Morgan Stanley was the lead underwriter on Snap's (NYSE:SNAP) initial public offering. The investment bank made $25.7 million in fees for underwriting 60 million Snap shares at its IPO. Then, 25 days later (after the quiet period ended), the research arm of the bank gave Snap shares an overweight rating and a $28 price target.

Earlier this week, Morgan Stanley's analysts changed their tune. Lead analyst Brian Nowak told investors, "We have been wrong about SNAP's ability to innovate and improve its ad product this year," downgrading the stock to equal-weight and its price target to just $16 -- notably below Snap's $17 IPO price.

Here's exactly where the analysts went wrong.

"Snap Inc." on a yellow background.

Image source: Snap

Advertisers aren't actually reaching many millennials

Snap's young user base is extremely attractive to brand advertisers hoping to hook 'em young. But ads won't do businesses any good if nobody's looking at them.

"Our latest industry conversations indicate many advertisers are struggling to develop [Snap] ad units with sufficient completion rates and consistent return on investment. Lower ROI holds back incremental ad dollars," Nowak said.

Sixty-nine percent of Snapchat users skip ads "always" or "often," according to a survey from Fluent conducted earlier this year. That number climbs to 80% when focusing specifically on the millennial audience Snap likes to tout.

Snap has tried to teach advertisers how to make ads that fit in with organic Snapchat content in order to help resolve the problem. Whether users will respond better remains to be seen.

Ad measurement is lacking

Snap has been making efforts to improve its ability to help advertisers measure their return on investment, but it's still lagging behind competitors like Facebook (NASDAQ:FB). Still, Nowak was unimpressed. "Ad ROI measurability has not improved as much as we had hoped or as much as expected by agencies this year," he wrote.

Snapchat lacks tools that allow advertisers to determine which ad campaigns produce the best return on investment for their dollar. Facebook, comparatively, allows advertisers to segment users into lookalike groups to run different ad campaigns and determine the best. Until Snap develops better measurement tools, it'll be difficult for it to attract more ad dollars from its existing advertisers.

Snapchat's self-serve platform is slow to roll out

Nowak also expressed concern over the slow roll out of Snapchat's self-serve ad platform. His team originally expected the platform to be fully launched by early 2017. Now, they don't expect it to fully scale until late 2017 or early 2018.

The self-serve platform is an important step to help leverage Snapchat's sizable audience and reduce operating expenses. Facebook's self-serve platform allowed it to scale to 5 million active advertisers over time and become less reliant on a sales force to grow ad sales. Snap is currently almost entirely dependent on direct sales of its advertising, reducing its operating margin.

The competition is tougher than anticipated

Instagram launched Instagram Stories last summer, and it's quickly grown to 250 million daily users. Facebook has also copied the format to its other three major apps: Facebook, Messenger, and WhatsApp.

"We believe Instagram is likely to be more disruptive than previously expected as our industry conversations indicate that Instagram is giving advertisers sponsored lenses for free," Nowak wrote in his note.

Facebook's aggressiveness in co-opting Snapchat appears to have slowed down the latter's adoption. User growth disappointed investors in the first quarter, and reports from SensorFlow show app downloads are down 15% to 30% year over year. Nowak is therefore reducing his estimates for daily users by the end of 2017 and 2018 to 182 million and 198 million, respectively. That's down from 185 million and 204 million.

There were plenty of warning signs ahead of Snap's IPO, but the company has failed to make much progress in the four months since. As such, Morgan Stanley's downgrade is warranted, and should give investors an idea of what to look for when management reports earnings and speaks at conferences.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.