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Snap IPO offers short-term allure, long-term quandary

A Snapchat sign hands on the facade of the New York Stock Exchange in January. Parent company Snap Inc. will be the first technology listing of the year.

Brendan McDermid/Reuters

There are plenty of reasons to buy into Snap Inc.'s initial public offering. The larger question is whether investors will want to stick around.

The maker of photo-sharing mobile app Snapchat will be the first technology listing of the year, the biggest social-media listing since Twitter Inc., more than three years ago, and is the daily compulsion of more than 150 million users. Add to that dizzying sales growth, and investors may find the offering hard to resist.

While that intoxicating combination could drive up early demand for investors who want to a quick profit, it's shareholders taking a longer view – who won't have any voting rights – who could be in for a bumpy ride, according to Allison Bennington, partner and general counsel at ValueAct Capital Management.

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Investors who don't hold sway over management decisions have less incentive to keep holding shares that don't meet performance targets, she said.

"You're not going to get a lot of people to boycott it because they will expect to get a pop in the first few days," Ms. Bennington said in an interview. If the shares "don't show performance pretty quickly," investors will have "way less time" in the investment community to hold them. "If it starts to turn, it will turn faster," she said.

Snap is seeking to raise as much as $3.2-billion (U.S.) in an IPO Wednesday, offering 200 million shares for $14 to $16 each. At the high point of the range, the Venice, Calif.-based company could have a market valuation of as much as $18.5-billion.

At that level, Snap would have a price to sales ratio almost double Facebook Inc.'s current multiple, a lofty level for a company that has yet to make a profit. Orders for the IPO are concentrated at about $17 to $18 a share, people familiar with the process said Tuesday.

A representative for Snap declined to comment, citing the company's pre-IPO quiet period.

Facebook and Twitter's debuts show what can go right and wrong when a social-media darling becomes accountable to public investors. Snap would do well to follow the former, barring that company's early tumultuous trading.

Smartphone Bet Facebook priced the shares in its IP0 at the top end of the proposed range in May, 2012. Following a first-day trading technology glitch, shares climbed less than 1 per cent and languished for more than a year.

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Once the company started to prove that its bet on smartphone software was paying off, things turned around. The stock surged 30 per cent in July, 2013, after Facebook posted revenue and profit for the second quarter that beat estimates.

Now, Facebook has about 1.2 billion daily active users on its flagship platform and 1.2 billion monthly on its messaging tool, WhatsApp. Facebook's Instagram introduced a video-reel feature – similar to Snapchat's stories – that already has 150 million daily users. Twitter is a different story. The micro-blogging site priced its shares above the marketed range in November, 2013, and the stock climbed 73 per cent in its first day of trading. The company then stumbled through its first few quarters, failing to show consistent user growth and trying to get investors to switch focus to different metrics.

A year and a half after its IPO, shares took a dive when Twitter cut its 2015 sales forecast, casting a shadow on chief executive Dick Costolo's credibility. The stock closed at $15.77 a share on Tuesday, down 39 per cent from the IPO price of $26. Twitter has about 319 million monthly active users.

Meeting expectations

A lesson for Snap founder and CEO Evan Spiegel from both of those: In Snap's first few quarters as a public company, it needs to meet the expectations management established during the roadshow, when it was marketing the stock to potential investors.

For Snap, that means continuing to increase revenue a user, addressing slower user growth – which fell below 50 per cent in the fourth quarter for the first time since at least 2014 – and inching closer to profitability.

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Snap posted a net loss of $515-million last year, according to the IPO prospectus, shelling out cash to infrastructure providers including Alphabet Inc.'s Google and for research and development. That compares with a loss of $382-million the previous year. Revenue climbed almost sevenfold in 2016, to $404-million from $59-million.

User revenue

Quarterly average revenue per user on a global basis, a key metric showing how the company makes money from user engagement, climbed to $1.05 in the fourth quarter of 2016 from 31 cents in the year-earlier period.

Snap's unique share structure means management is asking investors to place outsize trust in their decision-making. While other companies, including Alphabet and Facebook, also have multi-class shares that ensure control is in the hands of management, those were put in place after they'd already started to prove their business models to public investors.

Stockholders in Snap won't have a voice – other than keeping or dumping the shares. They won't be able to bring votable issues to proxy meetings, vote against acquisitions or related strategic moves, nominate directors or sound off on executive compensation. "Snap has structured its deal to ensure control," ValueAct's Ms. Bennington said. "What it may actually end up doing is set the stock up for a bumpy, volatile ride."

'Use case'

Executives seem to be aware of that. During the IPO preparations, Snap considered offering some employees what amounted to a loan on private shares, according to people familiar with the matter, curtailing the incentive for employees to sell stock after the listing.

At least one of the underwriters on the deal refused to be involved in that plan because the firms could have been left carrying a loss if the shares fell far enough, the people said, asking not to be identified as the details aren't public. Snap decided not to go forward with the plan, they said.

Snap said in the most recent deal prospectus that it expects about 50 million shares of the stock purchased in the IPO to be subject to a lockup period of a year, reducing the number of shares available to change hands during that time.

Snap's management has been pitching the company as the next big thing in digital communication, competing with the likes of Apple Inc. and Facebook, said Crawford Del Prete, chief research officer at IDC. But Snap has a way to go before joining the ranks of those tech giants.

"Snap is an application company that hit one 'use case' – one key use case – that one demographic is interested in," Mr. Del Prete said Monday in an interview, referring to the fickle millennium contingent that accounts for most of Snap's subscribers. As with Twitter before it, Snap is struggling to widen its offerings.

"They are struggling to add features that will get that growth accelerating," Mr. Del Prete said. "That's the problem."

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