Valuation of Snap Inc.

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.