Social networking apps have been in the limelight for the past several years. Snap Inc.'s (SNAP, Financial) initial public offering gave it a value in excess of $20 billion. Snapchat has been a success among teenagers and millennials given the rate of adoption, but is the outrageous valuation justified?
Price-sales ratio and active users point toward overvaluation
Snap has a market capitalization around $20.79 billion with revenue expected to grow in excess of $1 billion by the end of 2017. The number of active users is around 160 million. A look at the chart below gives us a sense of its valuation based on its business model.
Snap was expensive at its IPO compared to the likes of Facebook (FB, Financial) and Alibaba (BABA, Financial). This provides us with a slight reference as to the overvaluation of the image-sharing platform. Things get more disturbing when looking at the average number of active uses.
Snapchat is behind in terms of active users, not only compared to Facebook but also compared to Instagram, Messenger and Whatsapp. Further, Snapchat is not on the list of top 10 social apps in terms of monthly active users.
Peer analysis reveals overvalution
Snapchat’s primary rival is Facebook's Instagram. Instagram has around 400 million daily active users as compared to 158 million Snapchat users. WhatsApp and Messenger also surpass Snapchat.
| DAUs (million) | MAUs (million) | |
| 400 | 600 | |
| Snapchat | 158 | 200 |
| Messenger | 1150 | 1000 |
| 1200 | 1200 |
Source: Focus Equity estimates and IR pages of Facebook
Active users are a significant metric for valuation purposes as it can give an idea about future revenue generation. Snapchat has the lowest number of active users compared to its peers. Let’s look at the value the market has put on these counterparts.
| Market Value (in millions) | |
| Snapchat | $20,790 |
| $19,000 | |
| $35,000 | |
At $35 billion, Instagram is valued much higher than Snapchat, which is $20.7 billion, hinting Snap might be priced for perfection. But, there is a catch. Instagram more than doubles Snapchat in the number of active users. Further, based on price-sales, Snapchat is priced akin to Instagram.
Relative valuation - Snap is worth $17 a share
| Relative Valuation $ in millions | Sales 2016 | Sales 2017 (Expected) | Sales 2018 (Expected) | Value/DAU | P/S 2017 |
| $1480 | $2810 | - | 87.50 | 23.65 | |
| Snapchat | $400 | $1030 | $2040 | 131.58 (Expensive) | 20.18 |
The data above clearly depicts Snap is priced at similar price-sales valuation despite the fact it is expensive in terms of active users. The company might not be able to squeeze revenue from a smaller user base consistently. Moreover, it is a two-sided market. A high number of active users translates into more revenue as it attracts more advertisers. Therefore, valuation based on active users is more appropriate.
Average value divided by MAU based on Instagram stands around $45.83 per user. The value of Snap based on daily active users and monthly active users is around $13.7 billion dollars and $9.67 billion dollars respectively, translating to a price target of $17.68. The price target is based on 300 million MAUs and 160 million DAUs. Note that value of Instagram relative to active users is used as a proxy for Snapchat valuation. This is an optimistic proxy given Instagram’s seasoned management.
Further, Instagram’s growth appears to be healthier compared to Snapchat. It is worth mentioning Snap’s user growth declined to 3.2% in the fourth quarter of 2016 as compared to 7% in the third quarter of 2016; downloads of the app also declined as Instagram launched its own version of the stories feature, which allows users to share an image or video for 24 hours before being deleted.
Another key problem for Snap is rosy revenue targets that are hard to beat. Research firm eMarketer recently cut its 2017 ad revenue forecast for Snap from $800 million to $770 million. This can lead to a stock price collapse in the coming months as the company fails to meet those targets given the competition from Instagram stories, Messenger’s days and WhatsApp’s status. All in all, Snapchat is a sell amid concerns of stiff competition and a fundamentally incorrect valuation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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