SUMMARY: Snap Inc. is a holding company of Snapchat, a messaging and multimedia mobile application, highly popular with the coveted teenage and millennial demographic groups. Unlike Facebook, Twitter, or Instagram, the first thing you see when you open Snapchat isn’t a massive info feed. You see a camera in “automatic self-destruct” mode that has made this ephemeral, millennial experience powerful and international. The growing and highly engaged user base, combined with a roster of mainstream media companies contributing free content, and an increasing number of advertisers shifting their ad budgets to the site, has placed Snap in a strong competitive position in the digital media landscape.
Our research process involves proprietary channel checks with users, competitors, and industry experts, and synthesis of publicly available information from the company and other reliable sources.
Founded in 2011, Snapchat is a media sharing and messaging app, uniquely positioned somewhere between Facebook, Twitter and Pinterest. Starting off as a one to one photo sharing app, it has morphed into a potent platform. Built on the premise that pictures are the speech; the starting point of speech, today it is a vibrant platform with multi-billion daily views – 10 billion in November versus Facebook’s 8 billion. There was a need for an intimate and authentic platform, without the embarrassment and out of context repurposing of information that lasts forever. Call it the next iteration or social media 3.0. Snap is leading this next wave of social networking.
The company’s mobile native and visual format is appealing to a user base that is young and on the move, and tired of the filtered viral feeds of most online sites. Unlike Facebook, Twitter, or Instagram, the first thing you see when you open Snapchat isn’t a massive info feed. It’s a camera in automatic self-destruct mode that has made this ephemeral, millennial experience powerful and global. The transient nature of Snap pictures convinces users that it’s okay to share content that is only temporarily interesting. There is no sense that you are creating things for posterity. The “Snap” will disappear in 24 hours and the server will not save snaps either [The Memories feature, launched July 2016, now gives you an option to save your own – only your own – really interesting pictures and videos to local storage album]. Unlike a “like campaign” at Facebook or Instagram, the result of automatic self-destruct function is content that seems more genuine and authentic. This is perfect for fleeting, on the go and compulsive sharers.
Snap has established a strong competitive position, enough to catch the attention of Facebook and Twitter. The app’s engagement level is high, and its picture-centric, chronologically displayed content has hit the sweet spot when it comes to what the teenage and millennial target users prefer. More importantly, the company’s monetization strategy, while still nascent, appears to be taking hold. Our enthusiasm for the company however is tempered by the fact that a number of promising companies in the past – Friendster, MySpace, Alta Vista – and more recently – Yahoo and Twitter – had early leads that eroded as new and more innovative companies entered the competitive arena or the companies failed or are failing to monetize to full potential. Whether Snap can hold its own is unknown, but the odds favor its success given its innovative features and the robust growth trajectory to date. We are initiating coverage with a positive outlook but a cautious valuation given the nascent and untested monetization strategy, and a low long-term moat around the business.
Below we summarize the key investment merits, risks and valuation of Snap, followed by a more detailed discussion in the body of the report.
Key Investment Positives
Key Investment Risks
Snap is in the hyper-growth phase of its life cycle, so revenue growth and the user metrics are the most crucial data points – absent fully audited statements. Profitability is still a few years out and not the primary focus of Snap’s management at this point. The monetization spigot was turned on in October 2014 – less than two years ago. Our valuation analysis is based on revenue projections through 2018, using 2016 as the baseline year. For 2016, we have modeled revenue of $347 million (on the high end of the company’s target of $300 to $350 million, up from $59 million in 2015. For DAUs we have modeled 188 million in 2016, up from 100 million in 2015.
The three methodologies used in the valuation include the following:
Figure 1: Snap Valuation: Summary
Snap’s fair valuation is $18.3 billion. This is a weighted average mean of three different values ranging from $12.8 billion at the low end and $20.3 billion on the high end. Based on the weightings that we have assigned to these values, we believe a valuation on the high end of this range is justified. The $18.3 billion valuation translates to 16.0 times our 2017 revenue estimate of $1.14 billion and 9.8 times our 2018 estimate of $1.88 billion. We believe the multiples, while rich, are justifiable given the hyper growth trajectory of the top-line.
Our valuation is based on the current trajectory of revenues and user metrics. Additionally, we are not attempting to peg an IPO valuation given the multiple factors that will affect the final IPO price including, but not limited to, the demand/supply imbalance as a result of the dearth of IPOs in the B2C space, the hunt lately for high-growth technology stocks – particularly technology stocks, and the normal speculative buildup ahead of a high-profile unicorn IPO such as this one.
[Please see the Valuation section of the report for additional details on the methodology]
Snap has tapped into a few attributes of daily life that is appealing and attractive to the 18-34 demographic base. To its credit, the company understood these factors before the others did:
Mobile and millennial users have put a strong wind in Snapchat’s sails. Younger users were drawn to Snapchat for its fast delivery and auto erase features. The visual first, casual and private sharing has made Snapchat the go to platform. Ironically, the relative difficulty of getting the hang of the system has protected the youthful cool feature. The user interface for instance is not very intuitive and the updates are rolled out without tutorials – unlike the usual apps – leaving it to the user’s creativity to explore the updates. The disappearing nature of content and the ability to direct message have encouraged more and more regular instances of daily sharing.
Another key differentiating aspect of Snap is the authenticity of the content. Most social networks these days have lost their originality, with messages forwarded from one user to another. Bragging rights for having your message go viral has become a goal for many. Fortunately, the transient nature of Snap’s messages does not allow any single piece of content to become a viral hit within the app. As a result, all posts are real, original and for the moment. Importantly, the lack of public feedback in the form of likes, favorites, or retweets takes away any social pressure of a post meeting a certain criteria or threshold.
