By: Jeff Pollock
13, 2017

I don’t personally short stocks, but when Snapchat went public last March, I wanted to. Shares of the mobile application are down 45% from their $29.44 high of the year. Today, the stock closed at $15.69, well below its $17 IPO price.

Part of the selloff this past week was attributed to a Morgan Stanley downgrade. The investment bank dropped its former $28 price target to $16, despite underwriting its share issuance only four months ago. Yes, the research desk and its underwriters are supposed to work independently at an investment bank, but a downgrade this soon after an IPO is quite unusual to see.

Snapchat’s rival, Facebook-owned Instagram, is proving to be an existential threat with much deeper pockets. While Instagram Stories (introduced only last August 2016) commands 250 million daily active users, Snapchat grew its daily active userbase a mere 5% quarter-over-quarter to 166 million in the quarter that ended last March. Instagram surpassed Snapchat on this metric in April. Market share erosion against a rival the size of Facebook spells trouble for future advertising demand.

The adoption of Snapchat by younger consumers offers the best argument to attract advertising dollars. 60% of their users are under 25 (with high levels of disposable income) and the company’s penetration rate in the 18-24-year-old demographic is double compared to the 25-34-year-old market.

However, bear in mind that many technological fads have come and gone over the years. In the mid 1990’s, teens flocked to Geocities to design their own webpages. At its peak, the site had over 35 million users and was the third most valued webpage online. This enticed Yahoo to acquire the company in 1999 for $3.6 billion but only a decade later shut the operation down in the US, Canada, and Europe. In the late 1990’s, online messenger ICQ was a good way to communicate with friends and family. It had 100 million registered accounts in 2001, but only 11 million remained by 2013. If yet another example is needed, remember MySpace? At its peak, the social networking site attracted 100 million monthly users, but after News Corp acquired the company in 2005 for $580 million, Facebook entered the field and stole MySpace’s position as the dominant social media website.

In other words, consumer tastes and preferences change, particularly as technology evolves. Analysts project Snapchat’s revenues will grow almost 360% from $980 million this year to $4.5 billion in 2020. Based on the examples cited above, I doubt it. No one can forecast that far out on a technology company like this, especially when it’s competing against Facebook and 60% of its user base is under 25 years-old with exceptionally fickle tastes and preferences.

Technology companies require constant innovation to stay alive. For that reason, we seldom invest in their equity for clients. Instead, we look for business models that are sustainable and have a more predictable future. Much will need to be proven by the management of Snapchat that its business model is sustainable going forward and can compete with Facebook’s Instagram.


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