Valuing Snap After the IPO Quiet Period (C) case study provides for the valuation of Snap and recommendations for Elizabeth Kemp on whether to buy more Snap shares or harvest her gain by selling shares.
Marco Di Maggio; Benjamin C. Esty; Greg Saldutte
Harvard Business Review (218116-PDF-ENG)
June 05, 2018
Case questions answered:
- What should Elizabeth Kemp do: buy more Snap shares or harvest her gain by selling shares?
- How much is Snap worth per share? Assess the reasonableness of the key inputs in Morgan Stanley’s valuation analysis:
a) The WACC of 9.7%
b) The terminal value growth rate (TVGR) of 3.5%
c) The free cash flow forecast in general and Snap’s 2020 revenue forecast in particular.
- Which analyst is more credible: Brian Nowak from Morgan Stanley or Kip Paulson from Cantor Fitzgerald? What explains the differences in their recommendations?
- Did the underwriters of the Snap IPO do a good job? (optional)
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Case answers for Valuing Snap After the IPO Quiet Period (C)
EXECUTIVE SUMMARY – Valuing Snap After the IPO Quiet Period (C) Case Study
To provide a recommendation, a preliminary DCF valuation is used on the assumptions by Brian Nowak. With these, we received a price of $25.12 at the end of 2016, higher than the current market price of $22.74. However, it is arguable that the assumptions are realistic since Morgan Stanley has a significant financial interest in Snap’s revolving credit facility. A sensitivity analysis is then performed and important input assumptions are investigated.
We found that the 9.74% WACC is too low compared to other analysts while being too high compared to past assumptions of Morgan Stanley. This double inconsistency raises flags. We suspect that Nowak played around with the discount rate to give Snap a flattering recommendation since the value is most affected by WACC. We revise the WACC up to 11.5%.
For the Terminal growth, the Nowak’s 3.5% figure is seemingly unbiased. However, the valuation horizon is too short, the tax, debt, and EBITDA margin will not have reached their steady states by 2026, and thus the terminal value framework is inapplicable. While for the FCF assumptions, we state that the cash flow of young, high-growth firms are difficult to estimate, as can be seen by the high variance, and so we take the average values of the analysts’ assumptions to reach an estimator with more unbiasedness.
Once all the assumptions have been revised, we re-value the stock to reach a price of $24.68. This is in support of our initial value of $25.12 and the analysts’ average PT of $24.2.
We categorize the analysts into 1. the well-informed but with potential conflicts of interest; these are the underwriters of Snap, and 2. the opposite; independent analysts. We show evidence that the former place an upward bias even with the SEC’s regulations due to them receiving a significant fee that offsets their penalty. Thus, their PTs will be exaggerated. While the latter are less informed and rife with downward-bias from pooling equilibrium and thus the understated PTs. This confirms our method of averaging their assumptions to give a general unbiasedness PT of $24–$25.
We also believe that the 44% underpricing is the underwriters’ plan to please the players with market power, including Kemp, inducing them to hold Snap long-term by transferring wealth from Snap, but the amount of money left at the table is indubitably too high that Snap would be better using the cash to fuel its current negative cash flow.
In the end, we recommend that Kemp hold her stock for now at least until the price reaches our estimate at $25, all the associated risks should already be compensated by the underpricing, and she should be protected as best as possible by the underwriters.
DOUBLE DOWN OR TAKE PROFIT?
After the IPO quiet period of Snap has expired, Elizabeth Kemp is contemplating whether to sell the shares and take the profit of 34% following many of the ‘sell’ recommendations by the analysts or to double down and buy more shares in hopes even higher returns. Two main reasons she uses to support the latter choice is the bullish recommendations that suddenly popped-up from many of the analysts and the fact that she is still upset over the missed opportunity in short-term profit arising from premature selling of the Go-Pro shares last year.
However, two of these reasons are not rational and should not be served as bases of her decision, or at the very least they should be taken with a grain of salt. First, a large majority of the newly-issued bullish recommendations came from affiliated underwriters such as Morgan Stanley [CE81] which foreshadows potential conflicts of interest.
Her latter reasoning is also not entirely rational as she bases her judgment solely on the past emotional experience and the mantra of Warren Buffet rather than making her own informed decision based on relevant data. We also choose to ignore the oft-used argument of the long-run negative ‘anomaly’ of IPO due to the fact that the anomaly disappears when the Fama-French factors are considered (Brav & Gompers, 1997) and that the IPO after-markets are efficient (Ibbotson, 1975).
Therefore, to answer with rationality and give a recommendation as to what Kemp should do, we must gather relevant data and perform a valuation of snap post-IPO intrinsic value, preferably free from the effect of the short-term IPO underpricing. Kemp’s final decision will then be obvious: we simply need to determine whether Snap’s intrinsic value is indeed higher than the current market price or not.
The remaining of this report will be devoted to the valuation, and justifications of the assumptions and we will thus leave the final suggestion at the end of this report.
THE TRUE PRICE OF SNAP
We begin our preliminary analysis of Snap’s intrinsic value using the DCF method as our valuation model. The free cash flow forecasts used is provided by the Nowak in [CE10] along with the terminal growth rate of 3.5% and a discount rate (WACC) of 9.7%. With this, we attain a value of…