Today I’m sharing an article written by my friend Tama Churchouse, who with his father, Peter, runs Churchouse Publishing in Hong Kong. Peter and Tama write The Churchouse Letter, a monthly publication about investing in Asia, along with a free email called Peter’s Perspective, which you can sign up for here. Today, Tama writes about what will likely be the biggest social media IPO (initial public offering) in a number of years. And why you shouldn’t get too excited about it.
Oh, Snap! How much will you pay to reach the kids?
By Tama Churchouse
Do you have Snapchat installed on your phone? Have you ever even used it? I doubt it.
Why do I say that? My guess is that the contacts in my phone address book are a relatively accurate reflection of the demographic who read financial newsletters like this one.
When I installed Snapchat on my phone last year, like most social media and messaging apps, it synched my address book to tell me whom of my contacts was using Snapchat.
There were less than a dozen matches. And I have at least 500 mobile numbers in my address book.
Nearly everyone however in my address book is on Whatsapp, and the majority are on Facebook.
But Snapchat? Not so much.
That’s to be expected. As a 36-year old guy living in Hong Kong, I’m hardly a typical Snapchat customer.
The majority of Snapchat users are “millennials”, people in their late teens and twenties. This is an especially coveted demographic amongst advertisers. Consumers under 25 years old in particular are heavy users, opening the app over 20 times a day on average.
Snap Inc., the company behind the app that initially gained fame for its messages that automatically deleted after viewing, is planning to sell shares in an initial public offering in early March. It hopes to raise around US$3 billion at a valuation of just over US$20 billion (versus Twitter’s US$1.8 billion raise at a US$14.2 billion valuation).
This would make Snap Inc. the third largest U.S. technology IPO since 2012 after Alibaba and Facebook.
Snap the money hole
And that valuation is for a company that’s losing money. In 2016 it recorded a US$520 million loss, up from US$381mn in 2015.
Average revenue per user (ARPU) globally on the other hand, more than tripled from 31 cents in Q4 ’15 to US$1.05 in Q4 ’16 (see chart below).
Similar to Facebook, the vast majority of Snap’s revenues are from advertising. Ads are squeezed into video diaries (made by app users) or video stories contributed by media partners.
Marketers can also buy geo-filters (to geographically target users), or branded “lenses” that users can add to their videos or photos.
Ad revenue is growing quickly, up more than 6 times in 2016 to US$404 million from US$59 million in 2015. Meanwhile, its losses have been rising as well.
Why advertisers like Snap
Of Snapchat’s 150 million plus daily users, around 41 percent of all 18 to 34-year olds in the U.S. use the app.
One of the key reasons this demographic is so prized can be found in the chart below. Taken from Snap’s IPO prospectus, it shows the change in time spent watching television in the U.S. amongst different age buckets between 2010 and 2016.
What’s clear is that the youngest cohort of viewers (ages 12 to 24) now watch 30 percent LESS television than they did six years ago.
That’s a big fall in advertising exposure. And as streaming services like Netflix increase in popularity, it’s unlikely that young people are going to start watching more TV anytime soon.
As a result, advertisers need to find a different way to reach this younger audience. And Snapchat is one very viable route.
To buy or not to buy?
The big question is: should you be buying stock in a business that’s not only losing money, but losing increasingly more money?
Most people would argue no. But as Facebook founder Mark Zuckerberg said when he paid US$19 billion for messaging application Whatsapp, “The right strategy is to focus on connecting the people before aggressively turning them into businesses”.
When Zuckerberg bought Whatsapp it had around 465 million monthly active users. Today it has 1.2 billion.
Snapchat currently has 158 million daily active users. But as the chart below shows, year-on-year growth for its most recent quarter is below 50 percent for the first time.
Snapchat’s success will depend on its ability to not only keep high user growth, but also to keep increasing revenue per user.
Before you consider buying the stock, I’d recommend downloading the app and giving it a try.
The only utility I’ve managed to extract is it makes my kids laugh when I use its augmented reality filter to overlay rabbit ears on to myself.
I’m not sure that’s worth US$20 billion just yet.