Snap judgments: Why so much negative sentiment surrounds year’s hottest IPO

The Snap Inc. thrill has faded as quickly as those ephemeral messages on the Snapchat app, and the favored institutions that got IPO allocations have had their fun and dumped the stock. But the investors who are sticking around should expect a bumpy ride.

Shares of the freshly public company SNAP, +0.22% , after soaring initially, have fallen about 10% from their most exalted level, and many analysts and investors believe they have farther to go. In addition, there is a growing short interest in the stock, an employee lockup period will end in a few months, and other inside investors may also be gearing up to sell shares. The stock closed Friday at $22.07, below its opening price of $24 on the New York Stock Exchange, but, as it’s still well above the IPO pricing level of $17 a share, it’s not a broken IPO.

“Snap only made a few people a lot of money,” said Ross Gerber, CEO of Gerber Kawasaki Inc., a wealth- and investment-management firm in Santa Monica, Calif., not far from Snap’s headquarters in Venice. “Snap has no path to profitability at all. When we look out a year, you know how much stock is going to be available? There are four big players, the two founders and Lightspeed and Benchmark, and they have to sell their stock.”

Already, co-founders Evan Spiegel, Bobby Murphy and the company’s earliest investors have cashed out nearly $1 billion in shares.

While Snap’s shares fared well for institutional investors who bought allocations targeted for the IPO, many of those first investors quickly got out. The company has faced an unusually poor reception by Wall Street analysts. In their derision, Wall Street analysts have cited such factors as Snap’s frothy valuation; its use of nonvoting shares, which concentrates 88% of voting power in founder hands; increased competition from Facebook Inc., Instagram and WhatsApp; and huge financial losses.

Investors need to be alert to watching for Snap options to expire and for employee lock-up periods to end, which could lead to more selling waves. The Information reported last month that Snap had amended the lock-up period for employees with standard stock awards, enabling them to sell their shares 150 days after the offering, instead of 180 days.

Brian Wieser, an analyst at Pivotal Research Group, who initiated coverage with a sell rating on the stock, noted that the company’s total shares will be subject to ongoing dilution from a larger-than-normal program of stock-based compensation for employees. Snap’s fully diluted shares outstanding could jump to about 1.8 billion in 2021 from about 1.5 billion at the end of 2017, he said in a note.

Against that backdrop, short interest is growing in the stock. According to IHS Markit data last week, already 4.4% of Snap’s float is in the securities lending market.

“The data indicates that the demand to borrow Snap shares from short sellers has been relatively high, but not as high as [in the cases of] previous social-media IPOs,” said Simon Colvin, a vice president at IHS Markit. Groupon Inc. GRPN, +1.78% , for example, had greater short interest after its IPO.

Many corporate-governance experts believe the stock should be avoided because of the voting-rights issue. The Council of Institutional Investors, a Washington-based nonprofit, has launched a push to have companies like Snap with nonvoting shares excluded from market indexes. It’s larger ambition appears to be heading off future IPOs with founder-entrenched structures. Once a stock is included in a market index, such as the S&P 500, index-fund managers and pension funds that are based on those indexes automatically purchase the stock.

“When a company goes to capital markets to raise money from investors, those investors are entitled to certain rights,” said Amy Borrus, deputy director of CII, in an interview. CII, which calls itself “the voice of corporate governance,” espouses the view that “the indexes should say no to no-vote shares.”

Gerber, from Gerber Kawasaki, said he hoped that the indexes, and as a result, index funds, would eventually adopt better corporate-governance standards. “Everyone owns index funds,” he said, adding that the funds don’t typically have investor-centric points of view, always voting with management. “I do think index funds need to have some standards of right and wrong. They do represent a big percentage of the public.”

Snap isn’t likely to be included in the top indexes anytime soon. The criteria to be listed in the S&P 500 SPX, +0.39% include the requirement that a stock be traded for six to 12 months before being considered. A company also has to have a year of positive earnings under generally accepted accounting principles, or GAAP.

“Snap does not qualify under either of these requirements,” said David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices, in an email. Global stock index compiler MSCI Inc. MSCI, +2.55% also said on its website that Snap did not meet its market capitalization requirements for early inclusion in the MSCI USA Index.

While Snap’s structure and its insider selling may shroud it in a bad vibe, observers do appreciate the innovativeness of the company’s messaging service and its visionary young founders. “Snap’s founders seem to be dynamic leaders, but no leader is infallible,” Borrus added. “For every Facebook FB, -0.14% and [Alphabet Inc. unit] Google GOOG, -0.13%, there is a Zynga ZNGA, +2.52% and a GoPro GPRO, -0.41% ,” she said, referring to other tech companies that have dual classes of stock, with the founders, or founders and directors, control all the voting rights.

Efforts by investor groups and investors themselves can lead to more concerted action. Late last year, Calpers, the public-employee retirement fund, filed suit against IAC/InterActiveCorp IAC, +0.09% and its controlling stockholder, Barry Diller, over a plan to create Class C nonvoting shares, which could entrench his control over the company and dilute the voting power of other shareholders.

Calpers said it is fully behind CII’s ongoing effort, which also includes trying to get the NYSE and Nasdaq to reconsider its similar request in 2012 to bar the listings of companies with multiple share classes and unequal voting rights.

It’s unlikely those efforts will succeed. Hong Kong’s stock exchange and the Singapore Exchange currently prohibit listings of companies with dual-class structures, and Hong Kong, in fact, lost the big 2014 IPO of Alibaba because of its “one shareholder, one vote” rule. Singapore is now reconsidering its rule.

That’s quite a lot of negative sentiment surrounding what has been, by all accounts, the year’s hottest IPO. Investors will have to weigh the factors and reach conclusions on their own, but there’s little doubt that there exist plenty of factors that hold the potential to continue putting Snap shares under selling pressure.

Snap shares were indicating lower Monday. S&P 500 SPX, +0.39% futures were down 2 points.

By Therese Poletti
March 13, 2017

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.

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