Why I'm Staying Away From The Snapchat IPO

Snap Inc. (NYSE: SNAP ) the parent company of popular messaging app Snapchat, recently officially filed for its initial public offering ( IPO ). Calling itself a "camera company," Snapchat, which boasts a private market valuation of $17.8 billion, has ambitious plans to raise some $3 billion from the offering -- a figure which some analysts call merely a placeholder number for a far greater goal.

Don't Make Snap Decisions

Estimates suggest this offering to value the company between $20 billion and $22 billion, according to MarketWatch . But should retail investors, who the company says will have no voting rights, buy into the IPO? Just as important, given the recent IPO lemons we've seen from the likes of GoPro (Nasdaq: GPRO ) -- another camera company -- Snapchat investors must consider the bigger picture.

According to its recent filing, Snapchat has made considerable progress in terms of monetizing its core ephemeral photo- and video-sharing app, which had 158 million daily active users at the end of 2016 for an average of 2.5 billion "snaps" created per day. Aside from the ads posted on its photo-sharing platform, the company makes money from content created by third-party channels such as news organizations. And to better diversify its revenue stream, Snapchat recently launched hardware called Spectacles and has since implemented a payment feature called Snapcash.

Too Many Things Must Go Right

The company, which lists -- among others -- Facebook (Nasdaq: FB ), Alphabet (Nasdaq: GOOGL ), Twitter (NYSE: TWTR ) and Apple (Nasdaq: AAPL ) as competitors, said revenue surged to $404.5 million from just $58.7 million in 2015. Notably, that figure surpassed the company's own target range of $300 million to $350 million. Just as impressive, Snapchat's average revenue per user (ARPU), a closely-watched metric that denotes the strength of the business, grew to $1.05 in the fourth quarter, surpassing the previous amount, $0.31, posted a year earlier.

But here's the thing: The company is also drowning in losses and warned that it "may never achieve or maintain profitability." In 2016 Snapchat said it recorded a loss from operations of $520.4 million, which grew from a loss of $381.7 million in 2015. While the company has, indeed, improved its ARPU, that level of growth has come at great cost.

What Can Go Wrong? A Lot.

Granted, like most burgeoning young startups, the fact that Snapchat is losing money early in its growth phase is expected. At the same time, however, consider that some 98% of its 2016 revenues came from advertising, suggesting that in order for Snapchat to grow the company will topple the two-headed advertising monsters in Facebook and Google. And that's a daunting task, especially considering the fact that Snapchat's user growth hasn't been extraordinary.

While the company does boast 158 million daily active users, which Snapchat called a "critical measure" of user engagement, growth was flat in the fourth quarter. And this was preceded by only 7% user growth between the second and third quarters of 2016. Was it coincidence that between the second and third quarter Facebook launched Instagram Stories, which some analysts describe as a Snapchat-like feature? It could be. But it also underscores how Facebook still controls certain levers.

( Editor's Note: The risks of buying stock in an IPO are obvious -- and there's a much better way to invest in startups like this. The risks are smaller, and the potential payouts are much higher... learn more here ...)

Bottom Line For SNAP Stock

And while Snapchat does have an attractive demographic of young users, the company warned that its teen demographic is not "brand loyal" and could shift attention to another platform. For now, Snapchat is saying all of the right things and disclosing concerns investors might have before buying into the stock. And, yes, these disclosures could just be standard operating procedure prior to an IPO. But the company could also be telling the truth.

As such, the fact that Snapchat is burning through cash hand-over-fist, while user growth has slowed is too reminiscent of Twitter for me to get excited about its prospects. Even more ominous is the reality that Snapchat must beat Facebook and Google on their home turf to stop the bleeding. Yeah, good luck with that.

Risks To Consider: The strong popularity in Snapchat has already generated tons of excitement in SNAP's IPO. But the company must separate itself from the hype and prove it is a money-making franchise -- one that can sustain itself amid strong competition from incumbents like Facebook and Google. Likewise, cash is going to be an issue as the company must spend to innovate and grow.

Action To Take: Avoid the IPO and wait for the exuberance to taper off. Keep an eye on the high range relative to where the company priced the shares on the day of the offering. Price-to-sales ratio will be a key factor when comparing Snapchat's valuation to that of Facebook.

Editor's Note: The real winners from this IPO will be the ones who invested in Snapchat BEFORE it went public. Not so long ago, there was no way regular people like you or I could get the opportunity to become one of those investors... But times have changed. New regulations make it possible to be one of the early investors in some of the most exciting startups out there -- but you have to know how to pick the good ones from the bad.

Luckily, StreetAuthority has enlisted an expert: Joseph Hogue has written multiple books on the subject, and his most recent book, Investing In The Next Big Thing: How To Invest In Startups Like An Angel Investor, is available on Amazon now . His monthly newsletter Pre-IPO Millionaire is packed with advice and ideas for making successful investments in companies when they're just getting started. In addition, Joseph sends his subscribers a monthly list of all the latest opportunities available, and interviews angel investors and CEOs in a regular podcast -- also only available to subscribers.

Want to learn more? Click here ...

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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