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Snap Inc.’s IPO (A) Case Solution & Answer

Snap Inc.’s IPO (A)

Discounted cash flow estimate of Snap’s stock fair market value on a per share basis

Using the Morgan Stanley’s presented discounted free cash analysis provided in the Excel, and the consideration for long term growth prospects; the cash flows of the company are estimated by using the provided data. To calculate the share price with the use of a discounted cash flow method (DCF), the WACC is 9.7 percent while the growth rate is 3.5 percent.

Using the DCF method, the cash flows of the company are negative until the year 2020, after that, the cash flows are positive or greater than 1. The terminal value of the company amounts to $70047.8 which is then discounted back with the cost of capital. The discounted terminal value of the company amounts to $27754.168, whereas the net present value or enterprise value is $32484.469. The share price is calculated by the total share outstanding by the enterprise value. Using the DCF method, the price of the share is higher than the company price, its IPO is at$17 per share(Edleson, 2018).

Sensitive estimate of Snap’s stock price to key assumption such as growth rate and WACC

The estimate of the stock price of Snap is highly sensitive to the assumptions, such as: growth rate and weighted average cost of capital in a way that if the weighted average cost of capital increases, the price of the stock gets reduced and vice versa. In the similar manner, if the perpetual growth of the company increases, the price of the share would also increase and vice versa, which means there is a direct relationship between weighted average cost of capital and price and inverse relationship between perpetual growth rate and price of share.

Assumptions and forecast seems reasonable

The forecast of the company’s revenues does not seem reasonable as the revenues should be forecasted on the basis of the previous year’s growth rates. The growth rate could be calculated by subtracting the previous year revenues from the current year’s revenues and divide that number by the previous year’s revenues. Thus, the rate added in 1 should be multiplied with the previous year’s revenues to obtain the value of the current year’s revenue.

In addition to this, the values of capital expenditures and changes in the working capital for the actual year 2015 and 2016 could be taken from the cash flow statement of the company provided in Exhibit 7, in order to make an accurate forecast.

Analysis of Snap’s discounted cash flow under various alternatives of your own

Changes to the assumptions and forecast

The changes I would make in the forecast, include the growth estimation of the revenue, capital expenditures and changes in the working capital. I would make a assumptions on the basis of the historical trend or growth of the revenues. In addition to this, I would use the values of capital expenditure and changes in the working capital provided in the Exhibit 7, and then forecast the values for the forthcoming years.

Weighted average cost of capital

In addition to this, some assumptions are used for the calculation of the weighted average cost of capital, such as: the long term bond rate is used as a cost of debt 3.16 percent and the debt and equity ratios are calculated using the value provided in the exhibit for the year 2016. In accordance to the concept that the cost of debt is always lower than cost of equity; the cost of equity is assumed to be lower in comparison to the cost of debt, to avoid the violation of this concept. Hence, the cost of equity is assumed to be 3%. The tax rate is assumed to be 30%. Combining all these values, it has resulted in 2.91 percent weighted average cost of capital which is significantly lower than the analyst’s estimated cost of capital.

Recommendations to Snap, to deal with uncertainty associated with future growth

In order to deal with the uncertainty of the future growth and profitability, the company is recommended to run a pure play marketplace with its major focus on the core business operations, continuously enhancing the experience and satisfaction of the users of Snapchat and making considerable amount of investment in the consumer electronic market as the consumer electronic market is projected to grow in the forthcoming years. It is significantly important for Snapchat to stand out with the product, for the purpose of assuring its survival and sustainability in the competitive market.(Hutchinson, 2018).

In addition to this, the company is recommended to provide quality experiences to users through improving its quality, investing in the future and delivering core product value and increasing its daily active users and engagement, improving optimization and measurement and increasing the number of the active advertisers. Along with this, the company should strengthen its foothold in the new markets, with youthful and large population as the opportunity in terms of incremental user growth, is incredible.

Underpriced IPO

The company priced its IPO at $17 per share, and the valuation of share price which is calculated using discounted cash flow method, is $23, which shows that the company has underpriced its shares to the investors. In my opinion, underpriced shares at the time of the IPO is fair decision, because of the fact that the market is highly competitive and offering the price at discount would help the company to guarantee that the uninformed investors would buy the shares. In addition to this, underpriced IPO is wise decision in order to encourage the investors to take a risk on the company, and to boost the demand.

Conclusion

Snapchat is one of the valuable camera companies, which improves the way people communicate and live. The business model of the company is based on two main advertising products Snap Ads with Advertisement and Sponsored creative Tools, which allows the company to have revenues. The observers of the industry were expecting that the market of IPO would recover because of more clarity in policies of the US presidents and improved economic outlook. The interest rates would increase with the expectations then they would continue climb up in the year 2017. The capital structure of Snap is based on three classes of shares A, B & C. In the Class A’s common share, the investors do not confer any voting rights on their holding.

Additionally, the Class B and Class C come with one votes per share and ten votes per share, respectively. For the company, which said that it would raise 3 million dollars in its offerings, a key question is that whether the aggressive capital structure of the company would scare off the investors or not. The company is recommended to provide quality experience to its users through improving the quality of the snaps, investing in the future, delivering the core product value and increasing the daily active users and engagement, with an improved optimization and measurement as well as an increase the number of its active advertisers…..

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