Valuing Snap After the IPO Quiet Period (A) Custom Case Solution & Analysis

Evidence Brief

1. Financial Metrics

• IPO Pricing: Initial Public Offering priced at 17.00 USD per share. First day of trading closed at 24.48 USD, representing a 44 percent increase.
• Revenue Performance: 2016 total revenue stood at 404.5 million USD, compared to 58.7 million USD in 2015.
• Profitability: Net loss for 2016 reached 514.6 million USD.
• Cost Structure: Cost of revenue in 2016 was 452 million USD, exceeding total revenue. This resulted in a negative gross margin.
• Hosting Commitments: Contractual obligations include 2 billion USD to Google Cloud over five years and 1 billion USD to Amazon Web Services over five years.
• Average Revenue Per User (ARPU): Global ARPU was 1.05 USD in Q4 2016. North American ARPU was significantly higher at 2.15 USD.

2. Operational Facts

• User Base: 158 million Daily Active Users (DAU) as of December 31, 2016.
• Growth Deceleration: DAU growth rate slowed from 17.2 percent in Q2 2016 to 7 percent in Q3 2016, and further down to 3.2 percent in Q4 2016.
• Product Identity: The company defines itself as a camera company. Core products include Snapchat and Spectacles.
• Infrastructure: Snap utilizes a capital-light model, relying entirely on third-party cloud providers rather than building its own data centers.

3. Stakeholder Positions

• Evan Spiegel (CEO) and Bobby Murphy (CTO): Retain 88.5 percent of total voting power through Class C shares.
• Public Investors: Hold Class A shares which carry zero voting rights. This is a first for a US IPO.
• Facebook/Instagram: Primary competitor. Launched Instagram Stories in August 2016, directly duplicating Snapchat core features.

4. Information Gaps

• Spectacles Revenue: Specific sales volume and margins for hardware products are not detailed.
• Retention Data: Cohort-specific retention rates following the launch of Instagram Stories are absent.
• Path to Profitability: No specific timeline or guidance provided for when revenue will exceed hosting and operational costs.

Strategic Analysis

1. Core Strategic Question

• Can Snap transition from a niche messaging app to a scalable media and camera platform while defending against aggressive imitation by a dominant incumbent?
• How can the company justify a valuation based on growth multiples when user acquisition has stalled and unit economics are currently negative?

2. Structural Analysis

Competitive Rivalry: Intense. Facebook possesses a larger user base, superior ad-targeting data, and a documented strategy of feature replication. The launch of Instagram Stories coincided exactly with Snap growth deceleration.

Bargaining Power of Suppliers: High. Reliance on two cloud providers for critical infrastructure creates a structural floor for costs. These costs scale linearly with users, preventing the traditional software benefit of diminishing marginal costs.

Bargaining Power of Buyers: High. Advertisers have multiple options for reaching the 18-34 demographic. Snap must prove its ad units deliver higher engagement or better conversion than Instagram to command premium pricing.

3. Strategic Options

Option A: Vertical Integration into Hardware. Pivot resources toward Spectacles and augmented reality (AR) hardware. This creates a proprietary platform that Facebook cannot easily replicate via software updates.
Trade-offs: Requires massive R and D investment and introduces inventory risk.
Resource Requirements: Significant capital expenditure and hardware engineering talent.

Option B: Ad-Tech and ARPU Optimization. Abandon the pursuit of raw user growth in favor of maximizing revenue from the existing 158 million users. Focus on automated ad-buying tools and high-margin AR lenses.
Trade-offs: Limits the total addressable market but improves the path to profitability.
Resource Requirements: Investment in data science and self-service ad platforms.

Option C: Global Expansion into Emerging Markets. Invest in localized content and Android optimization to capture growth in regions with lower Instagram penetration.
Trade-offs: Lower ARPU in these regions may exacerbate the negative gross margin problem due to data costs.
Resource Requirements: High marketing spend and localized server optimization.

4. Preliminary Recommendation

Pursue Option B. Snap cannot win a war of attrition against Facebook for total user count. Success depends on establishing Snapchat as the high-engagement, premium destination for AR advertising. The company must decouple revenue growth from infrastructure costs by increasing the value of every second spent in the app rather than just seeking more seconds from more users.

Implementation Roadmap

1. Critical Path

• Month 1-3: Ad-Tech Automation. Launch a fully self-service ad manager to reduce the cost of sales and attract small-to-medium businesses. This is the primary driver for ARPU growth.
• Month 3-6: AR Developer Tools. Release a public software development kit (SDK) for AR lenses. Shifting content creation to third parties increases engagement without increasing internal production costs.
• Month 6-12: Infrastructure Renegotiation. Use the dual-provider setup (Google and Amazon) to bid down data transmission costs as contracts approach renewal milestones.

2. Key Constraints

• Cloud Dependency: The 3 billion USD commitment to Google and AWS is a fixed burden. If user growth stays flat, these contracts could consume all available cash.
• Android Performance: The app is notoriously buggy on Android devices. Failure to fix this limits the platform to a high-end iOS niche, capping the total ad inventory.

3. Risk-Adjusted Implementation Strategy

The plan assumes a 20 percent increase in North American ARPU to offset slowing user growth. To manage risk, the company must implement a hiring freeze in non-engineering departments. If DAU growth turns negative in Q1, the company must immediately pivot from hardware R and D to aggressive cost reduction to preserve the 3 billion USD in IPO proceeds.

Executive Review and BLUF

1. BLUF

Snap is currently a high-risk investment with broken unit economics. At a 24.00 USD share price, the market is pricing in Facebook-level growth that the data does not support. With cost of revenue exceeding total revenue and user growth stalling exactly when Instagram Stories launched, the company faces an existential threat. The recommendation is to avoid further capital commitment until the company demonstrates gross margin positivity. The path forward requires a shift from a growth-at-all-costs mindset to a focus on high-margin AR advertising and ad-buying automation. Speed in optimizing the ad-tech stack is the only variable within management control that can prevent a liquidity crisis before the cloud contracts mature.

2. Dangerous Assumption

The most consequential unchallenged premise is that Snapchat is a camera company rather than a social media app. By labeling itself a camera company, management justifies hardware R and D and high data costs. If the market views Snapchat primarily as a messaging utility, the valuation should be closer to a utility multiple than a high-growth tech multiple.

3. Unaddressed Risks

• Governance Risk: The zero-vote share structure prevents activist investors from forcing necessary management changes if performance continues to slide. This may lead to a permanent valuation discount. (Probability: High; Consequence: Moderate)
• Platform Risk: Dependence on iOS and Android as distribution channels. If Apple changes privacy settings or camera access, the Snap business model could be disrupted overnight. (Probability: Moderate; Consequence: Extreme)

4. Unconsidered Alternative

The analysis fails to consider a strategic sale to a larger technology firm (such as Google or Disney) that lacks a social/mobile foothold. While the voting structure makes a hostile takeover impossible, a friendly merger would provide the capital needed to compete with Facebook and would solve the infrastructure cost problem if acquired by a cloud provider. This path should be evaluated if ARPU growth does not materialize within four quarters.

5. Verdict

REQUIRES REVISION

The Strategic Analyst must provide a more detailed comparison of the marginal cost per user versus the marginal revenue per user. Specifically, address how the negative gross margin can be reversed if user growth remains below 5 percent per quarter. The current options are too optimistic regarding the hardware pivot.