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The Bull Case for Snap Inc

By Motley Fool Staff – Apr 7, 2017 at 9:21AM

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What investors should know about buying into a "venture-stage investment."

A swath of fresh research notes came out for Snap (SNAP 4.24%) last week, and most of them were glowingly optimistic.

In this segment from Industry Focus: Tech, Dylan Lewis and Evan Niu look at one of the reasons several analysts have cited for their enthusiasm -- early access to shares, and the risk and reward profile that carries. But is that really a net positive for regular investors?

A full transcript follows the video.

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This video was recorded on March 31, 2017.

Dylan Lewis: Evan, we've both been bearish on Snap. I thought, since there was a lot of optimistic notes coming out about the company, it might be good for us to look at it and see what the other side of the coin is, and whether we agree or disagree with any of the points that they're making. One of the first things that I clued in on here was a quote in the research note from Heath Terry of Goldman Sachs. He says, "Snap is a venture-stage investment in the public markets, something unseen in recent years where nearly all internet companies waited until later stages of growth and profitability to go public. While this clearly carries a higher risk profile, we believe it also comes with higher reward potential." This is something I agree with. I don't know about you.

Evan Niu: Yeah, I think it's kind of an apt description. I agree that I don't necessarily think it's a good thing. I mean, there's also a reason why most companies go public later in the stage. Trying to assess a venture-stage investment is extremely complicated and hard, and it's crazy risky. I don't think it's necessarily a good thing for public investors who don't have that kind of experience to analyze companies from at that stage. It's just a lot trickier to value and invest in, which is why that stage is usually done in the private markets. To open it up to public investors and say, you have a chance to invest in an earlier stage than most companies would do this, yeah, I agree there's probably a higher risk that translates to higher reward, but I think investors have this natural tendency, whenever they hear that phrase, "high risk, high reward," they don't focus on the high-risk part. They focus on the high-reward part.

Lewis: They just see the dollar signs, right?

Niu: Right. But you have to put equal weight into both sides of that equation. I think the risks here are extremely high. And it's true that they might turn into high reward. But I don't think public investors are as good at that, at weighing out all the risks for a company at this stage as an experienced venture capitalist is.

Lewis: Yeah, Snap is still so early in the monetization strategy, and what they will look like as a money-making business, if they ever become one, is still really hard to make out. I chatted with the founder of Indiegogo, Slava Rubin, and Bill Clark from MicroVentures, a venture capitalist, while I was at South by Southwest, and he said, venture-stage businesses, 7 out of 10 of them go belly up. I don't expect Snap to go bankrupt by any means. But that gives you a sense of the profile for the type of business that Snap is being equated to, and the idea that, it's really hard to picture what it'll look like in its full form. Because of that, you have the higher risk and potential for large gains down the road, but the downside is certainly there.

Niu: Yeah, I think that part of my skepticism also is, maybe there's a sense that they want to take the company public earlier than most other companies might do it because they want to cash out and take advantage of the environment and the hype. And also -- again, I'm being super skeptical here -- maybe they internally think unit growth is hitting a peak, so they're like, "Let's go ahead and cash out now. There's tons of hype, people want to buy in, and we're hitting this wall. And the hype might fade away if we don't do this." I just think that maybe part of it is that they wanted to cash out. If you look at how they structured the deal, it's not very investor-friendly, it's not very shareholder-friendly, from a governance perspective. Maybe that's a small part of it.

Lewis: And companies control when they go public, for the most part. So, if you're looking at your financials and the core business metrics, and you are seeing that sequentially user growth is 3% in the most recent quarter, you might decide it's starting to look like a good time to go public because your books are about as good as they're going to look before you really start rolling out the core monetization strategy.

Niu: It's all hype right now.

Dylan Lewis has no position in any stocks mentioned. Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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