SNAP IP​O

1. What are the key challenges and opportunities of Snap's business model and
economic proposition?
Key challenges:
- The majority of Snap’s users are between the age of 18-34, and lack of loyalty in
this demographic group can hinder growth as well as the ability to maintain its
user base (p. 7).
- Snap is highly dependent on Google Cloud and Amazon Web Services, making
the total expense for these two as high as 3 billion over the next five years (p. 7).
- There is a lack of transparency in the directors who are young and demand
concentrated power, giving no voting rights to Class A shareholders (thus
institutional investors will not have a say) and making it harder to attract talents
(p. 6, 7).
- The lack of a centralized headquarters impairs communication and makes it
difficult to scale the company (p. 7).

- Competition from other tech companies in mobile advertising is quite tough

(Exhibits 10a, 10b), and there is a possibility that Snap’s technologies will be
copied or lose advantages (p. 7).
- Security concerns have not been sufficiently addressed (p. 3).
- Snap does not have any long-term advertising commitment (p. 7).

Key opportunities:
- The mobile advertising market is growing rapidly (by 25% by 2020), the U.S.
accounts for 49% of this lucrative market (Exhibits 12a, 12b).
- Young users of Snap have a lot of space for penetration (p. 3).

2. What is driving Snap's decision to go public in March 2017?

a. What factors lead Snap to believe that the market conditions are optimal
for a large technology IPO in March 2017?
- In 2016, average IPO returns were up 23% from the offering price, which
was the best performance since 2013. Looking at this prior year's facts
(Brexit, election turbulence, low interest rate, favorability for M&A), Snap
might believe that situations will change and its 2017 IPO will be
successful (p. 8).
- The IPO market was expected to rebound in 2017, due to the improved
economic outlook and more clarity of the US’s policies.
- The expectation that the Fed’s rates would climb in 2017 makes the equity
market more attractive.
 - It is very likely that other tech decacorns will go public in 2017 (p. 8).

b. Compare the statistics and performance of Snap to its competitors at the

time of their IPOs.
- Twitter, one of the major competitors of Snapchat, at its IPO has 58% less
DAU compared to 158 million DAU of Snapchat. Snap’s users represent a
younger population which other players have a hard time accessing.
- However, Snap’s statistics and financial performance are poor: revenues
are growing fast but still result in a net loss; operating cash flow and
margins are hugely negative in 2016; growth in total DAU (daily active
user) is a modest 3.26% (158 quarterly DAU in 2016); average revenue
per user (ARPU) is only $1.05 compared to Facebook’s $4.83 (Snap’s
$2.15 vs. Facebook’s $19.81 in the U.S. in particular); Snap needs to
significantly boost their ad load to compete (Exhibits 8, 9, 15, 16a, 16b,
and 17).

3. What are some of the reasons a company may choose to stay private longer?
How might this potentially impact the broader market?
Reasons for staying private:
- Private investors are using alternative exit strategies and often holding on to their
investments for longer periods.
- M&A market attracts more companies (p. 8, Exhibit 11c).
- Many large tech companies achieve high valuations based on profit potential,
rather than actual results which the public markets usually expect. Thus, private
investors choose to hold the companies until they grow big enough to justify their
high valuations (p. 8).
- The abundance of private capital provides a cheaper and faster way of accessing
capital (p. 8).
- The cost of an IPO is significant because of the spread demanded by the
underwriter and the discounted initial trading price (Note on the IPO process);
IPOs usually take several months (p. 8).

Potential impact to the broader market:

- The fear of pressure from public market investors to deliver short-term results
makes the equity market less attractive.
- This also results in companies issuing multiple-class share structure to protect
the board’s voting power (p. 8).
- Private funding is thus more advantageous, in a sense that it helps managers
focus on long-term strategies instead of short-term goals.
4. A Morgan Stanley analyst produced the financial forecasts provided in the
Snap Supplemental Workbook shortly after the offering (see HBS publishing for
this Excel file). The analyst assumed a WACC of 9.7% and 1,404 shares
outstanding. Under these assumptions, what would be the discounted cash flow
(DCF) estimate of Snap stock's fair market value on a per share basis?
(see the excel file)
a. How sensitive is this estimate of Snap's stock price to assumptions
about growth and WACC?

