a company's infrastructure. Buildings, back-end technology and professional services are expensive early on and, relative to other expenses, should cost less over time."
Since Snap is a young company their G&A expenses should stay stable while the income increases. This is a difficult thesis to test, since outside of the S-1, G&A is combined with selling expenses to be SG&A. In order to get a direct comparison over several years, I tracked SG&A expenses over the early life of Twitter and Facebook. I excluded R&D expenses. SG&A will be expressed as a percent of sales. Facebook's SG&A as a percent of sales regressed from 35% to 18% in five years. Twitters SG&A, again excluding R&D, regressed from 86% to 50%. Both company's showed a marked decrease over he past 5 years, which seems to support the authors point. However, when we drill down and compare Facebook and Twitter more directly, 10 years into Facebook's life span its SGA was 22% of sales and Twitters was 50%. Twitter has had problems with controlling costs, once its user base stopped growing, the company's scaling efforts turned into bloat. These numbers suggest that yes, while G&A costs may go down overtime in comparison with sales, consistently high G&A costs are indicative of bad management. Snap is less than six years old. Its SG&A compared to Twitter's when they were six is only slightly lower. Twitters was at 86%, Snap's is at 71%. The earliest record of Facebook was when it was 7 years old in 2009. At year 7 SG&A was 26% of revenue. 26% is a sign of a well managed company. 71% is a severe red flag. Without proper cost control Snap will never be a successful company. While this problem of high G&A is not insurmountable, Snap needs to have disciplined, organized management. The small details of running a business matter a lot, but Spiegel spends most of his time designing products. I believe Spiegel should move to the head of product design and a full time, experienced CEO should replace him. This would help Snap management focus on strategy development and execution and help it trim down its cost and expand in a more controlled manner. Otherwise they could turn into another Twitter. High G&A costs are symptoms of the disease of bad management.
2. Snap is an absolute mess. According to a recent article by Business Insider, Snap Inc.'s management has little regard for its employees. Story's of detrimentally secretive management, regular upheaval, and a chaotic environment tells the story of a missile set to explode, not a rocket ship. While a fast pace is common in a startup, order and cohesion need to be present as well. Chaos precedes doom. Facebook management works to create a cohesive environment, using things like an annual Facebook birthday party, conference rooms named by employees, and a company field day. A cohesive business is one that produces more through synergy. One fractured by secrets and a strict hierarchy do not innovate effectively. Secretive management has a tendency to limit innovation. Cross pollination of divisions are what make company's like Apple, Facebook, and Google so innovative. If Snap is continued to run like this, they will struggle to grow further due to employee turnover and low morale. They will also struggle to produce the innovation they desperately need to in order to maintain their competitive advantage. A quote from a twitter engineer in 2012 sounds eerily similar to What is described in the Business Insider article. "The work culture is good, though chaotic. We're on a ridiculous hiring spree, and getting to the size where communication is difficult, and duplicate work is starting to happen." Undisciplined management is a huge red flag, as profitability cannot be attained unless the company is lean, innovative, and organized.
3. The success of Snap's products is amazing considering reports that Spiegel uses almost no research or consumer data to build these product. However, no one can be right all the time. Ignoring your consumers and your employees can lead to disastrous mistakes. Snapchat does not seem to prescribe to the lean fast start up strategy, which says a company should be low cost and use fast development to produce and then fix products. This allows a company to get feedback and perfect a design quickly based on what the consumer actually demands. The importance of this approach can be seen very clearly in the story of Gap. The Ceo of Gap in the 90's was named Drexler. Drexler was great at predicting the next fashion trend... until he wasn't. Gap then saw a huge decline in sales and almost went under. Unless Spiegel starts using data, consumer feedback, and market testing to improve and launch new products, Snap is doomed to fail. Snap seems to be Market testing their Spectacles, which is a good sign, but it is almost certain they did not use consumer input to design them in the first place. Market testing a hardware product is difficult to do, and results in very slow rollouts. If Spiegel wants Spectacles to be a profitable part of the business, he needs to be able to ramp up production soon.
4. Snap is the underdog by a huge margin. This point has been made by a great many people, but It becomes more alarming when one considers Spiegel does not seem to have the strategic and managerial chops to overcome this hurdle. Good product design and product innovations can be copied. Apple is constantly having features taken from its phone to be used in other, cheaper phones. Yet Apple remains dominant because of their brand, consistent innovation, and devoted user base. Their ecosystem of products and services makes defection a hard task. Snap has none of these things keeping their product safe from copy cats. This is a David and Goliath story where David has no weapons, no armor, and is being hunted. All David has is his wits. If Spiegel wants to succeed he needs to outsmart Zuckerberg. To think that Snap is a threat to FB at this point is delusional. It essentially comes down to numbers. When FB had their IPO they were already a conventionally successful company with a proven CEO at the helm. According to this article, Snap looks alot more like Twitter in regards to financial data. Here is the gist of the article:
- Snap lost $514 million in 2016. Twitter lost $79 million the year before its IPO. Facebook, on the other hand, was bringing in $1 billion in profit.
- Snap had revenue of $404 million in 2016. Twitter had revenue of $317 million the year before its IPO. Facebook was already a moneymaking machine, with revenue of $3.7 billion the year before its IPO.
- Snap has 158 million daily active users. Twitter, which only reports monthly active users, had 218 million. Facebook dwarfed them both, with 845 monthly active users, and 483 million daily active users.
- Snap has 1,859 employees. Twitter had 2,000. Facebook had 3,200.
5. Snap is already facing slowing user growth. We could be looking at another Twitter (NYSE:TWTR) situation here where they encounter user growth that drops off. Instagram recently copied one of Snap's features, the story feature, and it has already hit 150 million daily active users. The growth slowdown seems to be a direct result of Instagram's story feature as growth slowed right around when that feature came out. This threat of fast followers will never leave them. They have a compelling product which can easily be copied. They must learn to be faster and more innovative, something I do not believe they are currently capable of doing.
Snap may be the next Facebook. At this point, the smartest thing investors can do would be to wait and see. If Snap continues to grow revenue, slashes SG&A costs, and comes out with a new, significant way to drive user growth this stock could be a good buy.
Evan Spiegel, the CEO, is by most definitions of the word, a visionary. I use Snapchat on a daily basis. Its design is amazingly well put together. They continually do things to improve it and, in my opinion, rarely misstep. The new Spectacles, Spiegel's entrance into the hardware game, are similarly impeccably well designed. He is an innovator. He has a uncanny eye for what will be popular and what will attract users. Revenue growth is huge and monetization potential in the app is largely untapped. His users are devoted, and international expansion has also hardly been tapped. He has successfully created a hardware product, Spectacles, that people seem to like, and can most likely scale that business. He has a lot of room to grow the business and seems like one of the best men for the job. Snap has better reviews on Glassdoor, the employer reviewing site, than Twitter, though not as good as Facebook.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.