Snap Valuation: Is Snap Overvalued? (19:47)

Is Snap overvalued? Yes, but not by quite as much as you might think.

At its current share price of $20-$21 (roughly the post-IPO levels), the company is most likely extremely undervalued or extremely overvalued, with middle-of-the-road outcomes unlikely.

In the best-case scenario, there’s 2x upside in the company’s stock price; in the worst-case scenarios, there’s 4x-x10x downside.

For the company’s $20-$21 share price to be justified, you must believe there’s a 40% chance it will become the next Facebook.

We believe three outcomes are possible for Snap

• Outcome #1: Facebook-Like Success: 600 million daily active users by Year 10, approaching Facebook’s current 1.2 billion, with Average Revenue per User (ARPU) over $30.00 (vs. $20.00 for FB now), and operating margins at 40% in Years 10-20. This scenario also has very high Year-Over-Year (YoY) growth rates.
• Outcome #2: Twitter-Like Scenario: 400 million users by Year 10, above Twitter’s count, with ARPU over $8.00 (vs. $5.00 – $6.00 for TWTR); operating margins break even in Year 6 and reach 25% in Years 10-20.
• Outcome #3: Crash and Burn: Just over 200 million users by Year 10, ARPU of $5.00, and operating margins of 10% in Years 10-20.

The company is stagnant, but its profitability and cash flow improve in the maturity period (Years 10 – 20).

We assumed lower D&A, CapEx, and Working Capital figures in the analysis because Snap uses Google Cloud instead of owning its servers, unlike Facebook.

To account for this difference, we assumed that Snap’s long-term operating margin would be 10-15% lower than FB’s, while its CapEx as a % of revenue would be 10-15% lower as well.

So, its D&A as a % of revenue is 3% in the long term, CapEx as a % of revenue is 5%, and the Change in WC as a % of the change in revenue is 3%. The latter is close to Facebook’s figures, while the first two are significantly lower.

Discount Rate and Terminal Value

WACC, as calculated with FB and TWTR as comps, is around 7.5%, but we started it at 12% and made it decline to 7.5% over 10 years to reflect Snap’s young age and business model immaturity.

Earlier-stage Internet companies tend to have discount rates in the 10-15% range.

For the Terminal Value, we used multiples of 10x, 8x, and 5x in the different cases, and growth rates of 2.2%, 1.5%, and 1.1%.

Those compare to forward EV / EBITDA multiples of 11x-15x for FB, TWTR, and GOOGL currently and 2.5% estimates for long-term U.S. GDP growth.

We picked the multiples such that the implied growth rates made sense (e.g., the implied growth rate should not be 5% if the GDP as a whole is only growing at 2%).

The Results of the DCF Analysis

In the Facebook case, Snap is worth between $40.00 and $50.00 per share.

In the Twitter case, the company is worth between $4.00 and $6.00 per share.

And in the Crash and Burn case, the company is worth between $2.00 and $3.00 per share.

We don’t necessarily believe in probability weighting or Monte Carlo for a number of reasons, but for the company’s current share price to be justified, you’d have to believe in a 40% chance of the company becoming the next Facebook (and 30% for each of the other two outcomes).

But we don’t think a probability that high is plausible; with a lower chance, Snap’s implied share price might be between $5.00 and $15.00, a significant discount to its current share price.

We wouldn’t necessarily use this company in a “Short” pitch, though, because of the lack of catalysts, limited options volume (for hedging), and the 1-year lockup period on 25% of the shares sold in the IPO.