Rap for chat app chaps: Snap's shares are a joke – and a crap one at that
Wall Street greed meets Silicon Valley delusion – and they all get rich
First, we'll look at some quick facts at Snap – the Los Angeles-based developer of Snapchat that debuted on the stock market on Thursday, March 2.
- Snap's IPO price was set at $17 a share but hit the market at $24.47.
- Snap's shares were highly unusual in that they didn't give the holders a voting right.
- Regardless, the first big tech IPO in a long time was a "huge success," with share price jumping more than 40 per cent at launch and hitting a peak of $28.84.
- Except that now, just four days of trading later, it is down to $20.81 (at the time of writing).
If you take a look around, it is very easy to find financial experts confidently arguing the exact opposite of the person next to them. Snap is overvalued, say some; Snap is wildly undervalued, say others. Tech stocks are going to enter a new heyday, some argue; this is a disaster for tech stocks, says others.
It's hard to make sense of all this, so we'll make it very simple:
- Everyone who says Snap is great and the future is rosy has just made a ton of money out of a ludicrous financial system that at best resembles a Vegas casino.
- Everyone who says Snap is a disaster waiting to happen is annoyed – either they were left out of the deal, or other people that they don't like got rich because of it. And the only way they can make money at this point is if the share price falls.
The truth is that these IPOs – especially ones built around hyped-up tech – are a charade. An embassy ball in an otherwise dull existence that comprises scraping cents out of slight fluctuations in the value of huge companies that make toothpaste or lightbulbs for a living.
Snap's share price is ludicrous and everyone knows it.
At its peak, a company that makes an app that lets people share pictures and short messages was valued at $37.8bn. Not only is that nearly 100 times the $400m it made in revenue in 2016, but the company actually lost $515m at the same time. In fact, it lost more money each quarter as the year went on.
Even if everyone ignores the fact that Snap's user base is extremely fickle 20-year-olds who will jump ship to another app as soon as it gains more buzz; even if everyone ignores the fact that the app's navigation is so confusing that it is going to be extremely hard to expand that user base (and so not manage to achieve Facebook's success); and even if everyone ignores the fact that there's nothing stopping other larger companies like Twitter, Facebook and Google from grabbing Snapchat's most successful features – Snap's share price is still far, far too high.
Even the low-ball estimates of $10 per share overvalue the company. And the average of all the estimates comes out at almost exactly the initial IPO price: $16.50 compared to the launch price of $17.00.
But anyone expecting there to be some kind of reckoning or reality hit doesn't understand how the stock market works. And here's the easiest way to grasp it: how many shares do you personally own in Snap?
The answer is almost certainly none. And that's because it's a game that only a very few organizations and individuals play in. And all of them want only one thing out of it: money.
Perhaps the greatest indicator of this inside game and how it drives the share price comes in the interesting news that the Council of Institutional Investors has asked two of the biggest index providers – S&P Dow Jones and MSCI – to bar Snap from its share benchmarks.
Who on earth is the Council of Institutional Investors? Well, it is one of a number of hugely powerful financial organizations that you have likely never heard of, but it represents over 100 very large investors like pension funds and huge corporations like Microsoft, General Motors and General Electric. Combined, its members have assets worth over $3 trillion – and a big chunk of that is in real money rather than stock exchange money.
So why is this arcane organization asking the stock indices to bar Snap from their listings? Two reasons: the first, the public reason is that Snap's shares don't give shareholders voting rights. Without those rights, big investors have no way of exerting pressure on a company. Why do they care? Because many of the companies will be obliged to purchase shares in Snap because their investment policies say they must buy shares in the top few hundred companies listed by those indices.
In other words, if Snap is listed in the S&P 500, all the pension funds will need to buy the company's shares even though they don't get a vote and even though they are almost certain those shares are not worth what they will pay for them.
What's the second reason why the Council of Institutional Investors wants to pull Snap out of the indices? Because they were shunned by Snap's underwriters, Morgan Stanley.
Morgan Stanley decided on a strategy that went against the unwritten rules of Wall Street, where large institutional investors are given allocations of new IPO shares just to keep them happy – because those relationships are likely to be crucial for other clients in future.
Typically, these large investors say "thank you very much," take the shares and then almost immediately sell them, pocketing the difference.
That $17 IPO price that never existed in the real world? That's what companies on the inside track buy them for. The $24.47 launch price? That's the profit given to big financial companies for doing nothing except existing. A 44 per cent return within just a few hours.
Except, if Morgan Stanley had decided to give these allocations to big investors who would sell them the moment the market opened, the opening price would not have hit $24 because everyone outside the inner circle would know that they will sell their shares for whatever they can get above $17. A good bet would have been, say, $20.
Because there wasn't a huge glut of readily available shares from the offing, the share price opened much higher – resulting in one million news articles crying, "Snap IPO a huge success! Shares jump 40 per cent!"
And everyone got excited, which led to more buying and more excited stories and more buying and so on. All the while this rise was happening, the other group of people with special access to the financial markets, ie, not you or anyone who exists in the real-money world, were watching carefully.
Thanks to being plugged into the automated and lighting-fast financial systems, these groups are able to buy and sell huge quantities of shares in milliseconds and at virtually no transactional cost. No waiting on the phone for five minutes and paying $7.50 a trade for these guys.
And so they keep hyping up the market, trying to judge the perfect moment to sell those shares before they start falling in order to make the maximum amount of money.
At absolutely no point in this game does anyone give any thought to how much advertisers might be willing to pay for ads on Snap's app. Or whether those fun filters that let you swap faces or put flowers in your hair are something that is a long-term valuable product or no more than a fad that will die off in six months' time.
The institutional investors did not appreciate being left out of the cash-in. And they are even more worried that future IPOs will use the same tactic to get an early IPO boost, cutting them out of easy profits. And that is the other reason why they want Snap pulled out of the indices – to send a signal: Do not mess with the big boys.
But here's the thing: no one who decides the share price cares. So long as people at the end of the day have more money than when they started, the rest of it is utterly irrelevant.
And, after the dust has settled, the company that has just IPOed is now locked into a financial system that loves making money but hates losing it. So all the institutional investors – if they are indeed forced to buy massively overpriced stocks in Snap – will sit on them, using them as a balance against other fluctuations in other markets (or, in this case, Snap will likely be one of the fluctuations its other shares will guard against).
And that gives Snap a financial foundation that, frankly, it does not deserve. And everyone knows it.
Which all leads to two questions in Wall Street's mind when it comes to Snap:
- Is Snap going to be Twitter and keep losing money and so suffer a slow decline in its share price, or like Facebook and start making big profits, pushing the share price up? And how best can we make money from that movement?
- Did anyone notice what a scam that Snap IPO was – because we made a small fortune out of it. You think we could get away with doing another one soon? How about Dropbox? Or, better still, Uber?
And that is why Snap's IPO was a joke, and an unfunny one at that. ®