Snapchat has moved wisely and introduced many new features and elements. It has kept and grown huge audiences despite larger social media companies with greater resources. Facebook and other social networks have been working for more than a year on trying to make users increase their video consumption. Snapchat already has as many DAUs as Twitter, which had a five-year head start. Nearly 10,000 snaps are sent between users every second.
The popularity of Snapchat is apparent from its consistent high ranking on both iOS and Google Play. According to the latest AppAnnie ranking of the leading free Apps in the United States, Snapchat ranks #2 on iOS and #4 on Google Play.
Figure 2: iOS and Google Play: Top 10 Free Apps in U.S. – December 4, 2016
On any given day 48% of millennials in the 18-24 age group are on Snapchat compared to 30% on Instagram and 22% on Facebook, according to comScore. More importantly, this young group spends 54% of the total time on Snapchat, compared with 35% for Instagram and 11% for Facebook. That is important for advertisers, who gravitate to wherever youthful eyeballs go.
Figure 3: Snapchat – Compelling 18-24 User Base & Total Time Spent on Site
Though Snapchat was initially youth-centric, it’s starting to catch on with people over the age of 25. It means the monthly active users are not just millennials; the target audience is all ages. One of the big reasons 25-plus age groups use Snapchat regularly is its focus on privacy – not in the sense of keeping personal information secure, but in terms of how people share information, and with whom. The idea of “share more, worry less, posts are relevant today and not forever” is a comforting and attractive feature of Snapchat.
Snap, for all its popularity, is still US centric. Roughly 80% of Snapchatters live in the U.S. while 72% also use Facebook, and 64% of the 544 million daily photo uploads are from Facebook while 28% go to Snapchat (another 7% go to Instagram).
Younger users grew up on mobile, and it is their preferred means to receive news, interact socially, and even conduct personal transactions. Facebook famously struggled with its transition to mobile. Snapchat, conversely, was built for mobile, and its vertically-oriented video format is both natural for viewers and fits the spontaneity of content creation on smartphones. Snapchat is and has been a visual platform. CEO Evan Spiegel emphasized the everyday-nature of content on the platform from the beginning, famously saying:
“Snapchat isn’t about capturing the traditional Kodak moment. It’s about communicating the full range of human emotion—not just what appears pretty or perfect.”
The quote takes direct aim at the heavily curated lives many Facebook users create. This strategy is distinguishing for Snapchat, as encouraging photos or videos of any common-place object or occurrence encourages the type of daily use that makes the app so valuable. We also see a complete relaxation on the quality of the photography/videography as an issue. Where Instagram and others prioritize the quality of the photos and assume they have a long life, Snaps are fleeting, every day, social communication made visual.
Snapchat also captures a feeling of exclusivity, which younger users crave. This age group reached their teenage years with their parents already on networks like Facebook, giving them little sense of exclusivity or privacy. Snapchat focuses primarily on one’s phone contacts, and “snaps” can be shared selectively with a large group or just one person. That exclusivity means not having to worry about potentially troubling photos or posts being shared with the world, a frequent concern where any embarrassing moment can be found with a simple Google search.
Figure 4: Comparative Demographic Mix; Snap Ranks Highest in 18-34 Age Group
Snap – Well Grounded in the U.S.
The United States is the most lucrative market in terms of advertising spending and ARPU. A strong presence in the U.S. is absolutely essential for an ad-based business model. Snap is well grounded in the U.S., as reflected in the latest data on the company’s user metrics from eMarketer:
Figure 5: US Snapchat Users & Penetration; Figure 6: US Millennial Snapchat Users & Penetration
Secular Shift to Digital Advertising
Brands and marketers have increasingly been shifting advertising dollars to digital and away from traditional outlets like print and TV. The U.S. is the strongest ad market in the world, with most social sites realizing their highest ARPU in this region. Understanding the advertising spending outlook in the U.S. is crucial.
According to eMarketer, total U.S. advertising spending is expected to touch $215 billion in 2017. Looking deeper, a majority of this spending will be digital advertising for the first time, and 20% of it will be specifically on social sites. By 2020 digital ad spending is expected to be 45% of total media ad spend with the TV’s share dropping to 33 % from 40% in 2014. Digital will overtake TV ad spending in 2016 for the first time, ahead of the earlier forecast of the shift taking place in 2017. By the end of this year, US digital ad spending will reach $72.09 billion, while TV spending will grow to $71.29 billion. That means digital will represent 36.8% of US total media ad spending, while TV will represent 36.4%. Digital advertising is not only pulling dollars from traditional media, but it’s also creating new advertising opportunities at the local and national level.
Figure 7: US TV* vs Digital Ad Spending**, 2015-2020
The strong performance of the digital ad market is being driven by several factors, including, not surprisingly, mobile and video. Mobile ad spending will grow 45.0% this year to reach $45.95 billion. As it grows, it will represent an increasing share of overall ad spending. By 2019, mobile will represent more than a third of total media ad spending in the U.S. Google is the undisputed king of mobile and will remain so for the foreseeable future with a 32.0% of the mobile ad market, ahead of Facebook’s 22.1% market share this year.
Not only will video ad spending continue to grow by double-digit percentages, its share of total digital spending will increase as well. This year, video ad spending will reach $10.30 billion, representing 14.3% of total digital spending. That figure will climb to 15.1% by next year.
Display will continue to be the top format for digital ad spending through 2020. Display spending will reach $34.56 billion this year, slightly ahead of search’s $33.28 billion. Facebook will capture the vast majority of display spending, taking in $11.93 billion this year, 34.5% of total display spending in the US. Google is a distant second, with $4.79 billion or a 13.8% share.
Ad Buyers Attracted to Snap
Advertisers are intrigued by the new platform and its potential to help crack the mobile advertising nut. The success of the advertising campaigns can be judged by the steep ramp in ad sales compared to its peers (Figure 8). Snap’s growth curve is far steeper than the growth curves of Facebook, Twitter and Google in their respective first five years since inception.
Figure 8: Comparative Annual Ads Revenue Ramp in First 5 Years ($Mil)
Cord cutting and other millennial trends have made the notoriously fickle age group difficult to reach for marketers, while the disappearing-photo app has staying power in both the current 18-24 age group and additional ramp with its popularity amongst teenagers.
Brands have flocked to Snapchat given the native videos on the site over links to other videos. Native videos have 4 times the interaction rate compared to YouTube, Vimeo, or other sources, according to one study by Quintly, a social media analytics tool for brands. The costs are modest and the platform boasts very high DAU and engagement levels. Among leading users are GE, Everlane, Gatorade and Warby Parker. The New York Times has found an outlet and used Snapchat as an engagement tool and for distribution. Thus, a diverse set of leading brands has found a valuable communication platform already. This list is growing very quickly- as is revenue.
According to eMarketer research, more US senior ad buyers are planning to begin advertising on Snapchat than other social media sites. Some 22% of senior ad buyers said they plan to advertise on Snapchat this year for the first time. Additionally, 12% of respondents said they plan to begin advertising on Instagram, and the same percentage of senior ad buyers said they plan to advertise on Pinterest. Tumblr was another social media site that 10% of respondents said they plan to begin advertising on in 2016. Tinder, a social dating app, attracted 6% of senior ad buyers. More than a third of respondents, however, said they do not intend to allocate new spend on any social media sites.
Figure 9: Social Media Sites on Which Senior Ad Buyers Plan to Begin Advertising in 2016 (% of respondents)
Unique Content = High Engagement = More Advertising Dollars
Facebook has an “engagement” problem and that has been well telegraphed. One big reason is a decline in the posting of original content – personal pictures and posts that catapulted Facebook’s popularity (The Information, a noted news site on matters relating to social media and technology, reported that Facebook was seeing a 21% decline). Instead, people have been sharing more content like links to a story or a video on YouTube. Is Snap causing this trend? Very likely.
Time spent on Snap is growing at the expense of Facebook and Twitter. According to eMarketer, US adults spend an average of 22 minutes a day on Facebook, while it is projected that they will be spending 23 minutes a day by 2018. Engagement may be high and it’s certainly attributed to the mobile domination, but its growth may not be enough in the coming years.
Figure 10: Average Daily Time Spent (Minutes) per Day with Facebook by U.S. Adults: 2013-2018
Additionally, Snap ability to stitch together ten or twenty quick shared moments to form one story instead of many different posts over Facebook, is a powerful differentiator. For instance, when a knife-wielding attacker went on a rampage at Ohio State University recently, Snapchat’s news story was remarkable. Between scenes of government officials and students describing the attack, there were clips captured by students holed up in classrooms, expressing their fear and sense of bewilderment over what was going on. It wasn’t just an informative story, but it engendered a sense of empathy for its subjects that is rare in the news.
Snap is evolving into a vibrant platform by following the Facebook and Google playbook. The recent launch of “spectacles” is a hardware initiative that needs to be watched. The company’s experiments with producing original content on Stories, and introduction of textual messages are further indications of the company’s effort to go beyond its core photo-messaging offering. Below we highlight the key features of Snap and the company’s new initiatives.
Live Stories – The Most Lucrative Business Driver
Snapchat rolled out its “Story” function in 2013, and the feature quickly became one of its most popular. These snaps are analogous to a Facebook status update, in that any Snapchat “friends” can view them for exactly 24 hours. Once the 24-hour time limit is up, they are automatically deleted.
What differentiates Live Stories from other micro-video or feed-style apps like Instagram and Vine (before it was shut down) is that it is supposed to be just a brief look at what friends have been up to in the past 24 hours. This is a mobile, social check-in function that has and continues to drive nearly continuous check in to see other’s content and answer or add your own. In a smartphone-based world, constant connectivity is key. Adults who grew up on instant messaging and unlimited texting use stories as a simple, efficient way to stay in touch. Content can be raw and random, providing an authenticity that makes the app feel more personal.
Stories also provide a business purpose, boosting the reach of user content from a few selected friends to several hundreds. The most prominent accounts have become Snapchat “celebrities,” with users like DJ Khaled and Hilary Duff acquiring hundreds of thousands of followers without the typical intermediaries of press and PR.
Besides sharing your Snap to others, you can also view others’ stories under a certain topic or a certain publisher. Snapchat redesigned the Stories in an effort to boost views of publishers’ content, which allow publishers to include an image and a headline to promote each day’s story. For example, under “New York” a user can see a number of publicly shared snaps of the city, or of other exotic locations chosen each day. These stories are lightly interspersed with video commercials. These public stories are particularly popular for large venues such as concerts or sports games.
Facebook and Instagram were sufficiently impressed and distressed by Stories to rather aggressively launch their own stories. Literally, the desire to attract or retain users was strong enough that Instagram did not feel the need or go to the trouble to come up with a new name. The easy, raw and temporary nature of video has made this the market consolidator and millennial magnet that Instagram was and fears. Snapchat’s Stories has many more enhancements as well as automatic updates. The rich set of filters, features, selfie options and updates makes Snapchat stories more compelling than Instagram stories. However, Facebook and Instagram have many more users, larger cross selling and advertising budgets. The good news and the bad news here is that the largest most dominant social company in the world is explicitly developing products to compete with Snapchat innovations.
Figure 11: NASA’s First Snap on Live Stories
According to one survey by Carat in March 2015, 1 billion stories were viewed per day, with the more popular posts reaching as many as 27 million unique views within the 24-hour window. For perspective, the Game of Thrones Season 4 finale had 7.1 million viewers, with an average gross audience of 18.2 million views/episode including repeats – the largest audience ever for a HBO series. Live Stories routinely attract approximately 20 million viewers in a 24-hour span, and 44% of active Snapchat users reported using Live Stories/Discover. Considering the 20 million daily views, it is not unreasonable to expect an ad inventory worth $400,000. As the primary revenue stream of the company, ads on Live Stories will continue to grow strongly, and attract more publishers. Top global brands and all the others who value engaged-millennials as their target audience, are and will continue to look to Snapchat.
Snapchat enhanced the Stories function with a new feature called “Discover,” allowing content publishers their own individual channels on the platform. Discover acts as a media hub, which allows users to consume bite-sized content from publishers like ESPN, Cosmopolitan, and BuzzFeed. This product offering was a nod toward monetization and attracting leading branded content and brand advertisers. Thus far, it has been a dramatic success. The Discover feed is more curated, taking a “headlines” approach to providing news and entertainment, with some of the trademark Snapchat transient “just happened” feel. For consumers, the Snapchat video experience is more intuitively architected for watching on a smart phone. Controls and content allow consumption without having to hit play and being able to quickly skip through to the next video when bored.
Advertisers have been open to experimenting with the feature, describing this rapid consumption as “the future of TV.” Now, there are 19 publishers and channels on the U.S. platform, with 20 million views per month. The tiles feature alone represents a significant source of revenue with 15-20 companies paying in the range of $15-25 million for the coveted spot. Top channels include BuzzFeed, Comedy Central, Food Network, and so on. These numbers are growing rapidly. Huge audience during the Rio Olympics has fueled this. Snapchat’s deals with NBC and BBC drove 50 million viewers to watch the Olympics on Snapchat.
Figure 12: Snapchat Discover Screenshot
The ideas are similar – Snapchat divides revenues with publishers and advertisers on the Live Stories and Discover product platforms. However, content on Discover is often text-heavy, produced, and lacking in personality, compared with Live Stories. Live Stories looks to be the monetization platform that was long awaited and has grabbed the attention of advertisers and competitors.
Geo-Filters – Designed for Young, Engaged Users
Geo-filters allow for a new touchpoint with consumers and a revenue source directly from Snapchat’s young, engaged user base. There are two types: community geofilters, which can be submitted for free, such as the Bushwick section of Brooklyn or, the Chelsea area in Manhattan with no logo or marketing purpose. Additionally, Snapchat offers sponsored geofilters, where bigger brands can cover a large area as part of a marketing campaigns. Geo-filters originally were created by Snapchat for free, and users in specific locations could add a specific image to their snaps, like “Manhattan” or “Millennium Park.” The GPS technology in smartphones means Snapchat can allow users to tag their snaps with a fairly high degree of specificity, and Snapchat recently allowed users to create their own Geo-filters for events like parties or weddings. These short-term filters of a few hours can be as cheap as $5 and up. These location specific tools drive heavy engagement and offer unique and immersive campaigns to advertisers.
Figure 14 below takes a user through the steps to create a geofilter for a younger woman’s birthday party. On her birthday date (at an allotted time) at the party place (a specific area), the geofilter platform is activated. Snapchat’s first major advertiser on geo-filters was McDonald’s, a super-brand looking to reconnect with millenial customers it is feared to be losing.
Geo-filters represent an interesting opportunity, given the depth of engagement—the ability to hit a large percentage of users in a small, specific area. Unique advertiser offerings power greater engagement and turn users into dollars. This is brand to user engagement but, is quite different from other advertising methods. Billboards present the most analogous form of presentation, yet even these rarely have attention for more than a second or two.
Figure 13: Steps for Creating a Customized Geofilter
Lenses – Still Early
Snapchat lenses are a rotating set of filters that alter your face in real time. Selfie lenses can do things like transmogrify traditional head shots into a cute puppies, or shoot rainbows out of your mouth and otherwise enhance snaps. These lenses have proven very popular and are a foray into augmented reality. To sponsor a lens can cost $100,000 to $750,000.
Figure 14: The Ellen DeGeneres Show
The feature was introduced in Oct. 2015, and turned out to be a highly successful ad product. The lenses are entirely free, and the users’ number has now risen to 30 million up to June 2016. For Halloween 2015, 20th Century Fox became the first marketer to run a Sponsored Lens campaign, and up to May 2016, it has run more than 50 Sponsored Lens campaigns, including Super Bowl – the eponymous “Gatorade Shower” – “was reportedly used 165 million times in two days in Feb”; Taco Bell’s Cinco de Mayo – “was viewed 224 million times in 24 hours, and users played with the lenses for about 24 precious millennial-world seconds”; Unilever i summer is running a “Release the Brest” campaign across six European markets for its Magnum ice cream. In May 2016, Snapchat united 20th Century Fox, again, to start the first entire takeover (24 hours) of all Snapchat’s lenses to promote the release of “X-Men: Apocalypse.” All lenses were replaced by a set of well-known Marvel characters. Depending on the rate mentioned above, Snapchat Lenses get the ad fee of $750,000 within one day from 20th Century Fox.
Memories – My Eyes Only
Memories is Snap’s newest feature. Introduced in July of this year, this feature allows Snapchat users the ability to save old photos, videos and snap stories within the app. Previously, users could only screenshot snaps (which alerts the other user that you did so) or photos could be uploaded from your camera roll to share via the message section of the app.
Part of why people felt safe sharing anything is because the photos would exist for 10 seconds or less before being deleted. For some users, this change has been much anticipated, as people want the ability to save a funny snap or upload photos to their stories. This will make participating in “throw back Thursday” and “flashback Friday” all the more easier for Snapchat users. Moreover, it makes the Snapchat archive a place to store your photos instead of the native camera library on your phone. That makes it easier to share and edit right there in the Snapchat app, a huge plus for the company which naturally wants to keep users in its ecosystem as long as possible. It also serves as a historical timeline, essentially like having Timehop in your Snapchat account.
But, for others, this change commences an immense shift away from the original authenticity of the app, which was the key distinguishing feature to begin with. By remembering your photos and videos through Memories, Snapchat risks alienating its base of users who value the ephemerality of the content.
Figure 16: Snap Memories Screenshot
Spectacles – The First Hardware Rollout
In September 2016 Snap introduced Spectacles, a new type of camera. Spectacles are sunglasses with an integrated video camera that makes it easy to create Memories. It is one of the smallest wireless video cameras in the world, capable of taking a day’s worth of Snaps on a single charge, and integrates seamlessly into a fun pair of sunglasses – available in 3 different colors. Spectacles connect directly to Snapchat via Bluetooth or Wi-Fi and transfer a user’s Memories directly into the app in the brand new circular video format. Circular video plays full screen on any device, in any orientation, and captures the human perspective with a 115 degree field of view.
Figure 17: Spectacles Screenshot
Payments and E-Commerce on Snap – A Strong Possibility
Snap’s partnership with Square in 2014 set the stage to introduce payments and ecommerce feature on the app, similar to the features on Facebook, Twitter and Pinterest. The partnership with Square unveiled a feature called Snapcash that allows user to send money to people with the help of Square’s Square Cash app, in the same vein as Venmo (Acquired by PayPal) and Google Wallet. Beyond sending money to friends, it also helps in buying stuff from e-commerce sites and also process payments to online clients.
The service is currently available in United States for people over 18 years of age. Personal financial information will be stored on Snapchat’s servers. Consumers have to pay $10 to which a green button appears which a user has to use to complete the payment.
Figure 18: SnapCash – A Partnership of Snap & Square
Other Potential Features in the Future
We can envision a number of new products from Snap in the near future. Key among them include, digital publishing, text messaging, voice calling, streaming music. Turning into a digital publisher appears to be the low lying fruit given the company’s experience with the Discover feature on the platform. It has experimented with a channel of its own on the Discover page with original short form shows. Additionally, the company has created channels with content built around a theme like music with exploring different genres of music and bringing Spotify on as a sponsor of the series.
High Engagement May Not Translate to Strong Monetization
High engagement level is every social media website’s dream but that in and of itself does not guarantee success in monetization. The history of social media is littered with examples to show that is the case. Twitter being the latest example. Good service but limited scope for attracting ad dollars is a common challenge. Few reasons for this include limited real estate on the mobile phone form factor, pricing power erosion due to alternate options, and/or decline in popularity.
Snap is off to a good start, having turned on the monetization spigot in late-2014. High engagement level and its unique way of social networking has attracted a number of marquee clients. That said, Snap is a victim of its own success. The casual and ephemeral features of the app puts limiting factors. Users can’t linger on a snap for more than 10 seconds (20 with replay), they can’t share the snap, and the discoverability option – so important on social sites – is not there. Users just see their friend’s stories, or sponsored Discover stories from a set of paying advertisers and publishers. Furthermore, Snap’s users are constantly moving on to the next thing due to the nature of the app, limiting the effectiveness of the ads and the ROI for the brands and other advertisers. This point was not lost on Twitter, which has similar short messages as Snap, and very likely the primary reason to shut down Vine, its short video service. Short-form vides, it appears, are either ahead of the times, or just not appealing enough in their present form, even if they can be shared across platforms.
The biggest risk factor ahead, in our opinion, is the inability to scale up its ad engines. The Discover feature, for instance, shows users about 30 uncurated tiles from a selected group of media publishers. As a result, those shown at the bottom of the list may not get the attention they were hoping for given the high fees charged for the listing. Users now have the ability to subscribe to favorites, further diminishing visibility of other potential ads and publishers. Furthermore, interstitial video ads have a major challenge: they are too easy to swipe through; all it requires is a tap on the screen. Lenses are interesting but monetizing this feature has its limits, starting with how to measure the interest of the users. The lack of metrics is a common complaint. With no way of knowing whether a user follows through with a purchase, it’s more akin to the uncertainty around TV advertising than the more precise measurement of click-through activity that is possible in e-commerce.
Competition and Technology are Limiting Factors
The popularity of the Snapchat app has moved it into direct competition with the titans of tech. Instagram just added ephemeral live video and messages feature. The lack of options for brands regarding the distribution and the measurement of the content needs to be addressed to compete with the majors. Twitter appears to be having a tough year in 2016 mainly due to investor impatience and growing pressures to monetize. Snapchat could face similar challenges ahead if the existing monetization strategy stalls and the untested new initiatives fail to deliver.
Facebook, and particularly its Instagram app, is the juggernaut that could derail the Snapchat train down the road, if it fails to be innovative. Facebook’s daily user growth has been showing a strong increase, and there seems to be no stopping it. Snapchat has always been a threat in terms of acquiring younger users between the age of 18 and 24, but Facebook is not falling off the cliff, as some are suggesting. According to comScore, in the fourth quarter of 2014 the ratio of DAU to MAU (the most common metric to measure engagement) stood at 66.4% and that grew to 89.8% in the second quarter of 2016. While comparing the DAU to MAU ratio for the 25 to 34 age group, the number of Facebook US mobile users stood at 74% in Q4 2014 and rose to 86.4% in 2016.
For Snapchat on the other hand, the DAU to MAU ratio between the age group of 18 and 24 in Q4 2015 stood at 56.9% and grew to 66.6% in Q2 2016. In the age group of 25 and 34 years for the US mobile users, the growth was recorded at 51.4% in Q2 2016 as compared to 38.9% in Q4 2014
While Snapchat currently is the top mobile app in view count compared to Facebook, the latter still has a native advantage in that all of its videos are “interactive”—a user can click the account or link to learn more. Advertisers want to pull in users, and also can track these clicks for their own analytics. Snapchat is rolling outs its 3Vi (vertical video views and interactive) format with this in mind, creating multiple touch points. (3Vi ads are still in the earliest testing stages). Even though the ads are clickable, but depending on advertisers’ feedback, the rate is less than 10%, which means less than 10% of viewers have interaction with ads, no mention of installation of apps or purchase. Snaps on Snapchat last up to 10 seconds, and ads can only be shorter – 2 to 3 seconds, including the ad loading time. In this way, even though 3Vi is new, and profitable, ads monetization given the Snapchat’s video period is still challenging.
Another competitive threat is Facebook’s decision to emphasize video. Management noted they are prioritizing video across its apps, taking steps to make it easier for people to take and capture video. The company noted that since May, the number of people going “live” has grown 4x. The company is also testing new camera and video features in select markets that it expects to roll out broadly. Facebook believes that camera will eventually become the primary input for users to share stories on social media. Instagram app has more than 500 million active users, with 300 million daily active users and more than 500 thousand businesses advertising on it. The company highlighted that Instagram has begun to rank its feed based on relevance, and has since seen a positive impact on time spent on the amount of content sharing.
International Growth is Not a Given; Clones Taking Market Share
In a sign of the times, international growth of the most popular US smartphone app such a Snapchat is not a given. Snow, a South Korean clone of Snapchat has taken off in Asia. It sends short, self-destructing messages. It has a place to share videos called stories. It has camera filters that transform a person into a koala, a fried egg, a police officer or any number of foods, animals and figures.
Snow focuses on Asian consumers. Like Snapchat, it offers users an array of filters that can add dog ears, glowing eyes and bulbous foreheads to selfies. But Snow also lets users add bottles of soju, the Korean liquor, or images of Korean pop stars. Another filter adds a rain of fried chicken, a favorite South Korean nosh. For Japan there are sumo wrestler and sushi filters. A significant part of Snow’s roughly 30 million downloads have been from Asia since the app’s September introduction and, more importantly, it is also gaining traction in China, where the country’s 700 million users make up the world’s largest internet market and where Snapchat is blocked.
Snow’s popularity in Asia underscores a new reality for American app makers. Previously, popularity in the United States often led to corresponding growth overseas. Today, well-established internet firms in Japan, South Korea and China can move quickly into those niches.
Figure 19: Snapchat Clones: Snow of South Korea
As a new service with a valuable user base, Snapchat has significant pricing power. The service charges $0.04 per view ($40 CPM) on its 3Vi service mentioned above, which is above some other competitors. Facebook’s rates for video can vary from $0.02 to $0.10 per view, with the higher end coming through specific targeting of very valuable demographics. Google demands much lower rates for YouTube, with CPMs in the $2 to $8 to range, with varying degrees of targeting based on sign-in.
Snapchat is still improving this targeting function given it is not as data-rich as Facebook, while Snapchat often has little data beyond age and location. Integrating this data will take time as users become more engaged with brands through the app, but even so will take longer because of the lack of text entry in the app—a point of irony given the all-image format is part of Snapchat’s strength. An acquisition might be a good way for Snapchat to obtain more data on its users, or new products that can help create better targeting. Our calculation of Snapchat’s ARPU versus its competitors shows that it is much lower than other social networks’, likely at least partly due to the data issues mentioned above.
A Fleeting User Base?
Snapchat offers a unique, differentiated social experience that clearly speaks to today’s user. Today’s smartphone users are a fad-oriented bunch, with a new “world-changing” app jumping to the top of the app store every few months. One only has to look at the history of Zynga or Candy Crush to see how short attention spans for newer smartphone “games” can be. Although Snapchat clearly has staying power with its five year history, competition for mobile users’ attention continues to grow with news organizations, businesses, and gaming companies all seeking to increase their smartphone penetration.
Similarly, the apps are susceptible to displacement by other social networks seeking to imitate its disappearing-image business. Facebook, which owns three of the largest social networks – WhatsApp, Messenger and Instagram – has been encroaching on Snap’s turf by rolling out Snap-type features. The history of social networks shows stealing users can be difficult, as the failure of Google+ shows. As such, direct imitation is less likely to be a disruptor in the near-term, but competitors will likely continue to improve and expand their products in the hope to erode Snapchat’s market share.
Snapchat is a revenue story at this stage. The Company’s revenue streams come from Discover – publishers and advertisers, Live Stories – ads, Geofilters – decorations for users’ photos and videos that appear in specific locations, and Lenses – animated overlays. Discover and interstitial ads start at hundreds of thousands of dollars per day, and can easily reach into the millions per activation. Thanks to Snapchat’s 3Vi (vertical video views and interactive) videos/photos format, we expect revenue to flow from its own exchange (under development) RTB, and advertising API – a software tool for connecting services. Snapchat will let advertisers more easily inject their ads into content, as well as the app installs.
Snapchat has offered a number of products that can create revenue out of its valuable user base. The company has shown the ability to innovate by creating new features such as Stories, Filters and Discover. Augmented reality picture filters and video frames and enhancement have emerged as a popular set of innovative offerings. Beginning with messenger apps in Asia these offerings have quickly bloomed into a meaningfully popular mainstay of communication. This is particularly popular among younger female users. The filters are valuable as they seem to induce more sharing and more engagement on the platform.
CPM vs CPC, and API
Snapchat pays Google RTB to boost ads revenue, and the revenue mainly comes from its CPM and CPC charge to advertisers. Industry standard CPM is $20 CPM, but Snapchat charges double – $40 CPM, which means the app is charging a minimum of 4 cents a view for what it calls 3Vi ads (vertical video views and interactive). The interactive part is new, and it means the ads are clickable, that people can swipe up on them to watch a longer video, install an app, and shop. No matter people interact and purchase or not. Interactive ads have 10-20% conversion rates. Vertical format and clickable videos on Snapchat allow the app to charge the premium.
The company is also working on increasing its ad targeting capabilities, by investing in solutions provided by 3rd party data partners like Nielsen, and Millward Brown to target by age, gender, location and context.
By using Google Ads services, the company launched its API development earlier in Jan. 2016 as its “boosting ads technology initiatives” with growing digital ad business. Google charges 30% of bidding prices, and once Snapchat begins to use its own RTB exchange with API linking to demand side platform (advertisers), the company can not only get rid of the 30% fee, but also could potentially integrate those types of delivery optimization and bidding options on a web-dashboard in the near future.
Facebook has been very successful with its API. Instagram, which is piggybacking on Facebook’s technology spent 9 months to release its API in 2015 with 41 advertiser partners including Kenshoo, SocialCode, Nanigans, Adaptly, Adobe, Ampush, Salesforce, and Sprinklr. Up to Dec. 2015 Snapchat partnered with 239 advertisers including Media & Entertainment, Technology, Consumer Packaged Goods, and Auto. The top 20 advertisers renewed rate is 90% depending on company’s internal data. Top 10 advertisers make up 36% of sales ($26 million out of $71 million in GAV Q1-Q42015).
A filed patent from Snapchat allows the company to pick out real-world objects in users’ snaps in order to serve those related filers, ads, and coupons. It’s a new monetization initiative to boost revenue. As the diagram shows, a person who has taken a snap of a green tea Latte could be served a coupon to redeem in-store. Another example could be that a snap of a certain food type could throw up filters with calorie information. This platform could have a chance to hook up to an API (application program interface) server (under development), where advertisers could potentially use the RTB ((Real-Time Bidding) system elsewhere on the web to buy this sort of advertising too.
Figure 20: Snaps Recognition Initiative to Boost Monetization
Financial Model and Projections
Snap’s monetization strategy appears to be working well. We are modelling a 476% year/year revenue increase in 2016, to $340 million from $59 million in 2015. Looking ahead, we have strong conviction that the company can maintain its robust growth trajectory given the user demographic, the secular shift to digital advertising at the expense of the traditional outlets, and the continued attraction of the brands and advertisers to the site. We expect revenues to cross the $1 billion threshold in 2017, and end the year at $1.096 billion, an increase of 222.7% year/year. In 2018, we expect revenues to touch $1.8 billion, an increase of 64.3%. The key revenue drivers are going to be higher user base and ARPU.
Figure 21: Snap Revenue and User Metrics
Analyzing any business requires a deep understanding of the underlying value creation and capture dynamics. In the last few years, we have seen many new companies valued highly for their user base and revenue growth trajectory – Instagram and WhatsApp are two of the best examples. Facebook bought both of them. Snap has a similar business model to earlier iterations of Facebook but grew more rapidly and has started to monetize only over the last two years.
Snapchat, as with all private US-based companies, does not disclose audited financial statements. The best alternative was to synthesize all the data we gathered from our proprietary channel checks with users and industry experts, make informed assumptions on the industry dynamics, and the company’s competitive advantages and disadvantages. Finally, we layered on spotty revenue and user data that is available in the public domain – either in media reports and/or from senior management comments at various forums.
Our valuation of Snap is driven off of the company’s revenue model, given that Snap is a revenue story at this stage of its life cycle – and the company’s primary focus. The company started monetizing its platform late-2014, less than two years ago. Snap generated revenues of $60 million in 2015 and is on a run rate to exit full-year 2016 with revenue of $347 million, according to our estimate. This is on the high-end of the company’s target of $300 and $350 million for 2016 (source: comment made by management and reported by Re/Code). Additional data points from management include 100 million daily active users (DAUs) in 2Q15, which we believe increased to 150 million in 2Q16 and will reach 188 million by year-end 2016 2016. The company is not profitable at this point, preferring instead to invest for growth.
Against this backdrop, we derived Snap’s valuation from three angles: (1) Implied valuation from the mean IPO multiple of the peer group (2) Implied valuation from the EV/DAU multiple peer companies of other companies (3) Implied valuation from the current public market multiples of the peer group. As illustrated in the chart below, we took the values from these three methodologies and derived a weighted value based on our assumption of their relevance at this stage of the company’s life cycle.
Snap fair valuation is $18.3 billion. The weighted average mean of three different values ranging from $12.8 billion at the low end and $20.3 billion on the high end is $18.3 billion. Based on the weightings assigned to these values, we believe a valuation on the high end of this range is justified. The $18.3 billion valuation translates to 16.0 times our 2017 revenue estimate of $1.14 billion and 9.8 times our 2018 estimate of $1.9 billion and 9.0 times our 2018 revenue estimate. We believe the multiples, while rich, are justifiable given the hyper growth trajectory of the top-line.
Below we have summarized the three valuations methodologies, followed by a detailed description of each methodology.
Figure 22: Blended Valuation Summary Table and Graph
Source: Company reports, Thomson Reuters, MVR
Methodology I: Implied Valuation from the Mean Peer Group IPO Multiple
We believe IPO valuations, particularly of high-growth B2C companies such as Snap, are a reflection of the growth opportunities ahead. As such the companies get the benefit of the doubt in their ability to execute and grow into the valuation, which invariably are stretched. We expect Snap to be a beneficiary of this logic, just as Facebook and Twitter were at their IPOs. Accordingly, a significant slice of the investors will look at the mean 18.5x EV/Rev multiple of the high-growth peer group in assigning a value to Snap. Based on this analysis, Snap should be valued at $18.4 billion.
Figure 23: Implied Snap Valuation Based on Peer IPO Multiples
Methodology II: Implied Valuation from EV/DAU Multiples
We looked at implied valuation based on the current multiples of the daily active users (DAUs) of the peer companies. Given that Snap’s daily active user base is growing faster than Facebook, Twitter and Pinterest, among others, and the engagement level is on a steep incline, we believe an implied valuation based on the peer DAUs is justified. Based on this analysis, Snap should be valued at $20.3 billion.
Figure 24: Valuation Based on EV/DAU
Methodology III: Implied Valuation from Comparative Public Multiples
Deriving a valuation for a private company based on publicly traded company multiples is the most obvious and widely used methodology – particularly by the bankers and the venture capitalists. This method is based on the assumption that the public valuations reflect the collective wisdom of the investors in valuing the sector and the companies within the sector. Accordingly, the unadjusted implied valuation from this method provides a good baseline valuation. We then need to take it one step further and adjust for the hyper growth that most private disruptive companies by definition exhibit, and then apply a private market discount to reflect the lack of liquidity. Accordingly, Snap should be valued at $12.8 billion after applying a 30% growth premium and a 5% private market discount.
Figure 25: Valuation Based on Comparative Revenue Multiples
Snapchat has raised $2.66 billion to date in 9 rounds, following the initial $520,000 from angel investors in April 2012. In the last private round, Series F in May 2016, the company raised $1.81 billion at a post-valuation of $20 billion and $30.72 per share. Key investors included York Capital Management, Alibaba Group, and Fidelity Investments. Other prominent investors in the company include Lightspeed Venture Partners (seed investor), Benchmark Capital, IVP, Kleiner Perkins, and the Government of Singapore. A complete list of investors, by financing round, is noted below.
Figure 26: Snap Funding Rounds and the Implied Post-Valuations
The management team of private companies is one, if not the most, important factor in determining the success of the company, particularly in the entrepreneurial stage of the life cycle. After the business model takes hold and the size of the company gets large enough, the company needs to hire experienced professionals with operating and financial management skills. Led by Evan Spiegel, Snap is executing very well and key personnel are well positioned to prepare the company for its IPO and the challenges ahead as a public operating company.
Evan Spiegel, Co-Founder & Chief Executive Officer
Evan Spiegel is the co-founder and CEO of Snapchat. He studied Product Design at Stanford University while building Snapchat, a real-time picture messaging app in 2011. Mr. Spiegel earned his bachelor’s degree in Product Design from Stanford University in 2012.
Bobby Murphy, Co-Founder & Chief Technology Officer
Bobby Murphy is the co-founder and CTO of Snapchat. Mr. Murphy met Spiegel while they were students at Stanford University. They were both member of Kappa Sigma Fraternity. Mr. Murphy earned his bachelor’s degree of mathematics and computational science from Stanford University.
Drew Vollero, Vice President, Finance & Acting Chief Financial Officer
Drew Vollero is the VP and CFO of Snapchat. Mr. Vollero previously held the title of Division CFO, SVP of Finance and Strategy department of Mattel from 2000 to 2005, and SVP in Corporate Strategy, Development & Investment Relations at the same company from 2005 to 2015 – one year before he joined Snapchat in late 2015. Drew received his Master of Science in Management from Oxford University, and Bachelor’s Degree in Mathematics & Economics from Yale University.
Imran Khan, Chief Strategy Officer
Imran Khan joined Snapchat as Chief Strategy Officer in Jan. 2015. Khan started his career as an equity research in TMT space at JP Morgan Securities, and became of Managing Director, and Head of Global Internet and U.S. Entertainment in 2011. Prior to Snapchat, He held the title of Managing Director, Head of Global Internet Investment Banking at Credit Suisse (May 2011-Jan 2015). Mr. Khan was key to $200 million investment by Alibaba in Snapchat’s series E fund raising. Khan earned his Bachelor’s Degree in Economics from University of Denver.
Jeff Lucas, Chief Operation Officer, Vice President of Sales
Jeff Lucas was the former head of sales and marketing (ads) of Viacom, a global entertainment content company, with connects with audiences through compelling television programs, motion pictures, short-form videos, applications, social media and other entertainment content. Viacom partnered with Snapchat earlier in Feb. 2016, that under the deal, Viacom (the only television company) will have right to sell against its own content on Snapchat (mainly on Live Stories) as well as Snapchat’s U.S. owned and operated advertising inventory. Lucas will join Snapchat as COO on board in the coming July.
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Manhattan Venture Partners provides clients with accurate, timely and innovative research into the companies and sectors we cover. To that end we have established an experienced team of analysts, researchers, economists and industry veterans that focus exclusively on private companies with a proven track record of success. Producing quality research on a private company is uniquely challenging. Our analysts communicate with employees, ex-employees, early investors, VCs, competitors, suppliers and others to gather valuable information about the company under coverage. This information enables us to create unique financial models that value the underlying company and provide insight to our clients and industry experts, leveraging years of experience working for bulge bracket firms.
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About the Analyst
Santosh Rao has over 18 years of experience in equity research, primarily in the technology and telecommunications space. He started his equity research career as an Associate at Prudential Securities and later moved to Broadpoint Capital (Formerly First Albany Capital), where he was the Senior Equity Analyst, and later to Evercore Partners, where he worked with the Telecom and Data Services Group. Prior to joining Manhattan Venture Partners, he was the Managing Director and Head of Research at Greencrest Capital, focusing on private market TMT research. Mr. Rao started his career as a Financial Analyst in the Operations Groups at PaineWebber (UBS) and Prudential Securities. Santosh has undergraduate degrees in Accounting and Economics, and an MBA in Finance from Rutgers Graduate Business School.
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