Some Thoughts on Valuing SNAP

As everyone in the tech world probably already knows, Snap went public on Thursday. As I write this, its current market cap is roughly $31.5B. Clearly, the company is being valued on growth and future prospects rather than current cash flow since it’s not generating any. I decided to play around with what kind of assumptions we have to make — what we must believe to be true — to support a $31.5B valuation for Snap.

Before diving in, the obligatory Cover My Ass Disclaimer: This post is not intended to provide investment advice. Please don’t interpret this post as investment advice or, worse, actually invest your money based on this post. You’ll likely be disappointed in the outcome.

A Few Stats
Snap generated $404.5M in revenue in 2016. The S-1 filing cited the following values for Q4 2016:

  • 158M daily active users
  • $1.05 average quarterly revenue per user
  • 7% gross margin
  • Daily Active Users spend an average of 25–30 minutes on Snap every day

Clearly the company needs to improve at least one — if not all — of the financial metrics above to justify its valuation. Let’s look at them each in isolation and assume an 8% cost of capital (which is probably generous) and 30% tax rate.

User Growth Only
Let’s pretend the company only grows its user base without improving ARPU or gross margin and that overhead expenses don’t increase over their 2016 level.

In that scenario, if Snap achieves 4,330% user growth in 2017 and acquires all ~7B people on Earth as users, the present value is approximately $13.8B. And I ignored taxes in this scenario.

So, clearly ARPU and/or margins need to improve too.

Margin Improvement Only
Assuming 0% user growth, static ARPU, and a miraculous increase to 99.9% gross margin in 2017, we get a present value of approximately $1.7B. Given the company grew users 48% from 2015 to 2016, that’s obviously too pessimistic, but shows we’ll also need substantial user growth (and/or ARPU improvement) to support the current valuation.

ARPU Increase Only
If we hold margins and user numbers constant, we can support a $31.5B valuation if ARPU immediately increases to $358. Given that Facebook and Twitter reported $19.81 and $6.31, respectively in Q4 2016 that’s not realistic. If Snap improved ARPU to $20 immediately — while holding margins and users constant — we get a negative value because the company would still be burning cash. With constant margins and 0% growth we’d need a roughly $43 ARPU to get to any positive valuation.

Some More Realistic Assumptions
Obviously, none of the scenarios I described above are realistic. Snap’s user base grew 48% year-over-year, ARPU increased 238%, and gross margin improved by 12.3 percentage points. But, I think the models above were useful to set some boundary conditions.

Making some more realistic assumptions, we can support a $31.5B valuation in a number of ways:

  • Gross margin increases to 80%; 900M+ users within 5 years; no increase in ARPU
  • Gross margin increases to 90%; 750M+ users within 5 years; ARPU increases to $6.31 (i.e. equal to Twitter)
  • Gross margin increases to 80%; 650M+ users within 5 years; ARPU increases to $9.90 (i.e 50% of Facebook)
  • Gross margin increases to 70%; 400M+ users within 5 years; ARPU increases to $19.80 (i.e. equal to Facebook)

And the list goes on and on. These models are obviously oversimplified and the cost of capital I assumed is probably far too low given the risk involved. No doubt there are other also other scenarios, revenue streams, and wild cards I haven’t considered. For instance, if Spectacles are a huge hit and both increases the user base and positions Snap as the AR Company. But, the scenarios described above, while extremely aggressive, aren’t completely outside the realm of possibilities.

I came into this exercise expecting to conclude that Snap was wildly overvalued. After working through this, while I certainly don’t think it’s a safe bet, I can at least imagine a reality where one of the scenarios above (or one of the others I didn’t list) could unfold and make it an extremely valuable company. Bottom line, anyone who believes the current value is making some aggressive assumptions about user, ARPU, and margin growth.

Bonus: A few of my favorite quotes from the S-1:

  • “To generate excitement for X-Men Apocalypse, 20th Century Fox ran a Sponsored Lens campaign that let users turn themselves into the iconic characters in the upcoming movie. In one day, people spent a collective 56 years playing with the sponsored lenses….” (p. 102)
  • “Smartphones….are personal in a way that other forms of media never will be — we eat, sleep, and poop with our smartphones every day” (p. 110)
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