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NEW YORK (Reuters Breakingviews) - Investors have effectively just done what no self-respecting person ever should: wear sweatpants in public. With Snap's $3.4 billion initial public offering they have simply given up giving a damn. They handed their money over to an immature company and in the process abrogated their rights to fair treatment, good governance and reasonable valuations. If the $24 billion self-styled "camera company" run by a 26-year-old fails to achieve its ambitions, shareholders have only their capitulated selves to blame.
Snap founder Evan Spiegel's disappearing-message application has many things going for it. One of these attributes – its virtual inaccessibility by anyone over the age of 30 – may have helped its IPO. Few seasoned portfolio managers wagering on the maker of rainbow-vomit photo filters will have properly vetted the product, though they will have perhaps gauged its popularity by monitoring their children's mobile-data usage.
Still, there is a bull case to be made for Snap, which is why the sale of its securities (calling them shares would be a crime against the Old English etymology of the word) was 10 times oversubscribed and Morgan Stanley priced them above the range at $17 apiece. Snap has 158 million users, who check into the app, like, 18 times a day. It grew revenue almost sevenfold in 2016 to $405 million. Snap's backers hail it as the third pole to one day challenge Facebook and Alphabet in dominating the internet.
But the price investors are paying to participate in this rainbow hunch is too high – and not just numerically. Look at the numbers. As my colleague Richard Beales points out, Snap's new investors start by showering the Venice, California-based firm's staff with unwarranted riches. The company pledged 240 million shares to staff, including an indefensible one-time bonus of 37 million of them to entice Spiegel from his apparent reluctance to engage in this wealth-affirming liquidity event. That's some $4 billion of dilution from the get-go.
As for the price they paid, Seattle venture capitalist Erik Benson estimates Snap went for a near-50 percent premium to Facebook, which at the time was making $1 billion a year – compared to Snap's $515 million net loss in 2016. "If SNAP does have a successful IPO, I’m moving all of my investments to cash as it will be the leading indicator of market peak,” said the Voyager Capital partner. Benson's broker will be a busy man today. Snap surged by more than a third to $24 when trading opened.
If numbers are confusing, there are other reasons for investors to truly dislike Snap. The most important is the precedent it sets by offering stock that confers zero voting power. That is why calling them "shares" is an insult to, well, sharing. For now, they really should be considered rights to participate in Snap's losses. The total control this IPO structure has conferred to Spiegel and his co-founder Bobby Murphy is totally without precedent on Wall Street.
Snap offers ample warnings of the risks this presents to investors, such as the ability of the founders to liquidate their positions without yielding control. There's also a nod to the near-certainty that Snap's loss-participation rights may fail to appeal as a form of currency when making acquisitions: "If we develop a reputation for being a difficult acquirer or having an unfavorable work environment, or target companies view our non-voting Class A common stock unfavorably, we may be unable to consummate key acquisition transactions essential to our corporate strategy and our business may be seriously harmed."
With private money eagerly sloshing into multiple rounds of fundraising for firms like Snapchat, this slouch towards totalitarian capitalism may be inevitable. Even Jeff Ubben, one of the most successful activist investors in the world, gave the deal a shrug at a Reuters Newsmaker. Though not condoning it, "I understand it," he said, "if that's what it takes to get growth companies public and let the public participate in high-growth companies."
The willingness of stock-market investors to ignore the precedent this sets recalls the way bondholders rolled over ahead of the financial crisis. Back then they acquiesced on all manner of conventions, not just the paltry coupons they were being offered by companies with shoddy financial prospects. They agreed, for instance, to be paid in more debt if borrowers ran into trouble. In the end, they paid dearly for their pusillanimity.
Snap may be different. It could be the next Facebook. That dorm-room creation went public in 2012 at $38 a share. Today Facebook stock, which confers at least some semblance of a vote, fetches $136 and the group commands a $400 billion market capitalization. Alternatively, Snap, which calls itself a camera company, may be the next GoPro, which is a camera company that calls itself a media enterprise. It debuted at $24 and trades today below $10.
Even if Snap avoids such a fate, someone else who follows in its footsteps by pawning zero-voting stock to investors inevitably will. The bar for shareholder democracy in America is now set as low as it can go. Investors, don your sweatpants.
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