Snap Justifies over $20 billion Valuation by Engagement Metrics

Snap’s app enables users to send photos and messages that vanish within seconds of being read

It is common knowledge that Snap Inc., the maker of photo-sharing app Snapchat, is looking to make its maiden market debut in March 2017 that could value the company upwards of $20 billion. An IPO valuation of over $20 billion would be significantly higher than Snapchat’s most recent valuation of $17.81 billion, based on a $1.81 billion financing round in May 2016. It would also represent the largest IPO by a technology company since Chinese ecommerce giant Alibaba Group Holding Ltd. (NYSE: BABA) went public in 2014 and ahead of Visa Inc.’s (NYSE: V) $17.9-billion market debut. Interestingly, Alibaba had invested $200 million in Snapchat in March 2015.

Is Snap’s high valuation justified?

Snap Inc., which changed its name from Snapchat Inc. on September 24th, 2016, to reflect its broader ambitions, gained popularity with its Snap’s mobile application that enables users to send photos and messages that vanish within seconds of being read. Founded in 2011 by Evan Spiegel, Snap belongs to an elite group of highly valued and closely watched venture-backed companies, led by Uber Technologies Inc., to test the public markets. The Company has already raised more than $2.4 billion of financing from investors including Lightspeed Venture Partners, Benchmark, Institutional Venture Partners, General Catalyst Partners, Fidelity Investments, and SV Angel.

Snap primarily earns revenue by selling advertisements on Snapchat that are slotted in between stories contributed by media partners and video diaries posted by its 150 million daily active users. Marketers can also purchase location-based or event-based geofilters and “lenses” that add quirky characteristics to photos and video. Snapchat is dominant in the 18 to 24-year-old demographic, but it is now broadening its reach.

Snap, an ultra-secretive organization where employees are unlikely to know the goals or strategy of other teams, filed for its IPO confidentially under the Jumpstart Our Business Startups (JOBS) Act in October 2016. The company is now working with lead underwriters Morgan Stanley (NYSE: MS) and Goldman Sachs Group Inc. (NYSE: GS) to convince investors about its high valuation by stressing how important its app is to users’ daily lives.

Snap brings investor focus on engagement metrics

Kick-starting the IPO process with its underwriters, Snap revealed a slew of engagement metrics that will be used to build financial models to determine the valuation that it will seek. Management brought investor focus to the number of snaps, annotated photos, and short videos, that its users take daily, and the time that they spend on the app. Snap also detailed what percentage of users take photos using the app’s camera, as well as how many of those images use geofilters, colorful place names which users can place on top of their snaps, or are being saved with the new Memories feature. Snap also divulged the percentage of users sending messages through the chat feature.

Venice, California-based Snap’s valuation has grown over the last few years as the company added advertising and sponsored contents to its messaging service, paving the way for the Company to predict $1 billion in advertising revenue in 2017. According to research firm eMarketer and as reported by The Wall Street Journal, Snap’s user base is expected to jump 13.6% to 66.6 million by 2017. Despite these projections, Snap has cause for worry since its IPO launch comes at a time when shares of technology firms such as Square Inc. (NYSE: SQ) and Box Inc. (NYSE: BOX) that went public over the last two years are trading well below their private market valuation.

Snap, which is aiming to raise as much as $4 billion in its IPO, is divulging these metrics upfront as a sign of being more transparent about its metrics than its social-media peers, Twitter Inc. (NYSE: TWTR) and Facebook Inc. (NASDAQ: FB), have traditionally been. Snap has been seeking to distance itself from the Twitter debacle and learn important lessons from the ghosts of social-media IPOs in the past about the importance to disclose correct metrics from the start. The company will try to temper short-term inconsistencies in its user performance by focusing on the long-term investment thesis.

After its foray into consumer electronics with the release a wearable gadget called Spectacles, it remains to be seen how Snapchat will effectively use the IPO funding to increase its user base in the future. Snap could use some of the proceeds from its IPO for acquisitions in augmented-reality or virtual-reality as it has done recently.

On December 25th, 2016, Reuters reported that Snap is buying Israeli augmented reality startup Cimagine Media for an estimated $30 million to $40 million. Cimagine developed True Marketless Augmented Reality, a technology that allows users to virtually place furniture and appliances they wish to purchase in the space of their home, on their mobile devices, at the click of a button. Cimagine will become Snap’s R&D center in Israel and is expected to rapidly expand its workforce from its current 20 employees.

Being in an early growth phase where short-term performance may not make investors happy, Snap intends to focus on more technologically mature markets where it will look for ways to increase its average revenue per user. It remains to be seen if the excitement generated on Wall Street prior to its IPO indeed translates into long-term revenue and user growth.

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