Why Snap Will Fall Further

When I posted a forecast that Snap (NYSE:SNAP) would fall below $20 a share by the end of last week, the prediction was easy to make. Ahead of the IPO, investors were already warned the stock would have no voting rights nor may the company may never make any profits. Facebook (NASDAQ:FB) continued adding disappearing story functionality to its messaging app, including WhatsApp. Though SNAP was profitable for some longs after the stock peaked at $29.44 a share, the trade is now a loss for others.

Now that the stock is below $20 a share, where is it headed next? With only trailing user growth supporting the stock price, SnapChat’s stock is likely going lower in the weeks ahead.

Seeking Alpha User Yorick explained the three key steps to an IPO and why SNAP’s stock faces headwinds:

1. VC $100M through 3 tranches and although no profits make sure millions adopt it

2. File for IPO where the owners get out and market makers try not to get stuck with the bag while pumping to retail

3. Crash of the stock within days and weeks of IPO setting up purchase by company at real valuation which is roughly 1/10th the IPO valuation

New investors may not have experienced the stock crash for IPOs like Zynga (NASDAQ:ZNGA) or Groupon (NASDAQ:GRPN). Zynga’s business eroded quickly after it parted ways with Facebook. The company pivoted its business towards mobile apps and has yet to prove the transition will succeed in revitalizing growth. Investors ignored the unsustainable business model for Groupon. By offering steep discounts, businesses ran promotions at a loss, failing to generate repeat business from the coupon buyers. At the time, Groupon stockholders bet the revenue would grow forever.

SnapChat has similar characteristics of those over-priced IPOs. The valuation is a function of user growth. But Facebook is not going to let SnapChat take its Messenger users without a fight. By levering its user base of nearly 2 billion (as at the end of 2016), SnapChat will have a tough time taking market share from Facebook.

Now that SNAP options are available for trading, investors may now bet freely against the company’s prospects. The open interest for April, 21 $18 Puts is 31,844 at a cost of $0.53 per contract. Chances are good that the company’s active user growth will slow like that of Twitter, albeit for different reasons.

Twitter’s growth slowed when the company failed to simplify the site’s usability. It introduced live video for sports events like NFL. This move could reverse the quarterly drop in active users. SnapChat is many quarters away from facing the slowdown that plagues Twitter. In February, SnapChat had 158 million daily active users (“DAU”) creating 2.5 billion snaps a day. In North America, the company had 68 million DAUs. Unfortunately for shareholders, the $23 billion market cap values each “snap” at $33.80.

Snapchat’s advertising campaigns are tailored to the advertiser’s needs and undergo strict reviews from the company. This may raise the effectiveness of ads but it limits the ad volume, restricting the company’s revenue growth.

Takeaway

SnapChat shareholders will get more nervous on holding the stock now that it is below the $20 level and is headed towards its IPO price. Investors should look at past IPO successes like GoPro (NASDAQ:GPRO) or Fitbit (NYSE:FIT), which moved towards fair value and below that of the IPO price. Risks are high that with DAU numbers decoupled from SnapChat’s valuation, it will revisit its IPO price before potentially falling further.

Please [+]Follow me for continued coverage on value stock ideas. Click on my name next to my avatar at the top of the article. On the DIY Investing service, SnapChat was suggested a stock to buy and trade only but not to hold for too long.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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