Snap stock’s structure lets inner circle reap rewards
Since early March, Snap stock has fallen more than 20 percent below its IPO price of $17 to close Friday at $13.52. So clearly, private investors, including venture capital firms Kleiner Perkins Caufield & Byers and Lightspeed Venture Partners, had wildly overvalued the Los Angeles company, which makes the popular Snapchat photo app.
Making matters worse, lock-up provisions preventing insiders from selling stock will expire soon after the company reports secondquarter earnings Thursday. That means senior executives will be able to dump their stock onto the market, further depressing the share price.
Not that shareholders can do anything about it. Snap’s triple-class stock structure means that co-founder and CEO Evan Spiegel has all the voting power. Last week, S&P said it will no longer include companies with such stock classes in its indexes, including the S&P 500, S&P MidCap 400, and S&P SmallCap 600. Ponvert says that decision will further cut the price of Snap shares by 25 percent, because many passively managed funds peg investments to those indexes. If Snap’s not in the S&P 500, by definition they can’t buy it.
From the get-go, Snap was littered with red flags, starting with its high IPO valuation of $24 billion. Remember this a company with only one core product whose business depends entirely on advertising, a market dominated by Google and Facebook. And Facebook, which tried to buy Snap early on, has been edging in on its turf by mimicking Snapchat features.
Snap lost $514.6 million on sales of $404.5 million last year, which means it spends more than $2 for every $1 it takes in. And it expects operating expenses to grow. If Twitter, which has been public since 2013, has yet to turn a profit, when do you think Snap will make any money?
“One could make the argument that Snap went public too early, prior to definitively carving out a profitable, defensible path from Facebook and Instagram,” said Adam Epstein, founder of Third Creek Advisors, a Bay Area corporate governance advisory firm.
Sometimes executives argue that they need to take a company public to fuel its growth. And Snapchat did raise $3.4 billion, which can fund its losses for some time. But it didn’t really need that money: It had already raised $3 billion as a private company.
Ponvert said in a research report that venture backers pushed Spiegel to take Snap public prematurely, which allowed them “to cash out in what we view as a ‘frothy’ tech valuation environment.”
In any case, institutional investors obliged Snap: Fidelity Investments spent $569 million to acquire 33.5 million shares, according to Bloomberg data. T. Rowe Price spent $481.1 million for 28.3 million shares. Hard to see what these mutual fund giants bought for their money.
What they definitely did not get was any say in Snap’s future. Founders maintaining total control over companies even as they go public is a trend that started with Google in 2004. Facebook followed in 2012, and adjusted its share structure last year to ensure Mark Zuckerberg’s dominance. But those companies have made investors lots of money, which quiets any discontent about their corporate governance.
Snap does not have that luxury. The company might never turn a profit. That’s why S&P’s decision to ban companies with multiple share classes from its indexes is so important, said Hillary Sale, a law professor at Washington University in St. Louis.
The move might not deter companies from following Snap’s lead, she said. But at least S&P is saying that checks and balances are important to any public company and that investors need a way to challenge executives and boards who make questionable decisions, Sale said.
“Snap made itself the poster child for nonvoting public stock,” said Thomas Joo, a professor at UC Davis Law School who studies corporate governance. “I expect Snap’s poor showing will do more than the index policy to dissuade pre-IPO (corporations) from issuing multiple-class stock.”
Which raises another question: Why would anyone agree to serve on Snap’s board of directors, which is supposed to safeguard shareholder interests? The group includes chairman Michael Lynton, who used to run Sony Entertainment, and A.G. Lafley, the former CEO of Procter & Gamble.
Because Spiegel controls all of the voting power, the board is essentially a figurehead with no real power to protect shareholders, except to jawbone the founder.
“Snap’s board is functionally about as useful to shareholders as a screen door is to a submarine,” Epstein said.
And that’s exactly where Snap investors are right now: underwater.
“One could make the argument that Snap went public too early, prior to definitively carving out a profitable, defensible path from Facebook and Instagram.” Adam Epstein, Third Creek Advisors