Money

How Snapchat Loses Money and Is Still Worth Billions

You've probably heard over the last few days that Snapchat, the photo messaging app that transforms users into rainbow puking fairies and bug-eyed rocket-men, is worth anywhere between $24 and $34 billion. 

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The company's worth, or "valuation," was established on Thursday after it's "initial public offering (IPO)," the process by which it first makes shares of the company available on the stock market. 

Snapchat shares opened at $17 apiece, and shot to $26. With 200 million shares available, Snapchat was able to raise $3.4 billion, which put the value of the company at a staggering $34 billion.

However, not only is the company not only isn't profitable, it's lost more money every year it's been in operation. Snap's own Securities and Exchange Commission fling puts the numbers in stark terms:

"For the year ended December 31, 2016, we incurred a net loss of $514.6 million, as compared to a net loss of $372.9 million for the year ended December 31, 2015." Beyond that, the SEC filing warns "we expect to incur operating losses in the future, and may never achieve or maintain profitability."

So how does a company that's lost nearly a billion dollars and admits it might just keep losing have a value at dozens of times that?

In a word, potential. The app has 158 million daily users, almost entirely in younger demographics for whom mobile advertising is becoming the most effective way to be reached. According to their filing with the Securities and Exchange Commission, a federal agency charged with protecting investors, the company's user base grew by 48 percent in 2016, and by that same number in 2015. Continued growth at that number would give it nearly a quarter of a billion users in 2017. It's become an integral part of the way young people communicate, and has a strong profile with advertisers

A $34 billion valuation, then, isn't based on what the company is doing now, but what it could do in the future. 

But while the IPO generated tremendous excitement, it also generated intense skepticism regarding the company's value and future.

“Roughly, to justify a value of [$34 billion], you are making a set of lofty assumptions," Brian Hamilton, the co-founder of financial analysis firm Sageworks told ATTN: in an email. "They would need to grow for the next ten years at more than 50 percent every year."

Such a growth rate is virtually unheard of, and even less so for a company currently losing money.

For recent IPOs, it would compare to iconic companies like Facebook and Chinese commerce site Alibaba. But both of them are profitable, and saw their growth slow after they went public. Snapchat is already experiencing declining growth

Beyond that, while Snapchat is a popular product, there's no guarantee its popularity will last for years, or even months. “Their product is basically a trendy idea, which is subject to the whims of the generation of people they appeal to," Hamilton told ATTN:. "Therefore, it is very difficult-to-impossible to accurately forecast their long-run prospects, which should be the basis for good investing.”

Those investing in Snap should keep in mind the IPO of another hugely popular, yet totally unprofitable company: Twitter.

The social media app has become essential as a platform for breaking news and commentary by everyone from celebrities to foreign policy experts to the President of the United States. Even so, it's still unprofitable, with slowing growth and flat revenue.

"Investors who bought Twitter at its IPO in 2013 paid $26 a share. This week, it’s trading at around $16 a share," Hamilton said.

And it's not the only tech company to crater in value after going public. Groupon's stock lost almost 75 percent of its value in the years after its IPO, and trades at $4 per share, while mobile game maker Zynga went public at $10 per share, and today is trading at around $2.70.

Snap's incredible value now is no guarantee that it will retain any value going forward, nor a guarantee that it will hit its extremely lofty growth forecasts.

"The arrogance of the tech world (I'm in it) is that we believe we are immune from the basic laws of economics," Hamilton said. "We are physicists who have created our own world in which we jump off a building and expect not to fall or, if we do fall, we expect someone else to catch us.” ​