California-headquartered camera company Snap Inc.’s initial public offering (IPO), has been all the rage. The valuation at USD 24 billion (~EUR 22.4 Milliarden), including staff stock and deal bonuses, set the IPO target at USD 17. After its first day of trading at the New York Stock Exchange (NYSE: SNAP) markets are smiling and co-founder billionaires Evan Spiegel and Bobby Murphy, are beaming thanks to the stock closing 44% above its listing price. Today’s performance has been no less impressive – or unsustainable – given the stock’s underlying business model and some risks I’ll look into in a minute.
Others, such as venture capital firms Benchmark Capital and Lightspeed Venture Partners, Morgan Stanley as well as Goldman Sachs can also be reasonably expected to celebrate a nice pay-off. Valuation and legal advice – as controversial as some of it may have been – generated USD 26 million and USD 21 million respectively for the underwriters.
Criticism hasn’t been missing, though, concerns have been raised that:
- liberties were taken with investors’ rights, i.e. shareholders stripped of voting rights which leave them with no right to determine board members, influence merger & acquisitions or submit shareholder proposals;
- the business model appears thin with a user base dwindling and user growth slowing, difficulty to reach over 35-year olds and securing their engagement for more than a daily couple of minutes on Snapchat they currently offer;
- the company was founded in 2011, suffered a net loss of nearly USD 515 million in 2016, with an earlier net loss of USD 373 million in 2015 (see page 12 – Summary Consolidated Financial Data).
Snap Inc. has been aware of a range of risks, it seems. In fact, among its financial information for investors – SEC filings, is today’s filing, a prospectus pursuant to rule 424(b)(4) which lists a whole set of – though in extra small-print- risks investors should take into consideration. The major potential areas of concern are cloud services and technical risks, competition issues within the industry, user loyalty (and over-reliance on non-Android – i.e. iOS users), sole reliance on advertising, reputational risk, intellectual property risk and in general a focus on user retention, growth, or engagement rates that are at the core of operations, which means a decrease would render Snap Inc’s products not only less attractive but also cause serious harm to the business.
What the report – a dense reading of 240 pages – does not mention at all, though, is whistleblowing or ex-employees who might engage in such act. Litigation and lawsuits find ample discussion in the report and it seems Snap Inc. is acutely aware of the damage to reputation and drain on resources any legal action could have.
However, the (quite redacted) 31-pages lawsuit (via LA Times), filed in early January 2017 in the Superior Court in Los Angeles by former employee Anthony Pompliano contains allegations regarding misrepresentation of the company’s financial state. Pompliano alleges that his refusal to give in to pressure and engage in cooking the books in order to inflate the company’s IPO value by means of false representations of metrics resulted in unlawful termination.
Inaccurate representations and fake metrics are not just an ugly accusation of a disgruntled employee that is already causing reputational damage due to media coverage, but, if substantiated, carries serious penalties under the Securities Act of 1933 [amended]
UNLAWFUL REPRESENTATIONS SEC. 23. […] It shall be unlawful to make, or cause to be made, to any prospective purchaser any representation contrary to the foregoing provisions of this section. (…)
PENALTIES SEC. 24. Any person who willfully violates any of the provisions of this title, or the rules and regulations promulgated by the Commission under authority thereof, or any person who willfully, in a 75 SECURITIES ACT OF 1933 Sec. 27 registration statement filed under this title, makes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading, shall upon conviction be fined not more than $10,000 or imprisoned not more than five years, or both. [emphasis added]
Aside from all this remain two key questions:
- What role were analysts playing in the misrepresentation of metrics and related valuation, i.e. those individuals and teams working for the underwriters whose fees made headlines, i.e. above mentioned Morgan Stanley and Goldman Sachs?
- Also, the role of market data providers, such as Bloomberg who failed to raise the risks, the weak business model and other issues in their Snapchat/Snap Inc.coverage in late 2016 and seemed to contribute to what looks like another hype thanks to a price over revenue multiplied by an unsustainable valuation ratio of 60 (versus Facebook x 14.0, Twitter x 4.5).
Earlier this week we heard Warren Buffett (NY Times and Berkshire Hathaway 2016 letter) speaking angrily about [hedge fund] fee structures which he deemed “bordering on obscene”. In the broader context of SNAP Inc.’s going public triggering similar questions about fees and performance, we may be at a point where perverse incentives coupled with fairly blatant ignorance of a whole host of risk issues enter the mainstream media and public awareness, gaining some of the urgently required attention they deserve.
Ironically, shareholders, who are supposed to have a voice and stake in such matters, have been muted. In this bizarre tale of initial public offering marked by strange governance fascism, they have been – knowingly and with consent – robbed of their voice and potential power.
As to a potential case of IPO or valuation fraud, all hopes might be on the former employee who has been quickly dismissed as disgruntled. We may just see this whistleblower case settled out of court, and the bubble further inflating before it eventually bursts, though.