Wherever something fascinating
happens the excitement to watch it is overshadowed by the fact that we need to
add a snap story of it. In the time of what is touted to be one of the biggest
IPO’s, I valued Snap Inc. Here I present my numbers and the story behind the
assumptions.
Initially, while reading the S-1 what
stuck me is that Snap claims itself to be a camera company. Should I assume Snap operates in a business of
manufacturing cameras?? It doesn’t make sense. My valuation began with finding the
right industry in which Snap Inc, operates. The main source from which Snap derives
its revenues is the online mobile advertisement platform. In recent times
mobile advertising has become a big boom to companies like Google, Facebook,
Twitter. As of Dec 2016, mobile ads constituted about 40% of the advertising
sector. The major factor for mobile advertising is the average amount of time
an user spends on the app rather than the number of users. This is what has
driven the revenues of Facebook by 30% in the fourth quarter of 2016 and FB
claims that users spent more time on Facebook & Instagram which in turn
gave them the opportunity to expand the number of slots for ads. According to a
recent article on WSJ, when analysts asked Snap Inc. executives about its
decelerating user growth and competition from Facebook, Mr. Spiegel emphasized
that the number of users matters less than how much they spend time on the app.
Snapchat is next only to Facebook with an average user spending around 20-30 minutes
in the app daily.
When valuing relatively new companies,
everything seems to be offbeat and Snap
is no exception to it. The cashflows were negative in the last two years but it
showed an increase of 589% in revenues. It will be foolish if we expect the
same growth rate in the coming years. The best possible way to value startups
or new firms without any substantial cash flows is to compare the firm with its
peers. As Facebook went to IPO in 2012 in order to have a better picture I
considered the average growth rates of Google revenues for the last 10 years
and assumed Snap to be growing around the same average(35%) in the foreseeable
future. Initial growth rate was assumed to be 60%(2017-2019) and then a growth
of 30%(2020-2023), finally a 15% rate was considered from 2024-2026. Thereafter
I assumed that the terminal cash flows will grow at a rate equal to the US risk
free rate of 2.38%. The EBT margins were set to a value of 31.5% in 2026 and
the previous margins were calculated based on an improvement spread
of 50%. Snap claims that it owes Google Inc. $2 billion in the next 5 years for
using their cloud front services. The capital expenditures were calculated based
on this and an estimated sales/capital ratio of 2.
The following steps were
followed in arriving at the cost of capital
- US Risk Free rate of 2.38% and Equity risk premium of 5.69%
- The average unlevered beta of 0.90 is taken for the advertising industry and it is relevered at Snap Inc’s current Debt/Equity ratio.
- Cost of equity is calculated using CAPM and is equal to 7.54%.
- Based on the current Interest coverage ratio of -362.17, I considered a rating of D2/D for the firm and the corresponding rating based spread of 14% has been added to the risk free rate to arrive at a 16.38% cost of debt.
- Snap Inc. do not have any preferred shares.
- From the S-1 a total of 1151.15 million shares are being issued (look at the excel sheet for detailed calculation). The price per share was assumed to be at $16 based on reports speculating that Snap can be priced between $14-$16.
- The debt value is taken from the 10-k and the estimated cost of capital is 7.58%.
Proceeds from the IPO are estimated
to be $3 billion at $16 per share, which will be retained by the company. In
calculating value of options: volatility, strike price & term to expiration
are taken from the S-1 filed by Snap Inc. It is assumed that options do not provide
any tax advantages. Taking the above assumptions my value for Snap Inc. is
$10.87 per share. I want to be clear that $10.87 is the amount at which I value
a share of Snap Inc and it not the price per share of the firm.
Facebook had a worst IPO but now its
stock price is soaring high while Twitter had an excellent IPO but it is
plunging now. One major factor which I think will have a significant effect on
the stock price is acquisitions. If Snap Inc. can be a takeover target of
leading tech and media companies it greatly helps in boosting the share price.
The recent example is Twitter, when it was not preferred to be acquired by
either Google or Disney and the leaked list of Salesforce acquisition targets
didn’t feature Twitter, the share price fell considerably. Finally, I would like to conclude that it is
unpredictable to say how Snap Inc. will perform in the future. I prefer to
trade Snap Inc. rather than investing in the firm.
Click here to download the
spreadsheet depicting the valuation.
