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Uber, Airbnb, Shazam, Space X. One word is commonly used to describe those firms in the financial world: "Unicorn". A Unicorn is a company which is ....
A Unicorn is a company which is not publicly offered and has a valuation equal or above 1 billion US dollars. The reason its called unicorn is because the chance to find such a company is as big as to see real unicorn.
Those Unicorns raise money for years to develop their activities.
Their main investors are Venture Capital. Venture Capital are financial institutions making risky investments in young firms where they expect a long-term growth and eventually an Initial Public Offering or IPO. After a decade with very little interest, the Venture Capital sector seems to be attractive again, especially with booming tech era.
Today HNFC will focus on one Unicorn which has become public company recently, to be exact on Thursday, 2nd of March 2017, The Snapchat. Snapchat is messaging application for smartphones, most of you already familiar with it. The main purpose of SNAP is to send a limited lifetime picture to friends but recently a lot of new cool features has been added.
This app is available on the market since 2011 and has become public listed company few months ago. So far, Snap IPO is not a success.
The share price fell down by 45.76% from 2nd March till present day.
(It was well expected by most of investors, as clearly snapchat didn’t worth that much)
While the decrease in share price was happening, several causes has been found
(Low advertising revenue, wrong net assets evaluation, strategic issues, unexpected strong competition and many other serious issues). But a recent publication from Will Gornall and Ilya A. Strebulaev could give us another clue about Snapchat current financial failure.
I will briefly summarise and simplify this excellent publication, I present the Snapchat (Ticker: SNAP) as the case for our analysis. First things first.
1. The publication from Will Gornall and Ilya A. Strebulaev.
The subject of the publication is the capital valuation of Venture-Backed Companies (VBC).
VBC fund themselves through several financing rounds. A financing round is a period where a company offers a part of its equity to private investors through shares offering. Each financing round results in a new issued shares. The first offering is often called “Seeds”, the second “Class A”, the third "Class B" and etc.
As the capital of a VBC is evolving through its lifetime, valuating VBC is a complex process. Actually, it is a black box according to Will Gornall and Ilya Strebulaev. However, the financial sector commonly use a process which is called the "Post-Money Valuation". It is a calculus made after a financing round.
Calculated by formula:
VBC valuation = Last Share Price * Number of Shares Outstanding
It is “classic” capital valuation formula actually. It does work in a lot of cases. If the firm A has 30’000 shares outstanding and the share’s price is 10$/share then the valuation of company is $300’000
But, as mentioned in the publication, shares issued by VBC between the first financing round and the last are not the same in terms of assets’ classes. First issued shares are often common shares. But the more you go through financing rounds the more offered shares have options, a seniority position, are convertible or have a limited loss etc.
A value difference appears between Series of shares. Meaning that:
Price of Serie 1 at issue < Price of Serie 2 at issue
This difference comes from:
This is a problem for the Post Money Valuation formula. Because of differences between classes of issued shares, the last share price is not a fair value to rely on. With this approach the PM formula forgets to consider intrinsic value of individual share.
I strongly advise anyone who is interested in start-up or venture capital to read their publication here
(For financial lovers like me it is a pleasure from A to Z)
Snap Inc has been a Unicorn for years. It hit the one billion valuation in 2013. As any Unicorn, Snapchat made few financing rounds. Actually, there were 9 financing rounds with 7 different type of shares issued. The first round was on May 2012 with an investment of 485 000 $ and the last on May 2016 with a $1.8 billion raised.
Before Snap became public listed company they had 27 Venture Capital investors (Benchmark Capital, Lightspeed Venture Partners, Coatue Management and many others).
The valuation of the company at the IPO was at $23.8 billion.
As the publication says, Snapchat issued different types of equities during its financing rounds.
The SEC form D for each financing round shows what type of equity is offered.
It issued preference shares, common shares and other equities with options.
Then, according to Will Gornall and Ilya Strebulaev model, Snapchat was overvalued by 1 billion dollars on October 2016 which represents 5% of its capital. Therefore, the listed share price on IPO did not reflect correct intrinsic value of the company.
I will not take their model as the only truth. But it seems sensible that a company has to be fairly valued by looking at every shares intrinsically, rather than only market value.
It is a matter of common sense really. Therefore, results about Snap overvaluation seems fair to me.
Snap’s current fail in stock market finds its roots in two main reasons: strategic misevaluation and bubble which affects the Unicorn’s sector.
The strategic issue is undeniably the biggest problem for Snapchat.
The competition which comes from Instagram and Facebook has been much harder than estimated.
The revenue generated by advertising has also been overestimated and Snapchat fails to find new ways to make its financial model cost effective and thus profit making.
Most of analysts agree with this perspective.
The bubble in the Unicorn markets has also played a significant part.
Snapchat was overvalued by 1 billion dollars and its 7 months before its IPO. In a truly effective market, where the share price reflects whole information available to investors and other stakeholders,
Snap share price had to face reality and decline, as simply Snapchat did not worth that much.
This situation reminds me the dark time of 2007 mortgage bubble.
In 2007 we had big banks which were unable to clearly evaluate the risks and the value of
Asset-Backed Security (ABS). Why? Because it was a mix of different assets.
Today we have the Venture Capital sector which is unable to clearly evaluate the value of big companies (Unicorns) which play a major role in our modern economy. Why? For the same reason, it is mixture of different assets.
Investment Tips from HNFC team:
The purpose of this article is to show you the danger of Unicorn’s IPO, extreme volatility and uncertainty of Venture Capital valuation. This investments are more suitable for high-risk investors.
Any investment decision based on one of these two factors has to be taken very carefully,
be cautious your money is at risk.
Thank you for your time.
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Written by Samuel Chaineau │Independent stock analyst
Edited and Corrected
by Vee Venski