Valuing Snap After the IPO Quiet Period (A) – Case Solution

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Valuing Snap After the IPO Quiet Period (A) Case Answers

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Executive Summary – Valuing Snap After the IPO Quiet Period (A)

Elizabeth Kemp, the portfolio manager of Sand Hill Road Capital, bought 500,000 shares from Snap at an Initial Public Offering (IPO). On March 24, Snap’s share price was increased from $17 to $22.74, resulting in a $3 million profit. However, Elizabeth is hesitating whether she should sell and then harvest her gain or she should double down and buy more shares from Snap.

Currently, it seems that there are several suggestions from a number of different analysts. Among many of them, two analysts suggest Elizabeth buy more shares at the end of the quiet period, whereas seven analysts recommend she hold the shares first, and another seven of them said that she should sell them.

Based on those analysts’ diverse points of view and Elizabeth’s prior experiences, she must decide the best solution for the company. Considering buying more shares option, her company will be able to gain more profits if the share price is increased in the future.

To support this, it seems that most analysts are voting for a new buy option. Also, in the past, Elizabeth used to be disappointed over her decision with GoPro’s IPO (the price was increased after the quiet period from $24 to $80) and expects this will not happen again this time.

However, regarding selling share options, this will be good for the company if the share price is decreased later. To back up this solution, in accordance with the report on Snap from Paulson and Cantor’s internet analysts it demonstrates Snap’s unproven business model, untested management team, slowing growth, and also competitive threats from larger companies.

This report will evaluate Snap’s financial statement with problem identification for some assumptions and, consequently, summarize the credibility of analyst recommendations and also the cash flow from different valuation methods. As a result, according to the calculation, the sell recommendation is implemented.

Overview

Company Background

According to the summarized timeline above, Snap, the disappearing-message app, went public at $17 per share on March 2, 2017, making its two 20-something founders the youngest self-made billionaires in the country.

Over the next three weeks, 16 analysts make investment recommendations on Snap: two with buy recommendations, seven with withholds, and seven with sales.

When the “IPO quiet period” expired three weeks later, 14 more analysts — who worked at firms that served as the underwriter for the Snap IPO — issued recommendations: ten with buy and four withhold recommendations, with price targets ranging from $21 to $31 compared to a current market price of around 23$.

Situation

Elizabeth Kemp, the portfolio manager of a long-only technology fund at Sand Hill Road Capital, had bought 500,000 shares at the IPO and had to decide whether to harvest her gain or to double down and buy more shares.

Seeing an overweight recommendation from most analysts, especially Brian Nowak, Morgan Stanley’s internet analyst, who had a price target of $28, Kemp was inclined to buy more.

Nevertheless, she recalled seeing the report written by Kip Paulson, Cantor Fitzgerald‘s internet analyst, with a price target of $18 and an underweight recommendation based on concerns about Snap’s operational problems and the threat from larger rivals.

Analysis

Valuation

To value Snap, seen in Exhibit 10, Nowak forecasted free cash flow for 10 years, including the terminal year, used a discount rate (weighted average cost of capital or WACC) of 9.7%, and used a perpetual (terminal value) growth rate of 3.5%. Consequently, adding the excess cash flow, the target price of $28 per share was derived, and the overweight recommendation was issued.

Problem Identification

First, as can be seen in Exhibit 9, the summary of valuation assumptions for the firms that valued Snap using DCF analysis mostly, the discount rate (WACC) computed by Nowak was unreasonably low (9.7%) compared to other WACCs. To clarify this anomaly, the inputs should be considerably recalculated to correct WACC.

Second, according to the US Real gross domestic product (GDP) growth rate in the long term, which was approximately 2.22% to 2.88%, as seen in Exhibit 15, using the perpetual growth rate of 3.5% was quite…