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== PM Summary == 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. This clearly carries a higher than normal risk profile – Snap generates negative gross margins, is burning more cash than it is generating revenue, and we do not expect it to break even on an adjusted EBITDA basis until 2019. The company also has an unusually concentrated voting structure, senior management with no prior C level experience, and faces significant competition from platforms like Google and Facebook that are considerably larger, more profitable and better resourced. That said, Snap has a large, valuable, and highly engaged user base that occupies a unique space in the demographic (Exhibits 7/8). That engagement generates high value advertising inventory that should allow Snap to follow the now well-worn path of mobile monetization. While the public market has no recent experience valuing an internet company at this early a stage, at this scale, we believe the opportunities from growth in users, engagement, and monetization more than offset the considerable risk inherent in what is essentially venture investing through public equity. Therefore, we initiate coverage with a Buy rating and a 12-month target of $9. '''Key Investment issues''' '''User growth:''' Snap’s ability to maintain and grow its audience will be the key determinant of valuation for the company, in our opinion. Currently, Snap’s 158mn daily active users are highly engaged visiting the site 18 times daily for an aggregate 25-30 mins on average. That said, user growth decelerated materially in 2H16 (Exhibits 28/29) as competitive offerings and execution issues at SNAP impacted new user additions and engagement, though we have seen early signs of reacceleration (Exhibit 11) despite competition from larger social platform intensifying. While we believe Snap’s differentiated offering of creative content that disappears after viewing (ephemeral content) by the individual or small group it is shared with encourages a frequency of casual engagement that we believe will be difficult to replicate on other platforms known for storing life’s most treasured moments and sharing them with larger more public audiences. '''Monetization:''' The path to monetizing mobile advertising inventory is well worn at this point. While Snap’s efforts are extremely early stage, most of their ad units are less than a year old, companies like Google, Facebook, and Twitter have all developed the sales channels, partnership networks, and targeting and measurement technologies Snap will need. While we don’t expect Snap to reach the level of engagement monetization that those companies have (Exhibit 12) in the near term due to differences in usage, audience, and data, we believe that Snap’s video and user endorsement based inventory will prove extremely valuable to advertisers if management can effectively build out that sale, partner, and technology ecosystem. '''Competition:''' The competition for users’ time and advertiser’s dollars is intense and while the pool of both is growing, for companies growing at Snap’s and other online platforms’ rate, to maintain that pace competitive share gains are necessary. Snap has succeeded in those gains by innovating new products and seeking to differentiate its use case. '''Summary of fundamentals''' Snap Inc., began as a mobile photo sharing and messaging app (Snapchat) that allows users to send pictures, videos, and text messages (called “snaps”) to friends, which by default delete themselves after they had been viewed by the recipient. Snapchat rebranded itself in October of 2016 as Snap, “a camera company,” and subsequently introduced Spectacles – wearable sunglasses with an embedded connected camera that allow users to “snap” hands-free. The Snapchat app has 158mn Daily Active Users (DAUs), 57% of which were international as of 4Q16, and 78% of which were age 18+. Total DAUs grew 48% in 2016. While Snap is, in our view, well positioned to continue to take share of users’ media time and advertising dollars as new content features, network effects, and a growing platform ecosystem drive usage growth and new ad formats, technologies, and adoption drive monetization, the company is in the very early stages of these efforts. Snap’s monetization efforts really only began in earnest in 2Q16 (2016 monetization was a fraction of peers; Exhibit 1) and the company reported negative gross margins and negative operating income well in excess of 100% of revenues for FY 2016. While gross margins turned positive in 4Q16 due to seasonal and one time revenues, we expect the company will return to negative gross margins in 1Q17. We forecast CAGR over the next 5 years of 78% as the company monetizes its existing base of users, growing ARPU from $2.81 to $27 (Exhibit 2), and growing DAUs from 158mn to 278mn. At that scale we estimate that the company can generate gross margins of 77% and adjusted EBITDA margins of 27%. That said, given Snap’s early stage the range of outcomes over the forecast period is far wider than normal (Exhibit 14).
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