Growth is currently estimated at 3.5%. The growth rate is very sensitive to stock
price, especially when it is estimated above 7%.
WACC is currently estimated at 9.7%. The cost of capital is also sensitive to
stock price, but not as much as the growth rate because of convexity.

b. Do the assumptions and forecasts appear reasonable? What data would

you use to assess that?
The assumptions are a WACC of 9.7% and a growth rate of 3.5% at terminal.
The WACC seems reasonable because compared to FB’s WACC of 9.35%,
Amazon’s 7.14%, Twitter’s 6.34%, Snap’s WACC appears to be higher. This can
be justified by the fact that Snap is relatively a newly established company and
has yet earned a positive cash flow, thus requiring a higher rate of return, i.e., it
is riskier to invest in Snap compared to other big tech companies. Moreover,
currently Snap has no debt in its capital structure, and we know that equity
financing is much more costly than debt financing.

The growth rate seems reasonable, too, because Snap is forecast to consistently
increase its revenue over 20% each year during the period, and FCF is forecast
to stay close to one-fourth of revenue in the end. This forecast is consistent with
the growth rate of stable big tech companies in Exhibit 10 (FB’s 20.38%,
Google’s 54.16%, and Twitter’s 14.05%).

However, since the growth rate can significantly change the terminal value, which
accounts for over 85% of the total enterprise value, we must figure out this rate
as accurately as possible. Furthermore, using growth rate means that we
assume Snap will continue its operation forever, which is not usually the case. A
more consertive approach would be expanding the time horizon so that revenue
growth becomes more stable, as well as the capital structure remains almost
fixed. Nevertheless, this requires factoring in numerous economic factors after
the IPO, which may be infeasible to do so.

c. Analyze Snap's DCF value under various alternative assumptions of your

own.
i. What important changes would you make to the forecasts provided
in the Snap Supplemental Workbook, if any?
- I would be more conservative in estimating the revenues in 2017
and 2018, the only two years which currently have triple digit
increase. Snap has numerous challenges as mentioned above in
question 1, and its recent financial performance is poor relative to
other tech companies. There is no compelling reason to believe
that a boost of that much percentage is going to happen soon.
- CapEx is increasing very slowly, which makes sense because Snap
is a tech company. However, if managers believe that they would
spend more on cameras and other newly associated equipment as
side products, they must be increasing their expenditures more.
- I would also forecast the growth rate more accurately by expanding
the time horizon, or perhaps use the price-to-sales data provided in
Exhibit 14, or another reasonable multiple to forecast the terminal
value.

ii. What discount rate would you recommend using in this DCF
analysis? Assume a long-term government bond rate of 3.16%.

iii. How, in particular, would you deal with the uncertainty associated
with Snap's future growth?
 I would include a scenario analysis (see accompanied excel file) that
highlights the share price in the best, base, and worst case scenario. I
would also put the aforementioned WACC of 7.39% for the best case,
since this would make the share price jump by almost three times, and
signal to investors that Snap is just as risky as Amazon (which is definitely
not true!)

d. Do you believe that Snap underpriced its IPO? If so, why might it have
done so, and do you agree with that decision? If you were the CEO of a
company undergoing an IPO, would you agree to underprice it at the time
of the offering?

I do believe that Snap underpriced its IPO, but not as much of a divergence from
its base price of around $23 to $24. It might have done so to attract investors
who were skeptical about a high price, and boost demand thereafter. Snap can
also be underpriced if its sponsors are genuinely uncertain about the reception
that the stock will receive. After all, in the worst case, the stock price will
immediately climb to the price that investors consider that it's worth.

If I were the CEO of a company undergoing an IPO, I would agree to underprice

it at the time of the offering. Even though there will be a signalling issue, in the
end investors willing to take a risk on a new issue are rewarded, and the
company's executives are pleased. That is considerably better than the
company's stock price falling on its first day and its IPO being blasted as a
failure.