Snapchat’s IPO is lunacy, but it could be crazy good: Gadfly

Let’s say this up front: Buying shares in Snapchat’s IPO next week is an act of lunacy.

Let's say this up front: Buying shares in Snapchat's IPO next week is an act of lunacy. (Reuters)

Let’s say this up front: Buying shares in Snapchat’s IPO next week is an act of lunacy. It’s nuts to buy stock of a company with just a two-year track record of generating revenue, a loss of $1.27 for each dollar of 2016 sales, a valuation higher than just about every other big technology company and sole decision-making power in the hands of two twentysomethings.

But here’s the tricky part about this lunacy: No matter the wisdom of prognostications, it’s hard to predict which controversial, overvalued tech IPO candidate will prove to be a wise investment and which controversial, overvalued tech IPO candidate will be a dud. At this stage of life, it is nearly impossible to tell one crazy from another.

In the run-up to initial public offerings of many prominent internet companies, people tend to raise legitimate questions about slowing user growth, the risk of competition, bad business models, corporate democracy problems or irrational valuations. That’s true of just about every successful tech company that went public in recent years — and for nearly every one that turned out to be unsuccessful.

You May Also Like To Watch This:
[jwplayer aSzaXDEd-DE6UeepY]

I’ll administer a quiz to illustrate this point. Guess which prominent tech companies were the subjects of these skeptical quotes as they neared their IPOs:
1) “They were overconfident — not only in the number of shares, but also the price people would be willing to pay.”
2) “[The company’s] value is probably much less than most investors seem to think. … I’m sitting this one out.”
3) “This initial public offering has become another example of a company getting a pass on fundamentals such as earnings and quality of revenue.”
4) “We are left wondering whether [the company’s] ‘business model’ is really anything more than half-baked plan. … [D]oesn’t it make sense to wait until the market can better value the company?”
5) “It’s a non-obvious story of why one would buy this at an extremely high valuation until the engagement or growth story is dramatically more clear.”

Numbers 1 and 2 were said about Google (now Alphabet Inc.) and Facebook Inc., respectively. The final three were Twitter Inc., Groupon Inc. and Snapchat. Each of them faced serious doubts at their IPO. Google and Facebook doubters were wrong, although not necessarily off the bat. Facebook’s IPO was a disaster, and shares traded below the IPO price for the first 15 months. All the worst fears about Facebook came true, for a while. All the worst fears about Groupon were also true — and stayed that way.

That’s an important context in which to evaluate the slings and arrows Snapchat is facing as it pitches its IPO to apparently skeptical public company investors. Evaluating Snapchat parent Snap Inc. is particularly tricky because it has been in business for a short time, which makes predictions even harder. Finance professor Aswath Damodaran figures Snapchat’s fair valuation is between less than zero and $66 billion.

The bottom line is investing in IPOs is naturally risky, and investing in tech IPOs is doubly so. And investing in the IPO of a company like Snapchat with a short history is triply so.

Of the 200 tech companies that held IPOs on U.S. stock exchanges since the start of 2010 and are still alive, the median stock return is 18 percent from the IPO price, according to a Gadfly analysis of Bloomberg data. The S&P 500 has more than doubled over the same period. Nearly half of those tech companies are trading below the price at which they sold their IPO shares. Investing in tech IPOs during a stretch of soaring stock markets has essentially been a coin flip.

Of course, in the IPO coin toss, the rewards are outsized if fortune smiles on your pick. If you bought 100 shares of ServiceNow Inc. for $1,800 at its 2012 IPO, you would now have $9,300, including the value of the initial stock purchase. The same amount invested in the S&P 500 would be valued at $3,200, excluding dividends.

Odds That Your Tech IPO Shares Will Appreciate
50-50
The best line I’ve seen about Snapchat’s IPO was from an unidentified person quoted by Fortune: “I’m willing to risk losing 50 percent if there’s a chance this is like Facebook and I can get 10x.” That’s the logic to the lunacy of investing in young tech companies. The downside doesn’t seem drastic compared with the potential windfall.

So will Snapchat wind up like Facebook or Groupon? I have questioned the wisdom of Snapchat going public now. But the most honest answer is I can’t predict how Snapchat will do on day one as a public company, let alone on day 1,000 or 5,000. And neither can you. This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, Check out latest IPO News, Best Performing IPOs, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express Telegram Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.