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== Valuation and Risks == Our $27, 12-month price target is based on 18X 2018E EV/Sales. On a growth-adjusted basis, SNAP is currently trading roughly in line with peers, Alphabet, Facebook, Twitter, Amazon, and Netflix (Exhibit 38). Our price target implies a slight premium on a growth-adjusted basis, which we believe is warranted given our belief that there is potential upside risk to our near-term fundamental estimates, as well as the sustained hyper-growth that we expect over the next several years. Snap is a very early stage company with very few (if any) corollaries among prior Internet IPOs. When compared to past IPOs Snap is much earlier in its life cycle than comps such as Facebook and Google were at the time of their respective IPOs. Our estimated $980mn in Snap revenue in 2017 compares to Facebook’s $5bn+ and Google’s $2bn (over $3bn gross revenue). Additionally, Facebook’s adjusted operating margin was 44% the year it went public, while Google’s was 57%, compared to the negative 68% we expect for Snap this year. Twitter’s financials during its IPO year most closely resemble Snap’s, as Twitter’s revenue was $665mn with negative 3% operating margins (Exhibits 36 & 37). We believe there are material risks to our estimates, price target, and rating. Upside risks include: * Improving DAU growth – an important investor concern is the competitive landscape and whether Snapchat will be able to accelerate DAU net adds in 2017. If Snapchat is able to accelerate its pace of net adds in 2017, we believe it would do much to mitigate that investor concern, leading to improved sentiment around the name and potential multiple expansion, in addition to the direct impact it would have on fundamentals. * Outperformance on monetization – our model is highly sensitive to ARPU, given the large user base. Should Snap improve its monetization at a faster pace than we anticipate, it could reach scale and profitability sooner than we predict. * Innovation – Snap has a strong history of feature and product innovation, as well as a history of quick pivoting away from features that were negatively viewed by users (such as the lens store). If Snap is able to accelerate its pace of innovation and introduce new features and products that are well received by users, or introduce new ad types that are well received by advertisers, we would expect user growth, engagement, and monetization to improve. Downside risks include: * Competition – Snap competes primarily with Facebook and Google, including Facebook’s Instagram, Messenger, and WhatsApp platforms, and Google’s YouTube platform. All of Facebook’s major platforms have introduced replicas of Snap’s key ephemeral content feature, as well as Stories clones. Competition will probably not draw many current users away from Snapchat entirely in our view, but could negatively impact engagement which could cause a decline in DAUs. Increased competition will also make it more difficult for Snap to attract incremental new users to the platform. * Highly sensitive model and volatility – our financial projections are very sensitive to several metrics, including ARPU, DAUs, and CoRPU. The DAU metric, is itself a very sensitive measurement, given that user behavior and seasonality could cause material swings, as discussed on page 10. If the company underperforms on any one of these metrics in a given quarter, it could materially impact revenue and profitability. Given that management does not plan to provide any guidance on financial metrics or user metrics such as DAUs or ARPU, we see added sensitivity to reported figures, and potential for a wide range of estimates included in consensus. * Execution risk – Snap’s executive team does not include any individuals with prior C-level experience at public companies. Additionally, the company has a short operating history, and plans to rapidly scale its operations and workforce. Less than 1/3 of the workforce has been with the company for a year or more, and we expect new hires (tenure less than 12 months) to make up the majority of the workforce through at least 2018. We see material risk to execution as the company expands internationally, and ramps up its sales force and engineering efforts.
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