Why Snapchat Was Right to Turn Down Facebook's $3 Billion Offer

Facebook (NASDAQ: FB  ) reportedly offered Snapchat $3 billion for its business, and the mobile app company rejected it. The Internet blew up! The overall sentiment: Snapchat founders Evan Spiegel and Bobby Murphy are crazy!

They're not. Looking at the big picture, $3 billion is not a lot for a social media company with an estimated 30 million users. Here's a nice little graph I made to put it into perspective, comparing the small startup to Facebook, Twitter (NYSE: TWTR  ) , and LinkedIn.

 

*Snapchat numbers are based off estimates and Facebook's offer. All other data from Yahoo! Finance and Asymco

Although companies like Google (NASDAQ: GOOGL  ) have offered less for apps with significantly more users (see WhatsApp), I argue that Snapchat users ought to be valued more highly for two reasons. One, with just 30 million users, Snapchat has tons of room for growth. Two, Snapchat has some of the most highly engaged users of any social media company.

User growth
Fellow Fool contributor Leo Sun pointed out that Snapchat's user numbers aren't very impressive. He points out five social messaging apps with more global users, none with fewer than 80 million users. Leo uses this to argue that Snapchat's competition already have a significant lead, and that it takes a lot of users to generate a little revenue. 30 million ain't gonna cut it.

The reverse, the way I see it, is that there's huge demand for social messaging apps. If anything, these apps indicate how much Snapchat could still grow. WhatsApp has 300 million users. What's preventing Snapchat from getting just as many?

If the argument is that people are already using a different app, there's some ironic logic to it. The entire reason Facebook is interested in Snapchat is that the company is losing engagement from younger users, where Snapchat thrives. Certainly, Facebook has widespread use. Snapchat is encroaching on its user base as well as those of other social messaging apps.

The growth seems evident in the number of "snaps" sent each day. Between June and September, Snapchat saw "snaps" increase from 200 million to 350 million. That's phenomenal growth that could continue for some time. That means each current user should be worth significantly more to account for growth.

It also points to my second argument.

High engagement
With just 30 million users, Snapchat's 350 million daily "snaps" translate to close to 12 pictures sent per day and about 25 times of looking at the app (since each picture is sent to at least one other user). This is significantly higher than a lot of bigger companies.

Twitter, for example, produces 500 million tweets every day from a user base of 232 million. Facebook's Instagram produces 50 million photo uploads from 150 million users.

Compared to other social messaging apps, however, Snapchat may seem less engaging. WhatsApp produces 11 billion messages read by 20 billion users from a base of 350 million. That's almost 90 average views per day.

But Snapchat, by its nature, forces its users to engage with the app on another level than other social apps, making them more valuable. First, Snapchat is less a utilitarian platform than it is a creative platform. Creativity means users are thinking about their snaps more than messages on other platforms. This presents a great monetization opportunity for the company.

Moreover, Snapchat, despite calling itself a photo-messaging app, is really a video-messaging app. Even when a user sends a photo, it "plays" for a designated amount of time. Videos are more easily monetized than pictures, and I believe SnapChat's platform of personal video messages with its "press and hold" instruction means people will pay attention to ads slotted in before a video.

The argument that users will ditch the app if the company puts ads in it makes no sense to me. Where will they go? Why would another app pop up if it can't monetize either? They're not doing this for charity. There will be a few people that leave because of ads, but that happens on every platform -- Facebook, YouTube, Twitter, Instagram.

We saw what Google did with YouTube. Despite putting advertisements in some videos, engagement has stayed high. Yes, there are other options besides YouTube to watch videos, but YouTube remains the place for it. YouTube has grown revenue exceptionally well, with estimates that it will grow revenue 36% this year overall and is growing even faster on mobile.

Advertising might be a tough nut to crack for SnapChat since it doesn't collect much data on its users. It may benefit from partnering with Facebook or Google to get more information on its users and serve more targeted ads.

Not even close
Sure, $3 billion sounds like a lot for a company with a relatively small user base and absolutely no revenue. But Facebook's offer seems far away from paying for the true value of those 30 million Snapchatters. Google is rumored to have offered $4 billion and was turned down. The founders are raising another round of capital at a valuation between $3.6 billion and $4 billion.

In other words, there's no premium in these offers. Why would SnapChat sell?

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