Snap Inc. shares soared on the first day of trading Thursday in an initial public offering that was originally priced at $14–16, later increased to $17 at IPO. Once trading began “SNAP” quickly surged 44% above its offering price to close at $24.48 as investors clamored for a piece of the…
Investors, bystanders, opinionators, your 17 year old cousin who thinks you are too old for anything remotely cool — all have an opinion on Snap.
Snap IPO-ed with a business that generates a loss. Not only that, if see their financials, the trend is worrisomely negative. It has been generating larger and larger losses, primarily due to the fact that it’s per user cost has been going up. In other words cost of revenue for Snap is higher than the revenue itself.
You are thinking, that makes no sense. The whole point of tech companies are that costs go down over time, scale and increased user base should decrease per user cost not increase it. Yet here we are, 440 basis points above its initial listing price, looking at a 34 billion dollar company. Valued higher than Target, Marriott Best Buy, Ferrari, American Airlines, Twitter (giggles come out) and many more.
The questions begs — what gives? Costs are going up, and so is the valuation. Before addressing this business conundrum at hand, lets quickly glance over our shoulders at the large looming elephant in the room that hasn’t even been noticed. Facebook’s Instagram and Whatsapp (to a lesser extent, and most likely imminent failure) released features directly targeting the same user base as Snap, halting the up-and-coming’s user growth right in its tracks.
By now you must be thinking — wow, investors are truly idiots. Costs are going up, Facebook is dooming Snap (Instagram has almost 4 times the user base; and in this world network > everything else). Why is the stock price still ticking upwards?
Well, investors are. Idiots that is. If you make a quick search on Google News and read the top 15 “analysis” on the stock, its split evenly between its doomed and potential. Sometimes it pays to be lucky rather than smart. Strip away speculators, market riders (the public equity market’s are at an alltime high. Yes ALL-TIME), growth-seekers and IPO’s usual “pop” riders. You will probably get a much less excited market for Snap.
We are probably, looking at Snap with the wrong lense.
Snap is not a Facebook competitor. Facebook’s cost per user went down as it grew, it was the classic tech company that leveraged the Internet. Invest upfront heavily into product & infrastructure, due to the zero distribution costs of the Internet, proceed to make money until the end of the world.
Most companies use their S-1 to explain how they are building a sustainable competitive advantage, i.e. get user base with unique value proposition, proceed to monetize user base ala Facebook…sit on cash. Snap proclaimed there isn’t a competitive advantage:
In a world where anyone can distribute products instantly and provide them for free, the best way to compete is by innovating to create the most engaging products. That’s because it’s difficult to use distribution or cost as a competitive advantage — new software is available to users immediately, and for free. We believe this means that our industry favors companies that innovate, because people will use their products.
This sounds a lot like a company up in Cupertino, with a legendary product visionary. Allow me to recount a few similarities:
The personal computer market is highly competitive and has been characterized by rapid technological advances in both hardware and software development, which have c substantially increased the capabilities and applications of personal computers.
Thats a blurb from Apple’s S-1 filing, notice how both recognize immense competition and the rapid pace of change. Therefore, would rather focus on creating different products rather than compete in the current trenches.
Steve Jobs vs. Evan Spiegel — both are extraordinary product visionaries. They live(d) to create products. Differentiated, powerful, impactful products.
Super-engaged fan/user bases — Snapchat users open the app 18 times per day. Apple fangirls/boys don’t need further introduction. Both companies repay this loyalty by constantly bringing more awesome and cooler products to their users.
Don’t have an obvious competitive advantage — both Apple’s and Snaps focus is not any one product. It’s constant innovation and development. The S-1 of Snap labeled itself as a camera company (more on this later) not a Social Network.
Uniquely combine software + hardware — Spectacles are a near perfect example of how a new quirky hardware product for the eyes should be launched (turns and stares at Google). Snap had the software (Snapchat) and married it with the hardware (Spectacles). Apple’s iPhone without it’s iOS would be just another Android OEM.
Both went up against giants — Microsoft & Facebook.
Having identified an analogy (or comparable as the Wall Street people like to say). Lets look at the upside now, and why Snap is probably still undervalued.
Snap calls itself a camera company. Huh? GoPro vs Snap? No, not really. Recall the similarity I pointed out between Apple & Snap. They integrate software + hardware like no other. Snap’s Spectacles have so much more potential because of the fact that it seamlessly integrates into an existing software/ecosystem/product — Snapchat. GoPro will never have that.
What is a camera company then, you ask? Before getting to this, a little about my background to contextualize my hyperboles. I’m an associate at a really awesome VC fund, as VCs our job is to see the amazing things that companies could do, i.e. potential. We don’t get a cookie for telling how an entrepreneur and her/his idea will fail, i.e. doom. These pair of spectacles (pun intended) we wear are the reason why I’m bullish on Snap: we see what the future might look like in hyperboles. Now to the good part.
Snap’s definition of a camera is a method of communication. It’s a method of creating. Up until today the most widespread method of communication was the keyboard. WhatsApp for example is a keyboard company, even Instagram is still a keyboard company. You consume but you don’t reply with videos back to your friends. They all use the keyboard on your screen to enable you to communicate with all your friends and family. This changes everything.
Combine an engaged user base and the Spectacles that fit right into that ecosystem, you are changing the way people are communicating. Further extrapolating, you could see how the aforementioned Specs become more and more powerful (Moore's law, energy storage trends, etc) up to a point where they replace what you have in your pocket.
There is limited amount of ways we can receive stimulus, the most effective method so far has been vision. So far that vision has only consumed from 3.5 inch to a more recent 6 inch screen. Making a product that you are not irked out to wear on your head & eyes (turns and stares at Google once more) is probably the next best thing to just directly stimulating the brain (foreshadowing here).
To this end, seeing increased cost per user go-up is actually a positive sign. It signifies the fact that Snap is continually innovating, be it in augmented reality, be it communications or hardware they are generating a surplus of value to their users. Alas, these users are at the moment not their customers — Snapchat users don’t pay for any of these innovation (Spectacles are changing that, but they are a tiny part of revenue at this point) the advertisers are. This is where Snap becomes so powerful, it wants to make the best possible products for its users…
Our drive to create new things comes from the belief that we can create products that will improve the lives of the people who use them. We believe it’s always worth trying to build something that will empower people to express themselves, live in the moment, learn about the world, and have fun together — even when it’s not clear that what we build will be successful or make money.