It's pretty challenging to make sense of Snap's (NYSE:SNAP) valuation, even as its stock continues to trend lower in the wake of the IPO earlier this month. At yesterday's close, shares were trading at 59.5 times sales; shares had reached nearly 50% higher on the second day of trading. That's beyond being priced for perfection -- there's almost no way Snap can live up to it, even if it executes flawlessly.
That's more or less the argument that Cantor Fitzgerald analyst Youssef Squali is making as he initiates coverage on Snap shares with an "underweight" rating, or the equivalent of a sell. Squall has also pegged an $18 price target on the Spectacles purveyor and Snapchat operator, according to Tech Trader Daily.
Time to grow up
Even if you give Snap the benefit of the doubt in terms of execution and ramping ad sales comparably to Facebook's early years, Snap is still woefully overvalued. Shares trade at almost 28.6 times enterprise value (EV) to 2017 estimated sales, while most peers trade at just 5.5 times EV/sales.
Part of the challenge is that Snap's ad platform is so young that it's not clear if advertising customers can earn a satisfactory return on their ad spending. A lot of the brands that currently buy placement on Snapchat are spending out of what Squall considers "small experimental budgets." Snapchat is extremely popular in young demographics that are generally harder to reach and appeal to, so making an attempt on their preferred ephemeral social media platform is worth a shot. Snap has a strong position in mobile video, and advertising dollars are expected to continue flowing out of TV ad channels and toward mobile video.
This may be a challenge for CEO Evan Spiegel, who is famously averse to aggregating user data and once said, "We care about not being creepy," referring to that moment you're browsing the internet and start seeing ads pop up everywhere based on something you searched for or clicked on an hour ago. Spiegel has also always prioritized user experience over data.
But data is what advertisers care about, including for ad targeting as well as measuring the effectiveness of ads. Snap is going to need to present advertisers with data that shows their ads are working or risk losing those ad dollars. This is especially true if rival social media platforms competing for those ad dollars are able to provide performance metrics. Squali is optimistically modeling for $162 million in EBITDA in 2019 and nearly $400 million in free cash flow for 2020, but still can't justify the current valuation.
A good company does not necessarily make for a good stock if the valuation isn't right. Snap may very well perform well as a company, but the stock will likely disappoint mostly due to the hype. It looks like Spiegel may have to come to terms with the fact if you want to build a company whose revenue model is advertising, being "creepy" at times is simply par for the course.