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Perhaps even more than in the typical debate over tech company IPOs, opinions are split on whether Snapchat’s shares are worth buying in its initial public offering and whether it will prove a fit and lasting public company. The answer to the first question will come on Wednesday, when Snapchat is expected to close its first stock sale to the public.
If parent company Snap Inc. does start life as a public company on the right foot, it will mean investors have chosen to focus on Snapchat’s sunny qualities: its short but impressive history of generating advertising revenue and the affection younger people have for its consistently creative app.
If investors turn up their noses, it’s a sign they are fixated instead on some of Snapchat’s red flags, among them its relatively small and slow-growing audience and cash burn likely to persist for several years.
Cheer
The Money Machine: Snapchat’s best pitch to IPO investors is how quickly the company has been able to generate advertising revenue from a standing start two years ago and narrow the gap with digital advertising powers such as Twitter Inc. and Facebook Inc.
The average revenue Snapchat generates from each daily user more than tripled in the fourth quarter of 2016 from the year-earlier period. If Snapchat can grow to Facebook’s average revenue per user, Susquehanna Financial Group estimates that would translate into an additional $5.5 billion in annual sales, even if Snapchat’s audience size stays the same.
The Kids Are All Right: Snapchat has won over young people, which are highly valued because they are tough to reach with traditional marketing messages on TV or in newspapers. More than three-quarters of Americans 18 to 24 who have smartphones use Snapchat at least once month, according to comScore.
And Snapchat in its IPO document said that on average its users younger than 25 spent more than 30 minutes on Snapchat each day in the fourth quarter of 2016. The ardor of Snapchat’s youth fan base — and the company’s creative and evolving features for advertisers — are a big reason many hardened marketers love Snapchat.
Fear
Bigger Is Better: Snapchat CEO Evan Spiegel has a contrarian point of view for an internet company: Small is good. That is, Snapchat thinks it can be a healthy business without attracting the hundreds of millions or more than 1 billion people that are the typical audience size for large and successful internet companies.
Investors seemed to challenge Snapchat’s strategy in recent meetings with managers. They were peppered with questions about why growth in its number of daily users slowed markedly toward the end of 2016 to 158 million users. The company added about 10 to 20 million new daily users each quarter from mid-2015 to mid-2016, but that slowed to just 5 million at the end of the year.
The company has said technical problems with its Android phone app was one reason for the user growth slowdown, but the timing also coincided with Instagram’s August launch of a feature that copied Snapchat’s popular daily video diaries called “Stories.” If Snapchat has trouble selling its IPO stock at the price it wants, it means Spiegel’s “bigger isn’t better” mantra didn’t win over investors, who have come to believe more and more people need to use internet hangouts to keep increasing advertising revenue.
Cash Dumpster Fire: I’ve grown inured to unprofitable companies in the tech industry. But the scale of Snapchat’s losses surprised even me. The company’s cash flow from operations minus capital spending was negative $188 million in the fourth quarter of 2016, compared with revenue of $165.7 million, or a ratio of $1.14 in incinerated cash for each dollar of revenue Snapchat generated. It is an eye-popping torching of cash.
The big reason is Snapchat has a unique business setup for a relatively large internet company. It outsources all the messy computing chores of running its app to specialists including Google. That means Snapchat has to pay the computing costs of every chat among friends and virtual images of taco heads even if Snapchat doesn’t generate revenue from those interactions.
Snapchat’s computing outsourcing model could turn out for the best if its revenue continues to outpace the increase in its computing costs. It is hard to figure exactly when Snapchat might flip from cash bonfire to profits. Susquehanna estimates Snapchat won’t have positive free cash flow until 2020.
If there’s a failure to launch at the IPO, it shows Snapchat’s impressive revenue growth couldn’t compensate for the uncertainty about the company’s profit potential.
—Bloomberg
Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal