In the spring of 2017, global markets crowned Evan Spiegel the new boy king of tech. At just 26, Mr Spiegel took his Los Angeles based photo message and camera company Snap public for $24bn, making it the biggest IPO in years. The lossmaking company was valued more highly than Facebook, with a market capitalisation nearly 60 times bigger than sales. By the end of the year, stock-based awards made Mr Spiegel the highest-paid chief executive in the US.
Two years on, Snap has suffered an executive exodus including two chief financial officers, the chief strategy officer and the head of human resources. After a disastrous redesign, user numbers have stopped growing. Shares now trade 30 per cent below the listing price.
The social media network has gone from scrappy start-up to multibillion-dollar public stock to plotting its own recovery in the space of just eight years. The compressed timeline illustrates the late stage of Silicon Valley’s current investment cycle.
This year is expected to set a record for tech IPOs from the likes of Lyft to Pinterest, Slack and Uber in terms of money raised and the size of listings. Like Snap, most are not yet profitable. All hope to be valued at large multiples of sales. But Snap’s experience over the past two years suggests their finances may be judged more harshly once they swap the Silicon Valley bubble for public life.
Mr Spiegel promises a turnaround in 2019. User numbers have steadied and the share price is rising. Problems at larger rival Facebook could present an opportunity. But the clock is ticking. According to a Financial Times analysis, the company has just over three years to become cash flow-neutral before it will need to raise fresh funds. In that time, Snap must raise user numbers and cut costs while fighting off Facebook’s plan to neutralise all and any competition.
From the beginning, Mr Spiegel’s fortunes have been entwined with Mark Zuckerberg’s social media giant. His pedigree as an elite college dropout allied with a hit social media idea echoes Mr Zuckerberg’s almost perfectly.
Snap’s smartphone-designed, camera-centric messaging app Snapchat made Facebook look old-fashioned when it gained popularity in 2012. Teenagers flocked to the new network, delighted that their parents, who were panicked by the idea that it was a sexting app, did not understand how it worked. By 2013, around 400m photos and videos per day were being sent via Snapchat — more than the number shared on Facebook-owned Instagram. Brands and media companies like CNN, BuzzFeed and Starbucks were lining up to sign deals.
Facebook’s response was to try to buy the upstart. When rebuffed, it swiped Snapchat’s most creative features, including cute, animal ear selfie filters and collections of disappearing pictures and videos called Stories for Instagram. The cut and paste job was shameless. But it was both legal and effective. Instagram Stories now has more users than Snapchat.
Snapchat is still popular. Over 186m people use it each day — 60m more than use Twitter. But while user numbers are high, they are declining. This is a bigger impediment to a steep valuation than financial losses. Around 5m people have stopped using the app since last year, all but destroying the notion that Snap is a Facebook-killer. While Facebook’s market value has grown to reach the equivalent of over $250 per user, Snap’s is less than $90.
“Facebook has taken so much oxygen that everyone else is having trouble breathing,” says Aswath Damodaran, finance professor at New York University. “Snapchat is still attuned to a certain young demographic — it was the first video social media company. But it now needs to . . . find its niche and survive.”
When Snap listed, there were plenty of jokes about the uncanny similarities between a company that created self-destructing messages and the risks involved in investing in a lossmaking organisation with few assets. The revenue multiple it sought was higher than both Twitter and Facebook’s had been when they listed and it was losing more money. Its founders retained near total control by only selling shares with no voting rights.
Yet the chance to buy into a new social media platform encouraged investors to throw caution to the wind. On the first day of trading the stock rose 44 per cent.
In many ways Snap looks a good bet. Social media networks are still growing. China’s WeChat, developed by Tencent, has over 1bn monthly users. YouTube has close to 2bn. Facebook has over 2bn monthly users across all its platforms. The success has encouraged new entrants like video platform TikTok.
Like other social media companies Snap makes most of its money by selling adverts. And digital advertising is booming. This year, the market will exceed traditional ad spending in the US for the first time, according to eMarketer. By 2020 it is estimated to reach $150bn. Even better, Snap brims with so many ideas that it tends to make its competitors look slow and tired. Features like augmented reality rainbow vomiting clouds painted over videos and photos were an instant hit.
The problem is that not every idea is a winner. Mr Spiegel’s decision to change how users follow celebrities and message friends in 2017 prompted a backlash from “influencers” like Kylie Jenner and regular users. “I hated the redesign,” says Cara Beckford, one of an estimated 14m people in the UK who use Snapchat. “So did everyone I know.”
Snap declined to comment for this article but in an interview last year, Mr Spiegel told the FT that the company’s mistake was moving too fast for its audience to keep up.
Yet in another key part of product development Snap has been too slow. Mr Spiegel promised users, and investors, an overhaul of its Android app — which had been neglected as Snap prioritised iPhone owners — in 2017. The update is vital if Snapchat is to broaden its appeal outside the US, where Apple has a far larger market share than in most of the rest of the world. But after prolonged delays, the full roll-out will only be completed by the end of 2019.
Unlike Facebook and Twitter, Snap still runs at a loss — $192m in the last quarter, and $1.3bn for 2018. Both are an improvement on the previous year. But the cash the company has on hand has dwindled to around $1.3bn and it will struggle to raise fresh investor funds while its user count is down.
“Arguably Snap listed years too soon,” says Michael Nathanson of research company Moffett Nathanson. “And it did not raise enough capital when it went public or take out cheap convertible debt so that it would have the proceeds on hand when it needed them. Now it’s too late. No one will buy convertible debt unless they think the stock price is rising, and that is too uncertain.”
The control wielded by Mr Spiegel and co-founder Bobby Murphy has made some uneasy. The pair hold roughly 97 per cent of voting rights, up from 88.5 per cent at the time Snap listed. That is largely to do with early investors with voting rights switching to non-voting shares in order to sell them.
Without recourse to votes, the majority of investors have no say in the company’s direction. That means Snap’s decision to cover the costs of operating an aircraft owned by Mr Spiegel is not up for discussion. The perk is not uncommon for executives of large companies. But it is a questionable luxury at a business with negative operating cash flow.
Snap’s rapid and sustained share price fall since listing has deterred other tech founders from trying to claim similar voting rights, says Anne Sheehan, chair of the SEC’s Investor Advisory Committee. Lyft, the ride-sharing company, opted for dual class shares but the founders did not seek the same level of control. “I think even if the stock had performed well that share class arrangement would be a one-off,” she says. “Snap pushed the issue over the edge.”
Shares have begun to recover in recent months with the company tightening its grip on finances — a shift credited to chief financial officer Tim Stone, who joined the company last year. Some costs however, cannot be cut. Snap expanded quickly by using external servers from Google and Amazon Web Services. This cost increases as it grows more ambitious and gains more users. Hosting costs accounted for 70 cents per user in 2018 — up from 60 cents the previous year. But negative operating cash flow also improved, by $50m in the last quarter, amid job cuts.
Snap has lowered barriers for advertisers, moving from a direct sales ad team to an automated platform and cut prices. Even as user numbers have stalled revenue, at $1.2bn in 2018, has risen. And there are more advertisers to attract. In the US, Snapchat reaches more 13-24-year-olds than Instagram yet only a quarter of marketers use Snap while two-thirds use the rival platform.
Since Snap listed its average monthly cash burn — the rate at which costs exceed money generated — has been $68m. If it can maintain the last quarter’s tight cost controls then this can slow to $33m — giving Snap more than three years to raise user numbers before it requires new funds. By that point it may be profitable. If not the company should take a leaf out of Tesla’s book and consider issuing convertible debt, which carries lower interest rates than plain-vanilla bonds.
To raise user numbers Snap needs old people. In social media terms that is anyone aged over 35. They may be less proficient at taking selfies but they do tend to be loyal to the platforms they adopt and appreciate the privacy afforded by Snapchat’s default to deletion and messaging system.
Focusing on that goal will require a financial discipline the company has only just begun to demonstrate and one that runs counter to some of Snap’s grander ambitions. In January, Mr Stone announced he was leaving after just eight months. The concern is whether this will give the founders free rein to spend more.
Snap trades at $12 a share, which means that its market value is 13 times trailing revenue — far lower than it was when it listed. But it still trades at a higher multiple than Twitter, which has similar revenue growth but is profitable. This suggests investors are betting on Snap soon becoming profitable or revealing a new idea.
Yet it has been a while since it dreamt up an idea that captured the imagination of its users. A move into gaming and extra original content, announced in April, will help engagement and appeal to advertisers. But Snap is up against big spenders with similar plans at Facebook, Apple and Alphabet, the parent of Google.
In the longer term, Snap’s big bet is the rise of augmented reality and the end of smartphones. Its camera-toting smartglasses, Spectacles, sold poorly and required a near $40m write down of unsold inventory in 2017. Undeterred, Snap has released a second iteration.
“We really see a future — it’s probably going to be more than a decade — but computing will stop being confined by a little screen and will be overlaid on the world,” Mr Spiegel told the FT last year. “At that point we’ll have had years and years of learning and iteration [from people buying and using Spectacles] that is very very hard to replicate. That core understanding of the product is the differentiator.”
Yet smartglasses are still a niche product — too clumsy to be cool and lacking features that would make a phone obsolete. At the same time, Snap is being outplayed in its main business by Facebook, which has announced that it plans to focus on private conversations.
Cost cutting and a rejig in advertising mean Snap has escaped immediate danger. But it is too small to counteract Facebook’s enormous economies of scale. Snap can coexist with the world’s largest social network, but Mr Zuckerberg’s business generates almost as much in annual free cash flow as the entire market capitalisation of its smaller rival. Snap has a little over three years to settle its business and turn a profit before it runs out of cash. But Facebook can inflict plenty of damage before then.